March 20, 2012 / 8:17 PM / 5 years ago

TEXT-S&P affirms Momentive Performance Materials at 'B-'

Overview	
     -- U.S. silicone and quartz producer Momentive Performance Materials Inc. 	
(MPM) plans to enter into a new $175 million term loan for refinancing.	
     -- We are affirming all our ratings, including the 'B-' corporate credit 	
rating, on MPM. At the same time, we are revising the outlook to negative from 	
stable.	
     -- We are also assigning our 'B' issue-level and '2' recovery ratings to 	
MPM's proposed term loan.	
     -- The negative outlook reflects our view that there is potential for 	
MPM's earnings and cash flow to worsen more than we expect, causing a covenant 	
breach and further deterioration of the financial profile during the next year.	
	
Rating Action	
On March 20, 2012, Standard & Poor's Ratings Services affirmed its ratings, 	
including the 'B-' corporate credit rating, on Albany, N.Y.-based Momentive 	
Performance Materials Inc. (MPM). At the same time, we revised the outlook to 	
negative from stable.	
	
We have also assigned our 'B' issue-level and '2' recovery ratings to 	
Germany-based MPM subsidiary Momentive Performance Materials GmbH's proposed 	
$175 million senior secured first-lien term loan maturing in May 2015. The '2' 	
recovery rating reflects our expectation for a substantial (70% to 90%) 	
recovery in the event of a payment default. The loan will be issued under the 	
accordion facility of the company's credit agreement. The borrower plans to 	
use the proceeds to repay term loans due in December 2013.	
	
Rationale	
The outlook revision reflects our expectation that MPM will continue to face 	
challenging market conditions during the next several quarters primarily due 	
to tepid global economic growth and silicone oversupply following industry 	
capacity additions over the past year. We believe this will result in weak 	
EBITDA generation and negative free operating cash flow. However, based on our 	
expectation for stronger global economic growth in the second half of the 	
year, we expect MPM's operating results to gradually improve. Although we 	
think liquidity would remain adequate even if last-12-months EBITDA dropped by 	
20%, if the pace or magnitude of sequential quarterly improvement throughout 	
this year is less than we expect, or working capital fluctuations are greater 	
than we expect, we believe that MPM could violate the financial covenant in 	
its senior credit facilities.	
	
We believe that the merger of MPM and Momentive Specialty Chemicals Inc. (MSC) 	
benefits credit quality only modestly. In October 2010, controlling 	
shareholder Apollo Global Management L.P. (Apollo) placed the two companies 	
under a single holding company. Although each company maintains a separate 	
capital structure, we assess both in a manner that recognizes their shared 	
parentage. As a result, our corporate credit rating on both companies is 'B-'. 	
We are maintaining a stable outlook on MSC, but could revise it to negative or 	
lower the ratings on both companies if MPM's financial profile declines 	
further and we determine that these developments elevate credit risk at the 	
combined company.	
	
The ratings on MPM reflect the company's "highly leveraged" financial profile 	
and "fair" business risk profile (as our criteria define those terms). MPM's 	
leverage has been very high ever since Apollo acquired the company from 	
General Electric Co. in 2006. As of Dec. 31, 2011, the ratio of total adjusted 	
debt to EBITDA was about 10x. Total adjusted debt was approximately $3.9 	
billion. We adjust debt to include pay-in-kind (PIK) seller notes at MSC's 	
direct parent company Momentive Performance Materials Holdings Inc. (unrated). 	
This debt adjustment also includes tax-adjusted unfunded postretirement 	
obligations, capitalized operating leases, and trade receivables sold. After 	
improving in the first half of 2011, results weakened in the second half of 	
the year on less-favorable economic conditions, industry capacity additions 	
that resulted in price competition in the silicones business, a slowdown in 	
the semiconductor industry that affected the quartz business, and customers 	
reducing inventory. Although we expect market conditions in the first half of 	
2012 to remain very challenging, our assumption of moderate global economic 	
growth for the full year should produce stronger results in the second half.	
	
Nevertheless, we factor in the likelihood that MPM's free operating cash flow 	
will be significantly negative in 2012 after capital spending of $120 million 	
to $130 million, pension funding that management expects to total $19 million, 	
and modest costs to achieve synergies with MSC. We do not currently expect 	
working capital to be a significant use of cash this year. However, this could 	
change if raw material costs spike. In future years, we expect free operating 	
cash flow to be modestly positive, but we think there is limited potential to 	
reduce leverage significantly with free cash. In addition, the PIK feature of 	
the seller note at the parent holding company represents a significant offset 	
to any potential future debt reduction at the operating company. If MPM 	
performs worse than we expect and leverage continues to climb, we believe the 	
likelihood of a default or debt restructuring could increase. Moreover, MPM 	
has considerably more debt than its primary competitors, which could erode its 	
competitiveness over time if it impedes sufficient business reinvestment.	
	
MPM is a large producer of silicones (representing more than 90% of sales and 	
about 75% of EBITDA in 2011), which are used in a wide variety of 	
applications, and quartz, which is used primarily in semiconductors. Both its 	
businesses are cyclical, but this cyclicality has historically been more 	
pronounced in quartz than in silicones. Silicones are used in construction, 	
transportation, personal care, electronics, and agriculture. They are 	
generally used as an additive, providing or enhancing attributes such as 	
resistance (to heat, ultraviolet light, or chemicals), lubrication, adhesion, 	
or viscosity. Positive industry factors include significant consolidation and 	
historically above-average growth rates, though there is vulnerability to 	
volume and margin declines during periods of economic contraction or downturns 	
in key end markets. We believe that capital intensity, technological know-how, 	
and well-established customer relations provide meaningful entry barriers. MPM 	
benefits from good diversification by end market and region, as well as an 	
increasing contribution from specialty products.	
	
MPM is backward integrated to a high degree into the production of siloxane, a 	
key intermediate raw material. Siloxane industry capacity increased 	
significantly in 2011, with an MPM joint venture and another major competitor 	
completing expansions in Asia. With the economic slowdown there and in Europe, 	
this new capacity has resulted in price competition in silicones. MPM is also 	
subject to fluctuations in market prices for silicon metal and methanol, which 	
have proven more difficult to pass on to customers amid soft recent market 	
conditions. In its quartz business, MPM relies on a large supplier with whom 	
it has historically had a long-term agreement. The parties have extended their 	
current agreement to June 30, 2012, while they negotiate a new long-term 	
agreement. We assume an agreement can be reached that assures MPM of supply at 	
an affordable cost.	
	
Liquidity	
Liquidity is "adequate," as defined in our liquidity criteria. In our base 	
case scenario--a 20% year-over-year decline in EBITDA in 2012, we expect MPM's 	
sources of funds to exceed uses by 1.2x or more over the next year. Our 	
assessment of liquidity is based on the following assumptions and observations:	
     -- As of Dec. 31, 2011, the company had $258 million of availability 	
under its revolving credit facility, plus $203 million in cash;	
     -- Despite weak fourth-quarter EBITDA, expectations for only modest 	
improvement in the first half of 2012, and a likely increase in net debt, we 	
expect MPM to remain in compliance with the 4.25x maximum senior secured debt 	
to EBITDA covenant in its credit facility--we believe covenant headroom will 	
be tightest in the third quarter of this year;	
     -- The company also has a provision for equity cures under its financial 	
covenant, which could provide the equity sponsor an opportunity to support its 	
investment in MPM if the company breaches this covenant;	
     -- Debt maturities in 2012 are modest and, if the proposed refinancing is 	
successful, 2013 maturities would also be minimal; and	
     -- We do not assume any sizable acquisitions or any shareholder rewards.	
	
Recovery analysis	
For the complete recovery analysis, see our recovery report on MPM to be 	
published later on RatingsDirect.	
	
Outlook	
The negative outlook reflects our expectation that MPM's first-half 2012 	
results will be very weak. We believe that operating earnings and cash flow 	
will gradually and modestly strengthen during the second half of this year--in 	
line with our expectation of moderate global economic growth. However, in view 	
of our base case expectation of a 20% full-year EBITDA decline in 2012, we 	
assume that MPM's free operating cash flow will be negative. But even in this 	
scenario, we believe liquidity is likely to remain adequate, as long as 	
performance continues to recover.	
	
However, we could lower the ratings during the next year if industry 	
conditions or the company's performance are worse than we expect, or if MPM 	
consumes more cash than we anticipate, placing the company in danger of 	
violating financial covenants and making a debt restructuring or default more 	
likely. This could occur if siloxane overcapacity results in fiercer price 	
competition or significant loss of market share, if MPM has difficulty passing 	
recent or future raw material cost increases on to its customers, if it is 	
unable to renew its quartz supply agreement on affordable terms, or if global 	
economic growth stalls.	
	
On the other hand, if earnings, cash flow, and liquidity do not worsen beyond 	
our expectations and begin to trend upward to the degree we expect, liquidity 	
remains adequate, and MPM remains comfortably in compliance with covenants, we 	
could revise the outlook to stable later this year.	
	
Related Criteria And Research	
     -- Methodology And Assumptions: Liquidity Descriptors For Global 	
Corporate Issuers, Sept. 28, 2011	
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009	
     -- Key Credit Factors: Business And Financial Risks In The Commodity And 	
Specialty Chemical Industry, Nov. 20, 2008	
	
Ratings List	
Ratings Affirmed; Outlook Action	
                                        To                 From	
Momentive Performance Materials Inc.	
 Corporate Credit Rating                B-/Negative/--     B-/Stable/--	
	
Ratings Affirmed; Recovery Ratings Unchanged	
	
Momentive Performance Materials Inc.	
 Senior Secured                         CCC                	
  Recovery Rating                       6                  	
 Senior Secured                         B                  	
  Recovery Rating                       2                  	
 Senior Unsecured                       CCC                	
  Recovery Rating                       6                  	
 Subordinated                           CCC                	
  Recovery Rating                       6                  	
	
Momentive Performance Materials GmbH	
Momentive Performance Materials USA Inc.	
 Senior Secured                         B                  	
  Recovery Rating                       2                  	
	
New Rating	
	
Momentive Performance Materials GmbH	
 Senior Secured	
  US$175 mil bank ln due 2015           B                  	
   Recovery Rating                      2                  	
	
	
Complete ratings information is available to subscribers of RatingsDirect on 	
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 	
by this rating action can be found on Standard & Poor's public Web site at 	
www.standardandpoors.com. Use the Ratings search box located in the left 	
column.

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