Structured FINANCE Die Kongressmesse für Unternehmensfinanzierung Moody s Rating Committee Simulation MATTHIAS HELLSTERN, MANAGING DIRECTOR

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1 Structured FINANCE Die Kongressmesse für Unternehmensfinanzierung Moody s Rating Committee Simulation MATTHIAS HELLSTERN, MANAGING DIRECTOR STUTTGART, 25 NOVEMBER 2015

2 Agenda 1. Moody s Credit Rating Process: High Level Overview 2. Reason for today s Rating Committee 3. Rating Committee Discussion 4. Rating Recommendation 2

3 1 Moody s Credit Rating Process: High Level Overview 3

4 INVESTMENT GRADE Ratings are forward-looking opinions How CRAs communicate their analysis and views about credit risk» Moody s credit ratings are forward-looking opinions of the relative credit risk» Credit risk: the willingness and the ability of an issuer to pay its debt in a timely manner (in accordance to its contractual promise) Moody s rating system provides a rank ordering of relative creditworthiness:» 7 broad categories; 21 refined categories» Short-term ratings» Further refined by Watch-lists and Outlooks LONG TERM Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C SHORT TERM Prime-1 Prime-2 Prime-3 Not Prime 4

5 Key elements of Moody s corporate ratings Industry Rating Methodology» Auto Manufacturers» Healthcare» Telecom, etc. Peer Comparisons Credit Rating Liquidity Analysis Applying appropriate liquidity framework: LRA (Liquidity Risk Assessment) Other Methodologies & Analytical Considerations» Corporate Governance» Ownership structure» Government-Related Issuers (GRI)» Macro factors (Sovereign Risk, Regulation, etc.)» Loss Given Default (LGD) Source: Moody s Investors Service 5

6 Typical Rating Committee attendees Analytical Team» Gathers relevant information and presents a view Rating Committee Chair» Moderates the discussion within the committee and fosters a debate to air the various considerations Other Relevant Persons as appropriate» Provide differing perspectives Rating committee outcome is determined by vote» Majority, not consensus» It will be Moody s opinion Attendance based on Relevance, Knowledge & Expertise 6

7 2 Reason for today s Rating Committee 7

8 Verdi - The Acquirer Company profile & current topics» Verdi is one of the leading manufactures and distributors of water pumps for hygiene application in Europe» Small size company with low international diversification but resilient financial performance» Market leader with reliable customer base and significant barriers to entry with low risk of technology obsolescence 16.0% Baa2/STA 15.9% 16.2% Credit metrics 31/12/ /12/ /12/2014 EBITDA Margin 16.0% 15.9% 16.2% Debt / EBITDA 1.2x 1.6x 1.2x FCF / Debt 28.1% 26.2% 33.3% RCF / Net Debt 40.0% 51.2% 93.4% EBITA / Interest Expense 7.6x 13.0x 16.1x All numbers and ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. Source: Moody's Financial Metrics *RCF: Retained Cash Flow What could change the Baa2 rating, Stable outlook Down» FCF/Debt consistently below 20%» Debt/EBITDA exceeding 2.0x» Deterioration of liquidity profile Up» Debt/EBITDA sustained below 1.0x» Substantial revenue growth, whilst sustaining its current profitability levels, and adequate liquidity *EBITDA: Earnings Before Interest, Tax, Depreciation & Amortization 8

9 The Acquisition Summary of the transaction Verdi Acquisition of 100% for 470* million in cash Gershwin» The acquisition is expected to be funded through a combination of senior secured revolving credit facility and senior secured term loan» Purchase price represents a multiple of 10.6x pre-synergies on 2015 estimated EBITDA» In addition, the company intends to pay dividends going forward» Combined group s debt/ebitda will weaken by 1.2x to 2.4x * EUR/USD:1.2 9

10 Gershwin - Target: Unrated Company profile & current topics» Gershwin manufactures and distributes water pumps for hygiene application, generating more than 60% of revenues in the Americas» Global footprint with regional manufacturing presence and sales in more than 100 countries» Diversified product mix 16.0% 16.4% 17.2% Credit metrics Revenue breakdown 31/12/ /12/ /12/2014 Revenue ( million) EBITDA Margin 16.0% 16.4% 17.2% Debt / EBITDA NA NA NA FCF / Debt NA NA NA RCF / Debt NA NA NA (FFO + Interest Expense) / Interest Expense NA NA NA (EBITDA - Capex) / Interest Expense NA NA NA *RCF: Retained Cash Flow *EBITDA: Earnings Before Interest, Tax, Depreciation & Amortization 10

11 Should we have a Rating Committee? DEBATE» Do the facts merit rating committee consideration?» What should the lead analyst focus on?» What should the key drivers for the Committee s discussion be? Has the company s ability and/or willingness to repay its outstanding debt on time changed? 11

12 Rationale for Rating Committee» Change in strategy which could result in an increase in business risk as the company deploys resources internationally» The deal evidences need to invest internationally to offset the risk of operating in a mature domestic market in which revenues remain under substantial pressure» Execution risk in achieving synergies» Debt funded transaction which changes financial metrics (i.e. financial leverage doubles to 2.4x by 2015e) for the current rating. We expect financial ratios (leverage) to exceed guidance limits under the current rating with no improvement expectation in the near term» Concerns related to the liquidity risk management resulting from the acquisition» Change in financial policy (further M&A activity, start of dividend payments) 12

13 3 Rating Committee Discussion 13

14 5 key analytical factors for Global Manufacturing Industry Industry key rating considerations 1. BUSINESS PROFILE (20%)»Market position»operating Performance Resilience»Revenue Mix - Product and Consumer Segment Diversification Cost Base 2. SCALE (20%)»Revenues»Market Share»Market Concentration 3. PROFITABILITY (10%)»EBITA Margin 4. COVERAGE & LEVERAGE (40%)»EBITA/Interest Expense» Debt/EBITDA» RCF/Net debt»fcf/debt 5. FINANCIAL POLICY (10%)» Commitment to Maintain Ratings» Appetite for M&A» Balance Between Shareholder and Bondholder Interests Source: Moody s Global Manufacturing Methodology *RCF: Retained Cash Flow *EBITDA: Earnings Before Interest, Tax, Depreciation & Amortization 14

15 A summary of the key rating considerations applied to acquirer ex and post acquisition Rating Factors Consolidated Global Manufacturing Industry Rating Methodology Global Manufacturing Industry Grid [1][2] 31/12/2014 (standalone) Moody's Forward View Months [3] Measure Score Score Measure Factor 1: Business Profile (20%) Business Profile Baa Baa Baa Baa Factor 2: Scale (20%) Revenue $1.7b Ba Ba $ b Factor 3: Profitability (10%) Factor 4: Coverage & Leverage (40%) EBITA Margin EBITA/Interest Expense Debt/EBITDA RCF/Net debt FCF/Debt 13.6% Baa Baa % 16.1x Aaa Aa x 1.2x A Baa x 93.4% Aaa Baa % 33.3% Aaa A % Factor 5: Financial Policy (10%) Financial Policy Baa Baa Ba Ba Indicated Rating from Grid A3 Baa2 Actual Rating Assigned Baa2 Baa2» Actual rating assigned differs from grid outcome for the following reasons:» Key man risks» Opacity» Provision of information (i.e. annual accounts etc.) [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations [2] As of 12/31/2014; Source: Moody s Financial Metrics [3] This represents Moody's forward view; not the view of the issuer; and incorporates Gershwin 15

16 Evolution of selected ratios Post acquisition Evolution of Debt to EBITDA ratio Evolution of FCF to Debt ratio Up Down Down Up Evolution of EBITA to Interest Expense ratio Evolution of EBITA Margin * Includes bolt-on acquisition in 2017 Leverage may increase further given the risk of further acquisitions Source: Moody s Financial Metrics 16

17 Business Profile & Scale Post Acquisition» Revenues to increase to 1.8 billion from 1.4 billion (including organic growth)» More balanced and diversified split of its business across its footprint by adding valuable brand and complementing new product category to the acquirer s existing portfolio» Global footprint with a moderately diversified revenue exposure» Limited improvement of product diversification 17

18 Other rating considerations» Shall we debate the company s financial projections post acquisition?» How sustainable will be profitability post acquisition (i.e. increased currency exposure etc.)» What else should we consider outside the industry methodology key rating factors?» Are we comfortable with the company s liquidity situation?» What should we expect the refinancing profile to look like?» How compares the combined entity with its peers?» Should we look at other indicators? DEBATE 18

19 4 Rating Recommendation 19

20 Deliberation Remember, the question is: Has the company s credit risk profile changed? If so, DEBATE» Why?» How?» By how much?» Have we addressed all the questions?» What would you as an analyst recommend?» Key drivers for the rating recommendation? 20

21 Appendix 21

22 Transaction Analysis SOURCES USES 2015 $53 million in cash and equivalents Full purchase price for Gershwin: $560 million New RCF of $50 million Transaction Fees & Expenses amounting $16 million Senior secured TL totaling $575 million maturing in 2019 Existing subordinated debt amounting $42 million Closing cash balance of $102 million Rollover of subordinated debt totaling $42 million TOTAL: approx. $720 million TOTAL: approx. $720 million 22

23 1/2. Business Profile & Scale Industry Rating Methodology Factor 1 & 2 Business Profile & Scale (40%) Verdi SIZE & DIVERSIFICATION» Verdi has a long-standing and successful presence in water pump industry with low risk of technology obsolescence» Relatively small size company» Low international diversification, with EMEA representing the biggest chunk of revenues generated» Operates around 50 production plants in 15 countries with broad customer base» Family owned» Limited product diversification Gershwin SIZE & DIVERSIFICATION» Leading global manufacturer of commercial use water pumps» Relatively small size company with regional manufacturing presence and sales in more than 100 countries» Strong footprint in US market and growing exposure to the Asian markets» Distinct multi-brand and multi-distribution channel strategy which allows to penetrate and develop local markets 23

24 1/2. Business Profile & Scale (Cont d) Industry Rating Methodology Factor 1 & 2 Business Profile & Scale (40%) Sub-Factor Weight Aaa Aa A Baa Ba B Caa Ca Scale (US$) 20% >=$40 $20 - $40 $10 - $20 $5 - $10 $1.5 - $5 $ $1.5 $0.1 - $0.25 <$0.1 Business Profile Business Profile 20% Expected volatility in results is almost non-existent. Supported by a commanding market position: entrenched cost effectiveness: technology advantages and a well-balanced global reach. Very low expected volatility in results. Supported by a deeply entrenched and leading market position that is highly defensible through cost effectiveness and technology leadership with global exposure. Low expected volatility in results. Supported by a strong market position in its relevant market: demonstrated and sustainable competitive advantages: insulation from raw material cost fluctuations: and solid diversity characteristics. Moderate expected volatility in results. Supported by a solid market position in its most important geographic or product markets. Is vertically integrated or can pass-through the majority of its costs. Good diversity characteristics provide a buffer against sudden/ unexpected shifts in demand. Products are largely undifferentiated and the marketplace highly competitive: exposing company to periods of heightened volatility. Such exposure is tempered by an established market position: favorable costs: an ability to pass-through raw material costs: and fair diversity characteristics including modest operational concentration. Products are undifferentiated: competition is intense and customers price sensitive: making results highly volatile. Company does not have advantageous cost profile or other competitive advantage to mitigate. High operational concentration. Results are expected to be extremely volatile. Company has modest market presence: few competitive advantages and may have above-average costs. Very high operational concentration (1 or 2 locations). Expected to have highly volatile cash flow generation: a single product line sold to few customers for a single use: an insignificant market position with many large competitors: concentrated exposure to a small cyclical market and uncertain demand: no pricing power: and a single operating site that has an uncompetitive cost structure. Permanent structural and technological disadvantages. 24

25 3. Profitability Industry Rating Methodology Factor 3 Profitability (10%) Verdi» Strong position in Europe with lower supplier dependency and customer concentration» Highly variable cost structure resulting in consistent margins in periods of both volume growth and decline» Ability to pass through raw material price increases to customers» Second-largest market share globally» Abundant growth possibilities» Limited capital requirements Gershwin» Strong footprint to US market and growing exposure to the Asian markets» Reliable customer base» Worldwide brands are a highly scarce asset» Attractive growth opportunities in emerging markets Sub-Factor Weight Aaa Aa A Baa Ba B Caa Ca EBITDA Margin 10% >=25% 20% - 25% 15% - 20% 10% - 15% 5% - 10% 2.5% - 5% 0% - 2.5% <0% 25

26 4. Coverage & Leverage Industry Rating Methodology Factor 4 Coverage & Leverage (40%)» Financial metrics will deteriorate as a result of the transaction, leverage (Debt/EBITDA) will be increasing from 1.2x in 2014 to 2.4x in 2015e post acquisition» We expect Free Cash Flow will improve, however high debt load will reduce FCF/Debt to about 17.5% in 2015e from its level of 33% in 2014 (standalone) Sub-Factor Weight Aaa Aa A Baa Ba B Caa Ca Leverage and Cash Flow Debt/EBITDA 10% <0.5x 0.5x - 1x 1x x 1.75x x 3.25x x 4.75x x 6.25x x >=7.75x RCF/Net Debt 10% >=60% 45% - 60% 35% - 45% 25% - 35% 15% - 25% 7.5% - 15% 0% - 7.5% <0% FCF/Debt 10% >=25% 20% - 25% 15% - 20% 10% - 15% 5% - 10% 0% - 5% -5% - 0% <-5% Coverage EBITA/Interest Expense 10% >=15x 12x - 15x 8x - 12x 5x - 8x 2.5x - 5x 1x - 2.5x 0.5x - 1x <0.5x Standalone Post acquisition Source: Company reports and Moody s adjustments as of December

27 5. Financial policy: how is transaction impacting? Industry Rating Methodology Funding: combination of senior secured revolving credit facility and senior secured term loan Dividend payments assumed in forecasted figures Verdi acquires 100% of Gershwin for 470 million in cash Debt/EBITDA will trend to about 2.0x FCF/Debt to be about 17.5% in 2015 and will reside on that level given further acquisition Post-acquisition adj. Debt/EBITDA in 2015 will be at around 2.4x, which is above our published threshold guidance for the likely downgrade of Acquirer * EUR/USD:1.2 27

28 5. Financial policy (Post acquisition) Industry Rating Methodology Factor 5 Financial Policy (10%)» Commitment to an investment-grade rating» There is a risk of limited share buybacks» Announcement of dividend payments Sub-Factor Weight Aaa Aa A Baa Ba B Caa Ca Financial Policy 10% Expected to have: extremely conservative financial policies; very stable metrics; public commitment to very strong credit profile over the long term. Expected to have: very stable and conservative financial policies; stable metrics; minimal event risk that would cause a rating transition; public commitment to strong credit profile over the long term. Expected to have: predictable financial policies that preserve creditor interests. Although modest event risk exists: the effect on leverage is small and temporary; strong commitment to a solid credit profile. Expected to have: financial policies that balance the interest of creditors and shareholders; some risk that debt funded acquisitions or shareholder distributions could lead to ratings migration. Expected to have: financial policies that tend to favor shareholders over creditors; above average financial risk resulting from shareholder distributions: acquisitions or other significant capital structure changes. Expected to have: financial policies that favor shareholders over creditors; high financial risk resulting from shareholder distributions: acquisitions or other significant capital structure changes. Expected to have: financial policies that create elevated risk of debt restructuring in varied economic environments. Expected to have: financial policies that create elevated risk of debt restructuring even in healthy economic environments. Standalone Post acquisition 28

29 Peer comparison analysis Peer Comparison Company Current LT Rating Reporting Period Business Profile Revenue (USD Billion) EBITA Margin EBITA/Interest Expense Debt/EBITDA RCF/Net Debt FCF/Debt Financial Policy Verdi Baa2 Next months Baa % x x % % Baa Peer 1 A3 Next months A % x % % A Peer 2 Baa2 Next months Baa % x x % % Baa Peer 3 Baa2 Next months Baa % % x % % Baa Peer 4 Baa2 Next months Baa % x x % % Baa Peer 5 Baa2 Next months Baa % x x % % Baa Peer 6 Baa3 Next months Baa % % x % % A Peer 7 Ba2 Next months B % x x % % Baa This company compares best to Peer 1 and Peer 6 29

30 Liquidity Assessment Liquidity Analysis Liquidity Uses vs. Sources* Maturity Profile *Forecast based on 2016 plan» We view Verdi s liquidity profile as good» since the company s cash sources sufficiently cover its projected cash uses for the next twelve months» However, the company is facing cash outflow due to debt repayments 30

31 Recommendation From Baa2 to Baa3 Outlook remains Stable» Our recommendation is to propose a one notch downgrade with a stable outlook as the acquisition, which is partly financed by debt, will increase leverage (above the guidance for the current rating category)» We are also concerned about: Integration of Gershwin, which can negatively impact management style/culture Additional M&A opportunities that might arise How this might represent a shift in strategy focusing management s attention more in the international footprint Changing financial policy» We have stated that we could downgrade by one notch if financial metrics deteriorate as a result of weak operating performance or an extraordinary use of funding that translates into adjusted debt/ebitda exceeding 2.0x or adjusted FCF/Debt consistently below 20%, with unclear signs of improvement» Nevertheless, we recognize that the Gershwin acquisition being assumed is attractive and although it is fully priced, it makes industrial sense to further enhance the international footprint in US 31

32 Alternatives to Recommendation Affirm Baa2 Change outlook to negative» One alternative recommendation would be the affirmation of the Baa2 rating, but change the outlook to negative if the committee members consider the following: Integration of Gershwin improves business profile while mitigating the integration risk Positively values the increased geographic diversification, but takes into consideration that this transaction broaden its product portfolio FCF generation helps to limit the impact of higher debt burden Taking into consideration the changed view on financial policy given start of dividend payments Expectation that selected credit metrics will return to target levels in the next months Affirm Baa2 Keep stable outlook unchanged» The other alternative recommendation could be affirming the Baa2 rating as well as the stable outlook if the committee members consider the following: Positively value the broader geographic diversification which outweighs a still narrow product portfolio Positive view on capacity to generate synergies Gershwin will be able to service the increased debt burden from most of its own cash flow Still positive free cash flow despite dividend payout 32

33 Main assumptions under our projections ( ) Other Methodologies & Analytical Considerations» Favorable macroeconomic fundamentals in Emerging Markets and US should support customer s demand for water pumps and optimization of cost structure in the scope of integration process» Marginal improvement of the EBITDA margin expected as a result of Verdi going through a cost optimization program in 2014 and stabilization in Same effect as it incorporates the Target» Capex over sales at around 3-4%% at Verdi and Gershwin at around 3% for the projected period» Acquisition of 100% of Gershwin for some $560 million» The acquisition is expected to be funded with senior secured revolving credit facility and senior secured term loan» Bolt-on acquisition in 2017 funded with senior secured term loan» Dividend payments amounting to 30% of net income starting in 2016 onwards» Major adjustments: Leases: assuming 137 million added back to debt Pensions: assuming 30 million added back to debt 33

34 Matthias Hellstern Managing Director Corporate Finance Group Anke Rindermann Associate Managing Director Corporate Finance Group Falk Frey Senior Vice President Corporate Finance Group Matthias Heck VP-Senior Analyst Corporate Finance Group 34

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