Outlook Improves For Health Care, Chemicals, Telecom

Standard & Poor’s last month identified three U.S. industries—health care, chemicals, and telecommunications—that it believes have the greatest potential to see upturns in their credit quality in 2010, and that could provide relief to a number of portfolio companies. Those three sectors accounted for about 12 percent of control-stake transactions closed by U.S. sponsors in the past two years, according to Thomson Reuters, publisher of Buyouts.

A company’s credit rating can affect its ability to issue new debt for add-on acquisitions, recapitalizations and other purposes. Many buyout firms plan to recapitalize investments made during the credit crunch (which typically required equity stakes in the 40 percent to 50 percent range) as a way to recoup equity and mitigate risk. Of the three industry segments listed, health care has been the most popular among the LBO community. Of the 1,402 control-stake deals that closed between 2008 and 2009, 115 of them, or about 8 percent, were in health care.

“The health care sector was the only sector in the U.S. to have more upgrades than downgrades from the end of 2007 through Nov. 30, 2009,” according to S&P, which tracked a total of 20 downgrades and 28 upgrades in that period. Indeed, health care issuers also proved able to reduce their overall leverage during the recession. The median debt-to-EBITDA ratio for health care issuers was just 4.1x in the third quarter of Q3 2009, compared to 5.4x in the fourth quarter of 2007, according to S&P.

Quarter-over-quarter, revenues in health care as a whole rose about 8 percent in the third quarter of 2009, despite the fact that approximately 70 percent of companies in the industry have speculative-grade ratings. New speculative-grade bond issuance in the health care sector totaled $7.8 billion through the first 11 months of 2009 compared to just $830 million in all of 2008, according to S&P.

That’s not to say that the sector is without risk. Of the three health care companies that defaulted in 2009, two were backed by buyout shops: Summit Partners’s Airborne Health and Warburg Pincus’s CCS Medical.

The chemicals sector, meanwhile, accounted for 30 deals, or just north of 2 percent of all U.S. sponsor-backed transactions that closed in the past two years, according to Thomson Reuters. The median debt-to-EBITDA ratio for issuers in the chemicals sector actually increased to 5.2x by the close of the third quarter of 2009 compared to just 4.1x in at the close of 2007. However, revenues in the second quarter of 2009 were up almost 8 percent for from the first quarter, and third quarter figures appear to be up another 4.4 percent, according to the ratings agency. The performance up-ticks helped the sector see $2.7 billion in new speculative grade issuance in through the first 11 months of the 2009 compared to just $480 million in full-year 2008.

Since June there have been six upgrades and only two downgrade in chemicals. Moreover, among the three chemical companies that could see credit upgrades due to improvements to liquidity and cash flow are Momentive Performance Materials Inc., backed by Apollo Management, and Polymer Holdings, backed by TPG and JPMorgan Partners.

The telecom industry, meanwhile, accounted for 25 transactions, just shy of 2 percent of all control-stake deals backed by U.S. sponsors in the past 24 months, according to Thomson Reuters. The aggregate revenue for telecom companies tracked by S&P rose by 5.3 percent between the end of 2007 and the third quarter of 2009, the ratings agency said. Meanwhile, of the four telecom defaults in 2009, only one was LBO-backed. Itegra Telecom, owned by Banc of America Capital Investors and Warburg Pincus, was hit with a selective default (‘SD’) rating in November, when it completed an out-of-court debt-for-equity recapitalization plan.

Looking ahead, S&P said it expects wireless operators to continue to focus on data services tied to smart phones to drive growth in the next few years because subscriber growth has begun to slip as the industry has matured. Cable television providers have been able to weather the recession considering that customers are reluctant to give up the service even as they reduce entertainment spending. Cable has also increased revenue through other sources, such as phone and high-speed Internet.

The telecom sector saw $10 billion in speculative-grade issuance through the first 11 months of the year compared to $3 billion in full-year 2008. Issuance could pick up in the speculative-grade sector over the next few years as issuers begin to refinance debt maturities. The median debt to EBITDA ration for telecom companies as of Sept. 30 was 4.8x, down slightly from 5.2x at the close of 2007, according to S&P.