Date: December 5, 2008
Source: Fitch Ratings and Moody's Investor Service
Fitch Downgrades Republic Services' IDR to 'BBB-' Following Merger Closing; Outlook Stable
Fitch Ratings has downgraded the ratings of Republic Services, Inc. (NYSE: RSG) following the closing of its merger with Allied Waste Industries, Inc., as follows:
Issuer Default Rating (IDR) to 'BBB-' from 'BBB+';
Senior unsecured credit facility rating to 'BBB-' from 'BBB+';
Senior unsecured rating to 'BBB-' from 'BBB+'.
Fitch has also upgraded the ratings of Allied Waste Industries, Inc. (AW), now a subsidiary of RSG, as well as AW's subsidiaries, as follows:
IDR to 'BBB-' from 'B+';
Senior subordinated rating to 'BB+' from 'CCC+/RR6'.
Allied Waste North America (AWNA):
IDR to 'BBB-' from 'B+';
Senior unsecured rating to 'BBB-' from 'B/RR5'.
Browning-Ferris Industries (BFI):
IDR to 'BBB-' from 'B+'.
In addition to the rating actions above, Fitch has withdrawn AWNA's senior secured credit facility rating, as the rated facility was terminated at the closing of the merger. Fitch has also withdrawn the senior secured ratings of AWNA and BFI, as the collateral requirements of the rated notes and debentures have been released. As a result, AWNA's senior unsecured rating applies to all of its rated notes, including those that were formerly secured. Fitch also has assigned a senior unsecured rating of 'BBB-' to BFI's senior unsecured debentures, which were secured prior to the merger. BFI's senior secured rating has been withdrawn. RSG's ratings have been removed from Rating Watch Negative and AW's ratings have been removed from Rating Watch Positive. The Rating Outlook for RSG and its rated subsidiaries is Stable.
Fitch's ratings apply to $5.7 billion in notes and debentures and two unsecured revolving credit facilities with a combined capacity of $2.75 billion.
On December 5, RSG completed its all-stock merger with AW, creating the second-largest waste services company in the U.S. The all-stock transaction was characterized as a 'merger of equals,' with existing AW shareholders now owning 52% of the merged company and existing RSG shareholders now owning 48%. RSG is the surviving parent company, with AW and its various subsidiaries retaining their prior organizational structure underneath RSG. RSG's Chairman and Chief Executive Officer, James O'Connor, continues to hold those positions in the merged company, while Donald Slager, former President and Chief Operating Officer of AW, has assumed those positions at RSG. In order to obtain required approval for the merger from the U.S. Department of Justice (DOJ), RSG has agreed to divest 87 commercial collection routes, nine landfills and 10 transfer stations, along with other assets, in 15 markets.
The 'BBB-' IDRs of RSG and its subsidiaries reflect the consolidated entity's credit profile, which is weaker than RSG's pre-merger credit profile but stronger than that of pre-merger AW. On a pro-forma basis, the company had total debt of $8.1 billion at September 30, resulting in pro-forma EBITDA leverage of 3.1 times (x). However, RSG's management has stated that debt reduction will be a primary focus of the company over the near to medium term, and Fitch expects leverage to decline below 3.0x over the next 12 months as RSG uses its free cash flow and proceeds from the DOJ mandated divestitures to reduce its debt load. Demonstrating its commitment to leverage reduction, RSG suspended its share repurchase program in June, and Fitch does not expect the company to begin repurchasing shares again until its leverage is closer to RSG's pre-merger level of around 2.0x.
In connection with the merger, RSG has established a new $1.75 billion unsecured credit facility that replaces AWNA's former secured credit facility. (RSG's existing $1.0 billion unsecured revolving credit facility remains in place, as well). With the termination of AWNA's secured credit facility, the collateral requirements of AWNA's senior secured notes and BFI's senior secured debentures have been released, and those notes and debentures are now senior unsecured obligations of their respective issuers. In addition, RSG has established upstream and downstream guarantee agreements between the parent company and the subsidiaries so that all of the senior unsecured obligations rank pari passu in the company's consolidated capital structure. Fitch expects that any new debt issued in the future will be issued at the parent company level, including debt issued to refinance maturing obligations at the subsidiaries, so that the amount of debt at the subsidiary level will decline over time.
Despite the ongoing U.S. recession, the waste services industry is expected to fare relatively well over the near term. Although collection and landfill volumes have declined over the past year, and likely will continue to decline somewhat in 2009, the pricing environment remains favorable as the industry continues to focus on margins and return on invested capital (ROIC) rather than market share. This industry pricing power is expected to drive continued strength in margins and free cash flow over the near to medium term. RSG's consolidated revenue likely will decline in 2009 versus the combined revenues of RSG and AW prior to the merger as the company divests the assets identified by the DOJ, but over the longer term, margins are expected to improve as the company realizes the merger's expected synergy benefits. The company currently estimates that these benefits will result in $150 million in annual operating earnings improvement by the third year following the merger, and, notably, these estimated benefits primarily are cost based, rather than revenue based, which increases the probability that the company will successfully achieve them.
In addition to ever-present risks tied to environmental and regulatory concerns, RSG now faces execution risk as it combines the operations of two companies. Fitch expects much of the integration to be relatively straightforward, however, there is some risk that certain elements of the integration, such as the harmonization of information technology systems and changes in the organizational structure at the regional level, could be more complicated. RSG also continues to be subject to AW's ongoing tax disputes with the Internal Revenue Service (IRS) which could result in substantial future cash taxes, interest payments and penalties. As of September 30, AW expected to pay a total of about $350 million to the IRS in 2008 (of which $196 million was paid in the first quarter) to slow the accrual of interest on one of the outstanding tax payments currently in dispute. RSG could make voluntary or required payments in the future related to a second IRS case, as well, although that case is at a relatively early stage in the process.
RSG's Rating Outlook could be revised to Positive in the medium term if the company demonstrates continued progress toward leverage reduction by continuing to pay down its acquired debt with free cash flow. On the other hand, the Rating Outlook could be revised to Negative if the declining U.S. economy causes industry pricing or volumes to weaken beyond current expectations or if integration-related complications result in a material weakening of RSG's credit profile.
Republic Services Inc - Republic Services Credit Rating Lowered To 'BBB', Allied Waste Upgraded; Outlook Negative
THE MCGRAW-HILL COMPANIES ("MHP-BHDNPX") - Republic Services Credit Rating Lowered To 'BBB', - Allied Waste Upgraded; Outlook Negative NEW YORK, Dec. 3, 2008--Standard & Poor's Ratings Services said today that it removed its ratings on Republic Services Inc. from CreditWatch, where they were placed on June 16, 2008. We lowered the corporate credit rating on Republic by one notch to 'BBB' from 'BBB+' and lowered the ratings on the senior unsecured debt and short-term obligations to 'BBB' and 'A-3', respectively, from 'BBB+' and 'A-2'. We also raised the corporate credit rating on Allied Waste Industries Inc. to 'BBB' from 'BB'. In addition, we raised the issue ratings on Allied Waste North America Inc.'s senior debt to 'BBB' from 'BB' and 'B+' and raised the ratings on Allied Waste Industries' subordinated debt to 'BBB-' from 'B+'. We also removed these ratings from CreditWatch, where they were placed on June 16, 2008. The outlook on Republic and Allied is negative.
"The downgrade on Republic and negative outlook on both companies reflect our view that Republic's financial risk profile--marked by higher debt leverage--will deteriorate after its impending acquisition of Allied Waste, more than offsetting the benefits to Republic's business risk profile," said Standard & Poor's credit analyst James Siahaan. The ratings actions anticipate the imminent closing of Republic's acquisition of solid waste services competitor Allied Waste in a stock transaction valued at roughly $11 billion including assumed Allied debt, following the receipt of the necessary antitrust regulatory approval from the U.S. Department of Justice. The negative rating actions reflect increased leverage and a more aggressive financial risk profile in the near term following the combination. Moreover, the challenges of integrating Allied's vast operations introduce additional elements of complexity and risk. Compounding matters is the current weakness in the economic environment, which has pressured collection volumes, and, if sustained, could further undermine the typically recession-resistant solid waste industry and its participants. The merger between Republic and Allied results in the creation of the second largest solid waste management company in the U.S., with the combined entity generating annual revenues of about $9.3 billion, serving more than 13 million customers in 40 states and Puerto Rico. The newly combined entity will be named Republic Services Inc. and will relocate its headquarters to Phoenix, Arizona from Fort Lauderdale, Florida. The new Republic will benefit from a strong investment-grade business profile, marked by its significant scale of operations, a high level of integration of services in the industry, and improved geographic, end market, and customer diversity. These factors solidify the company's business profile near the top of the U.S. waste services industry. The negative business risk factors associated with the acquisition are the somewhat low return on capital of roughly 13% for the combined company--compared with Republic Services' 16% in recent years--and the risks associated with the integration, given the large size of the acquisition. Despite the similarity of the businesses and the many months and man-hours of coordination that Republic and Allied have already invested, business risk concerns include the integration of information systems, execution of the plan to realize the expected synergies (stated at approximately $150 million on a pretax basis annually), and retention of key personnel. We expect that Republic will be able to maintain its rating during this current period of economic weakness, but failure to achieve a steady trend of improvement to key measures of credit quality could result in a modest downgrade. Factors that could prompt a downgrade include greater than expected deterioration in business conditions or the development of unforeseen integration challenges prior to the realization of Republic's debt reduction plan. If the company realizes its business plan and makes sufficient progress related to debt reduction within the next year, and we expect that business conditions could improve in 2010 and beyond, we could reassess the outlook for a revision to stable. Complete ratings information is available to subscribers of RatingsDirect, the real-time Web-based source for Standard & Poor's credit ratings, research, and risk analysis, at www.ratingsdirect.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com; select your preferred country or region, then Ratings in the left navigation bar, followed by Credit Ratings Search.
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