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Vertical U.S. Newco Inc. -- Moody's affirms TK Elevator's debt ratings, assigns B2 CFR to TK Elevator Holdco GmbH; stable outlook

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Rating Action: Moody's affirms TK Elevator's debt ratings, assigns B2 CFR to TK Elevator Holdco GmbH; stable outlookGlobal Credit Research - 14 Apr 2021Frankfurt am Main, April 14, 2021 -- Moody's Investors Service ("Moody's") has today affirmed the B1 instrument ratings on the senior secured term loans B, the senior secured notes, the senior secured floating rate notes, and on the senior secured revolving credit facility, raised by TK Elevator Midco GmbH and Vertical U.S. Newco Inc.; and the Caa1 instrument rating on the senior unsecured notes, issued by TK Elevator Holdco GmbH. Moody's has further assigned a B2 corporate family rating (CFR) and B2-PD probability of default rating (PDR) to TK Elevator Holdco GmbH, a holding company of German elevator and escalator manufacturer TK Elevator (TKE or group) and has withdrawn the B2 CFR and B2-PD PDR and the stable outlook at the level of TK Elevator Topco GmbH.The outlook of TK Elevator Holdco GmbH, TK Elevator Midco GmbH and Vertical U.S. Newco Inc. remains stable."TKE's ratings remain weakly positioned given its persistent high leverage, which we expect to reduce to appropriate levels for a B2 rating only by 2023. At the same time, we recognize the group's robust performance with gradual and significant profitability improvements achieved in the last two quarters, despite a pandemic-driven challenging operating environment", says Goetz Grossmann, a Moody's Vice President and lead analyst for TKE. "The rating affirmations also reflect our expectation of TKE to achieve further cost savings and operational improvements from implemented measures, which should enable additional margin improvements and positive free cash flow generation over the next two years."RATINGS RATIONALEThe rating affirmations follow TKE's first three quarters of independence after its acquisition by a private equity consortium from thyssenkrupp AG (tkAG) in July 2020. TKE's operating performance during the coronavirus pandemic so far shows a somewhat weaker than expected order intake development (-3% yoy in the financial year ended 30 September 2020, "FY 2019/20", and -12% yoy in Q1 2020/21), while its group sales and Moody's-adjusted EBITDA were broadly in line with Moody's forecasts. TKE's Moody's-adjusted leverage of around 9.1x debt/EBITDA for the 12 months ended 31 December 2020 (excluding E2 billion of PIK notes issued outside of the restricted group and shareholder loans, which Moody's treats as equity) continue to position the group very weakly in the B2 rating category. However, Moody's acknowledges TKE's ability to improve its profitability despite the pandemic-related challenges in some segments, as shown by a 2.0%-points increase in its company-adjusted EBITDA margin to 14.3% in Q1 2020/21 versus 12.3% in the prior year and 13.2% in FY 2019/20. This also supported TKE's free cash flow (FCF) generation of around E165 million (Moody's-adjusted) in Q1 2020/21. Moody's expects only around break-even FCF for FY 2020/21, however, due to increased capital spending needs for a new headquarter in the US and the capitalization of TKE's innovative ropeless elevator system MULTI, among others.Given the recent slowdown in order intake (Americas region mainly), increasing raw material costs and the risk of negative currency effects, while assuming recovering business activity as existing lockdown measures will likely be lifted in the coming months, Moody forecasts TKE's topline to be stable and its margins to modestly increase in 2020/21. The expected further margin expansion should be driven by ongoing benefits from the group's operational improvement and cost savings measures, which it expects to contribute E227 million to its adjusted EBITDA over the next two years. However, substantial restructuring costs still need to be incurred and will lead to a less material growth in Moody's-adjusted earnings. Moody's expects TKE's Moody's-adjusted EBITDA to steadily increase to over E1.2 billion over the next two years from just above E1 billon in FY 2019/20. Assuming only small debt repayments, TKE's leverage will therefore reach the 7.5x maximum level for a B2 rating only during FY 2022/23. This does not leave room for a potential slower performance recovery without negative rating pressure building up in the coming few quarters. More positively, Moody's expects TKE to maintain its adequate liquidity profile and modestly positive FCF over the next two years (1.5% Moody's-adjusted FCF/debt in FY 2021/22), which continue to support the stable outlook at this time. Moody's also expects TKE to establish and maintain a financial policy focused on de-leveraging, absent material shareholder distributions in any kind or debt-funded acquisitions.The assignment of the B2 CFR to TK Elevator Holdco GmbH and withdrawal of the CFR at TK Elevator Topco GmbH follows Moody's conclusive review of TKE's organizational and legal structure with TK Elevator Holdco GmbH as the top entity of the restricted financing group. This review also included a final assessment of a E5.5 billion shareholder loan at the level of TK Elevator Holdco GmbH, which meets Moody's criteria for equity treatment.The B2 CFR remains further constrained by (1) TKE's exposure to the cyclical construction industry; (2) execution risks regarding extensive restructuring aimed at achieving significant further profitability improvements over the next three years; (3) foreign currency risk (largely translational) with around 77% of group revenues being generated in currencies other than the euro; (4) intense competition and price pressure in China from both international and local competitors; (5) exposure to volatile raw material prices, especially in the largest new equipment market China, while the ability to pass on rising input costs to customer is limited; (6) lack of a track record as an operating entity after the separation from tkAG, from which it received corporate and other services that still need to be established on a standalone basis; (7) an aggressive financial policy, illustrated by the substantial amount of debt raised to fund its acquisition, including E2 billion of PIK notes issued at a level above the restricted group.TKE's rating is supported by its (1) strong business model as one of the world's largest manufacturers and services providers in the attractive elevator and escalator (E&E) market, which benefits from favorable mega trends of urbanization, rising demand for improved mobility by an ageing population and tightening safety regulations; (2) leading market shares across the Americas, Europe Africa and Asia Pacific regions, with a particular strong presence in the highly profitable since more services-oriented Americas market (41% of revenues in FY 2019/20); (3) sizeable installed base with around 1.4 million units under maintenance; (4) resilient business thanks to over 40% of revenues being derived from multi-year services contracts as well as a high order backlog of profitable new installation and modernization business; (5) healthy profitability, although still below the industry standard; (6) positive FCF generation due to generally low maintenance capital spending, moderate working capital needs and no dividend payments; (7) diverse customer base with the top ten customers accounting for less than 3% of group revenue; and (8) experienced management, focused on strengthening profitability and strong cash conversion.LIQUIDITYTKE's liquidity is adequate, reflecting Moody's forecast of modest positive FCF generation and no material debt maturities over the next few years. As of 31 December 2020, TKE's cash and cash equivalents amounted to E695 million and it had access to E382 million under its committed E992 million revolving credit facility. These cash sources provide TKE more than sufficient liquidity to cover its basic cash needs over the next 12-18 months.The RCF is subject to one springing covenant (Senior Secured Net Leverage Ratio), which basically needs to be tested when the aggregate amounts outstanding under the facility exceed around 40% of the total commitments. The covenant is set with significant headroom and Moody's expects TKE to ensure consistent adequate capacity under it.OUTLOOKWhile the ratings remain weakly positioned, the stable outlook reflects the group's adequate liquidity position and Moody's expectation of consistent positive FCF generation. The outlook is further predicated on an expected de-leveraging (in terms of Moody's-adjusted gross debt/EBITDA) to below 7.5x by the end of FY 2022/23 at the latest. Any signs of a delay in de-leveraging trajectory or weakening (negative) FCF generation, however, would lead to imminent negative rating pressure.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSUpward pressure on the ratings appears unlikely at this stage, considering TKE's very high leverage and the existence of a substantial amount of PIK notes above the restricted financing group, reflecting some risk of associated cash leakage over time. However, TKE's ratings could be upgraded, if (1) the group's targeted profitability improvements supported de-leveraging to sustainably below 6.5x Moody's-adjusted debt/EBITDA, (2) Moody's-adjusted FCF/debt ratios improved to at least 5%, (3) a prudent financial policy was established, as shown by excess cash flow being applied to debt reduction and no material shareholder distributions.Downward pressure on TKE's ratings would build, if (1) the group failed to steadily reduce leverage towards 7.5x Moody's-adjusted debt/EBITDA, (2) Moody's-adjusted free cash flow turned negative, (3) its liquidity started to deteriorate.PRINCIPAL METHODOLOGYThe principal methodology used in these ratings was Manufacturing Methodology published in March 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1206079. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.COMPANY PROFILEHeadquartered in Düsseldorf, Germany, TK Elevator Holdco GmbH is an intermediate holding company of TKE, a leading manufacturer of elevators and escalators with a presence in the Americas, Europe/Africa and Asia regions. In FY 2019/20, the group generated E7.9 billion in revenue and company-adjusted EBIT of E847 million (10.7% margin).In February 2020, a consortium led by global private equity firms Advent International and Cinven, together with the Abu Dhabi Investment Authority (ADIA), Singaporean GIC and the German RAG foundation, announced the acquisition of TK Elevator from German diversified industrial group thyssenkrupp AG (tkAG). tkAG, through a E1.25 billion reinvestment, retained an around 19% stake in the group.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. 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