Moody's raises flag on Hart's debt levels

DEBT LEVELS: Moody's says Graeme Hart's LBO of Pactiv will leave his investment vehicle will uncomfortable levels of debt

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Graeme Hart's leveraged buy-out of packaging and food services company Pactiv Corp. will leave his investment vehicle with uncomfortable if manageable debt levels, says Moody's Investors Service.

The amount of debt Hart's taking on has rating agency Moody's Investors Service nervous, with the firm putting Reynolds Group's B2 rating on negative outlook. Moody's said this week that the high debt to earnings ratio of 6.8 times for the combined entity is "stretched."

However, it expects Reynolds will be able to bring it down to 6 times over the next 12 to 18 months.

Hart's vehicle, which will get within a stone's throw of the biggest packaging company in the world if it pulls off the US$6 billion Pactiv deal, is looking to raise US$1.5 billion through senior secured term loans of five and six years, US$2 billion through senior secured eight-year notes, and US$1.5 billion in senior unsecured notes with eight-year terms. The company's bosses will be holding meetings with prospective lenders in New York next week.

Moody's concerns were echoed by US institutional research analysts.

Ghansham Panjabi, senior research analyst at R.W. Baird & Co. in New York, said Reynolds bondholders have to be a little concerned with the extra debt Hart's taking on, even though it's not an "egregious amount."

"It's a decent amount of debt they're taking on," Panjabi said. "It's manageable, but is it comfortable? Probably not."

Reynolds Group will pump in about US$734 million of equity into the new business, of which Hart will have to find US$200m from elsewhere in his empire. He recently poured a food services company worth US$300 million into the vehicle.

Al Kabili, an equities analyst at Macquarie Capital (USA) in New York, said the debt Hart's taking on is "feasible, but it is at the higher end."

"It's on the high end in terms of what we would have thought in terms of leverage, but it's not unrealistic," he said. "Packaging tends to be relatively resilient and relatively stable cash flow generation enable higher debt levels than more cyclical or industry exposures."

Both Kabili and Panjabi say Pactiv's shareholders will do well out of Hart's US$33.25 a share offer, echoing the endorsement from the U.S. company's board for shareholders to accept the offer. The offer exceeds the mean target price of US$33.18 of 10 analysts surveyed by Reuters.

"The take-out price is almost 40 per cent above where Pactiv's shares were on May 14 when the take-over talk started up. It's a pretty healthy premium," Kabili said.

He says the deal will rely on Reynolds squeezing US$200 million in savings from the two companies for it to be successful.

Reynolds' chief executive Tom Degnan told analysts last month he expects the combined unit to report annual sales in excess of US$10 billion, with earnings before interest, taxation, depreciation and amortisation of some US$2.1 billion.

Kabili said Hart has "managed to build a successful packaging empire" in a very short space of time.

"He's certainly got respect for what he's been able to do," he said.

Hart began building a packaging empire in 2006 with his NZ$3.3 billion takeover of Carter Holt Harvey, whose forest holdings he subsequently sold.

In 2007, he spent US$2.7 billion on aluminium manufacturer Alcoa's packaging business, which he later renamed Reynolds Group Holdings.

He later bought International Paper's beverage packaging unit and Swiss company SIG. Once Pactiv is rolled into the entity, Hart's empire will be worth more than US$11 billion.

- BusinessDesk