Fitch Removes Eaton from Watch Negative & Downgrades IDR to 'BBB+'; Outlook
CHICAGO -- November 08, 2012
Fitch Ratings has removed Eaton Corporation (Eaton) from Rating Watch Negative
and downgraded the Issuer Default Rating (IDR) and long-term ratings to 'BBB+'
from 'A-'. TheR Outlook is Negative. Eaton's short term IDR and commercial
paper rating are affirmed at 'F2'. A full rating list follows at the end of
The downgrade of Eaton's long-term ratings reflects the anticipated increase
in the company's debt and leverage associated with its pending acquisition of
Cooper Industries plc (Cooper). Upon closing of the acquisition, Fitch expects
to downgrade Cooper by two notches from 'A' to 'BBB+'. Fitch placed Cooper's
ratings on Negative Watch in May 2012 when the transaction was announced.
The acquisition price is approximately $11.8 billion, not including
approximately $1.4 billion of debt at Cooper as of Sept. 30, 2012 that will be
guaranteed by Eaton. The transaction has been approved by shareholders of both
companies and is expected to close during the fourth quarter of 2012, pending
final regulatory approvals. Eaton plans to fund the transaction with equity,
available cash, and approximately $5.1 billion of new debt. Fitch estimates
pro forma debt/EBITDA at closing will be approximately 3.3x compared to
Eaton's standalone leverage of 1.84x at Sept. 30, 2012.
The Negative Outlook reflects the potential for sustained high leverage if
Eaton is unable to realize expected synergies following its acquisition of
Cooper, or if financial results are pressured by a slowdown in Eaton's
electrical and other industrial end markets. Some of Eaton's key end markets
are experiencing weaker demand including heavy duty trucks, construction
equipment, certain international electrical markets, the aerospace aftermarket
and the automotive market in Europe. Eaton has taken steps to reduce its cost
structure in the truck and international electrical businesses which should
mitigate the negative impact of volume pressure on margins. Other rating
concerns include normal integration risks, the negative impact on leverage if
Eaton makes additional debt-funded acquisitions in the near term, which Fitch
believes is unlikely, and the company's sizeable underfunded pension
Eaton's leverage, adjusted to include the impact of the Cooper acquisition, is
weak for the ratings, but Fitch anticipates the company will use available
cash primarily to reduce debt and return credit metrics to stronger levels
within two to three years. Fitch estimates debt/EBITDA will decline toward
2.75 during 2013 and below 2.5x by the end of 2014. Leverage could be around
2.0x or lower by the end of 2015. Eaton could reduce leverage more quickly if
it realizes expected cost and revenue synergies with Cooper and sees a
recovery in its end markets. However, the anticipated reduction in leverage
could be delayed if economic conditions weaken further or if margins improve
more slowly than anticipated across the combined company, possibly
contributing to a further downgrade of the ratings.
Eaton's 12-month pro forma free cash flow after dividends, including Cooper,
was nearly $1.1 billion at Sept. 30, 2012. Free cash flow should benefit from
ongoing actions to improve margins at Eaton's existing businesses and the
absence of Eaton's $154 million contribution to a VEBA trust in 2011. After
2012, cash flow and profitability should improve as Eaton integrates Cooper.
Eaton estimates cost synergies at $260 million annually within four years, and
estimates annual cash management and tax benefits of approximately $160
million. Eaton also expects to realize sales synergies. These benefits will be
offset by estimated acquisition integration costs totaling $200 million
FCF will continue to reflect material pension contributions associated with
Eaton's U.S. pension plans which were underfunded by $1.2 billion at year end
2011. Non-U.S. plans were underfunded by $516 million. Cooper's net pension
liability was much smaller at $137 million.
Both Eaton and Cooper have solid operating profiles. The combined company can
be expected to generate consistent profits and free cash flow over the long
term, although exposure to cyclical end markets can temporarily affect
short-term results. Slightly more than half of Eaton's pro forma revenue will
be in the electrical sector, and approximately 25% of sales of the combined
company will be located in emerging markets. Both companies make a wide range
of electrical components used in industrial, utility, commercial and
government applications with minimal product overlap. Cooper's revenue,
margins and free cash flow are benefiting from demand related to global
industrial and energy projects, offset by weakness in Europe and in U.S.
Eaton's liquidity at Sept. 30, 2012 included $1 billion of cash and short-term
investments, approximately half of which was located overseas where it is
considered to be permanently reinvested. Liquidity included full availability
under three revolvers totaling $2.0 billion. The revolvers will remain in
place following the acquisition of Cooper. The facilities include a limitation
on debt-to-capitalization of 0.6x that becomes effective if Eaton's ratings,
as defined in the agreements, are lower than 'A-'. Eaton also has a $6.75
billion bridge facility which is available to provide temporary liquidity
during the Cooper acquisition process.
Liquidity was offset by $415 million of short-term debt and current maturities
at Sept. 30, 2012. Pro forma liquidity will be supported by proceeds to be
received from the divestiture of Apex Tool Group expected to close in the
first half of 2013 for a total price of approximately $1.6 billion. Apex is a
tool business operated as a joint venture and owned equally by Cooper and
WHAT COULD TRIGGER A RATING ACTION
Positive: An upgrade is unlikely in the near term, but future developments
that may, individually or collectively, lead to a stable rating outlook
--Stronger earnings and FCF that would enable Eaton to reduce leverage
consistently during the next 12-18 months;
--An effective integration of Cooper that supports growth in combined market
share and improved competitive position;
--Realization of higher, sustainable margins across the combined company.
Negative: Future developments that may, individually or collectively, lead to
a negative rating action include:
--Slower-than-anticipated reduction in leverage that could result from reduced
free cash flow or material discretionary spending for acquisitions or share
--A further slowdown in Eaton's end markets that could impair financial
--Failure to realize expected acquisition synergies, or unexpected challenges
Fitch has downgraded Eaton's long term ratings as follows:
--IDR to 'BBB+' from 'A-';
--Senior unsecured bank credit facilities to 'BBB+' from 'A-';
--Senior unsecured long-term debt to 'BBB+' from 'A-';
Fitch has affirmed Eaton's short term ratings as follows:
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
Approximately $4.1 billion of debt was outstanding at Sept. 30, 2012.
Additional information is available at 'www.fitchratings.com'. The ratings
above were solicited by, or on behalf of, the issuer, and therefore, Fitch has
been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', Aug. 8, 2012;
--'Parent and Subsidiary Rating Linkage', Aug. 8, 2012;
--'Short-Term Ratings Criteria for Non-Financial Corporates', Aug. 9, 2012.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Short-Term Ratings Criteria for Non-Financial Corporates
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