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Wella US Operations LLC -- Moody's assigns B2 corporate family rating to Wella Company; outlook positive

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Rating Action: Moody's assigns B2 corporate family rating to Wella Company; outlook positiveGlobal Credit Research - 17 Jan 2022London, 17 January 2022 -- Moody's Investors Service ("Moody's") has today assigned a B2 corporate family rating (CFR) and B2-PD probability of default rating to Rainbow UK MidCo 2 Ltd (Wella or the company). The company is an intermediate holding company within the Wella group formed for the purpose of the acquisition of Coty's Professional Beauty business by funds affiliated with KKR & Co. Inc. (KKR). Concurrently Moody's has assigned B2 ratings to the proposed $1,800 million equivalent (split in USD, EUR, GBP tranches) seven year guaranteed senior secured term loan B (TLB) and to the pari passu ranking $300 million six and a half year guaranteed senior secured revolving credit facility (RCF). The outlook on all the ratings is positive.The TLB shall be issued by Rainbow Finco S.a r.l. and co-borrowed by Wella US Operations LLC. The RCF shall be issued by Wella US Operations LLC and co-borrowed by Wella Treasury Limited and Rainbow UK Bidco Limited, all wholly-owned subsidiaries of the company.The proceeds of the TLB will be utilised, alongside $300 million of payment-in-kind notes, to refinance the group's existing debt, make a shareholder distribution and pay associated fees and expenses.The rating reflects:- High pro forma Moody's adjusted leverage of 6.7x as of June 2021, pro forma for the proposed transaction, reducing towards 5x in the next 12-18 months- A short track record as a standalone company- Solid expected cash flow generation before one-off separation costs and an advanced programme for cost reduction and efficiency gains.A full list of affected ratings can be found at the end of this press release.RATINGS RATIONALEWella's B2 CFR is supported by: (1) the stable to growing but highly competitive underlying market for hair and nail segments; (2) the company's well-known brands and solid market position in professional hair, a market with long-standing and deep client relationships; (3) good channel and geographic diversity, which have partly mitigated the sales decline during the pandemic and ongoing shifts in consumer preferences; (4) opportunities for cost savings and operational improvements from ongoing transformation initiatives; and (5) expectations of deleveraging, with solid free cash flow generation (after interest and non-recurring items) in fiscal 2023, ending June.The rating also reflects: (1) the company's relatively small scale compared to larger and more diversified competitors, mitigated by strong customer relationships and brands; (2) its short track record of standalone performance and large separation costs, mitigated by advanced execution of separation ; (3) a limited historic track record in terms of revenue growth when excluding the effects of the pandemic, which could indicate potential vulnerabilities in terms of demand, particularly in the smaller retail hair business; and (4) the company's high starting Moody's-adjusted leverage of 6.7x at 30 June 2021 pro forma for the proposed transaction.The company's solid market position and long standing client relationships in professional hair segment (representing approximately 54% of consolidated revenue in fiscal 2021), and the generally stable demand for hair and nail products provide a degree of visibility into the forecasts.Moody's forecasts that Wella will incur high non-recurring cash costs in fiscal 2022, which will be funded through internally generated cash flows and existing cash balances. Its free cash flow generation is expected to improve thereafter to between $170-190 million annually on a Moody's adjusted basis after cash interest and reduced non-recurring outflows. Interest expense will be the largest cash outflow while capital expenditures will likely remain limited around $60-70 million over the forecast period, mainly relating to investments in the supply chain and information technology.However, Wella has a short history as a standalone company and focused industry player, and visibility over the adequacy of operating expenses and capex is somewhat limited.LIQUIDITYWella's liquidity profile is adequate. The proposed refinancing transaction is expected to leave approximately $75 million of cash on balance sheet at closing and will provide access to a new $300 million guaranteed senior secured revolving credit facility due 2028, which will be undrawn at closing. The facility will have a net senior leverage springing covenant tested when 40% net drawn, under which the company will retain ample headroom. Moody's expects the company to continue funding its large separation related one-off costs through internally generated cash flows in fiscal 2022 and to generate significant positive free cash flow from fiscal 2023 onwards.STRUCTURAL CONSIDERATIONSThe B2 rating on the $1.8 billion (equivalent) guaranteed senior secured term loan B and pari passu $300 million guaranteed senior secured revolving credit facility are in line with the CFR, reflecting the fact that they are the only debt instruments in the capital structure. The senior facilities will be guaranteed by the borrowers and material subsidiaries representing at least 80% of consolidated EBITDA, subject to specific excluded jurisdictions, and benefit from security over the assets of US and UK guarantors.The use of PIK debt outside the restricted group and the need to repay the instrument upon maturity creates a degree of structural complexity and uncertainty regards the ultimate timing and source of repayment.ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONSMoody's take the impact of environmental, social and governance (ESG) factors into account when assessing companies' credit quality. In particular Moody's considers governance risks within the rating the fact that the company is currently majority owned by funds controlled by KKR, which is expected to maintain a tolerance for high leverage.OUTLOOKThe positive outlook reflects Moody's view that Wella's revenue and EBITDA will continue to grow over the next 12-18 months supported by organic growth and cost reductions. As a result, Moody's expects adjusted debt/EBITDA to reduce towards 5x by fiscal 2023. The positive outlook also incorporates Moody's expectation that free cash flow (FCF) after separation costs will turn significantly positive during fiscal 2023, that liquidity will remain sufficient to cover financial obligations and that no material debt-financed acquisitions or distributions are undertaken which would slow the expected pace of deleveraging.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSThe ratings could be upgraded if Wella (1) builds a successful track record as a standalone business, supported by a longer history of consolidated audited accounts, (2) Moody's adjusted leverage reduces to below 5x and, (3) Moody's adjusted free cash flow to debt improves towards the mid teens in percentage terms.An upgrade would also require that the company achieves mid-single digit organic revenue growth and growing EBITDA margins. In addition, the company would need to demonstrate a financial policy consistent with sustaining the above metrics and maintain at least adequate liquidity.The ratings could be downgraded if leverage fails to reduce below 6.5x on a Moody's-adjusted basis over the next 12-18 months, if Moody's-adjusted free cash flow to debt trends towards zero, or if there is a material decline in organic revenues or EBITDA margins. A downgrade could also occur if liquidity concerns arise.PRINCIPAL METHODOLOGYThe principal methodology used in these ratings was Consumer Packaged Goods Methodology published in February 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1202237. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.LIST OF AFFECTED RATINGSAssignments:..Issuer: Rainbow Finco S.a r.l.....Senior Secured Bank Credit Facility, Assigned B2..Issuer: Rainbow UK MidCo 2 Ltd....Probability of Default Rating, Assigned B2-PD....LT Corporate Family Rating, Assigned B2..Issuer: Wella US Operations LLC....Senior Secured Bank Credit Facility, Assigned B2Outlook Actions:..Issuer: Rainbow Finco S.a r.l.....Outlook, Assigned Positive..Issuer: Rainbow UK MidCo 2 Ltd....Outlook, Assigned Positive..Issuer: Wella US Operations LLC....Outlook, Assigned PositiveCOMPANY PROFILEThe company was formed in December 2020 following the spin-off of the professional beauty products retail business from Coty Inc., with Rainbow JVCo Limited, an intermediate holding company ultimately majority-owned by funds affiliated with KKR & Co. Inc. As the company is currently transitioning to a standalone business, several interdependencies with Coty Inc. remain. The Wella Company manufactures and distributes hair and nail products and hair appliances (styling tools, hair dryers and curlers) for professional and consumer use through an extensive network of professional salons, wholesalers, retailers and e-commerce platforms, including its own websites. The company generated revenue of $2.3 billion in fiscal 2021, ended 30 June.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 http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288235.At least one ESG consideration was material to the credit rating action(s) announced and described above.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Roberto Pozzi Senior Vice President Corporate Finance Group Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Richard Etheridge Associate Managing Director Corporate Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service Ltd. 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