Fitch Rates L-3 Communications' Proposed Notes 'BBB-'
NEW YORK -- May 13, 2014
Fitch Ratings assigns a 'BBB-' rating to L-3 Communications Corporation's
(L-3) proposed senior unsecured notes due in 2017 and 2024. L-3 plans to issue
a mix of three and 10-year notes totaling $1 billion which will rank equally
with the company's existing senior unsecured notes. Proceeds will be used to
redeem L-3 Communications Holdings' convertible contingent debt securities
(CODES) and for general corporate purposes. L-3's total debt will increase by
approximately $300 million and Fitch's ratings will cover approximately $3.9
billion of outstanding debt after the completion of the announced
transactions. The increase in leverage does not affect the ratings. The rating
Outlook is Stable. A full rating list follows at the end of this release.
Fitch expects to withdraw the 'BB+' ratings of the CODES upon their repayment.
The CODES are rated one notch below the company' IDR and senior unsecured debt
due to the subordination of the securities' guarantees. Upon the completion of
the transactions, L-3 Communications Holdings, Inc. will not have any
outstanding debt and L-3 will be the only entity with indebtedness within the
company's capital structure.
KEY RATING DRIVERS
Key factors that support the ratings include L-3's adequate credit metrics,
albeit somewhat weakened with the additional debt; strong liquidity position;
and Fitch's expectation of solid margins and substantial free cash flow (FCF;
cash from operations less capital expenditures and dividends). Other positive
factors include L-3's diverse portfolio of products and services, and L-3's
increasing percentage of international military and commercial sales which
accounted for 27% of sales in 2013, up from 24% and 18% in 2012 and 2011,
Most of the growth in L-3's non U.S. government sales was driven by higher
foreign military sales which comprised 14%, up from 11% in 2012. L-3's
commercial (both international and domestic) sales remained flat at 13% of
revenues in 2013. Fitch expects L-3's commercial sales will remain in the 13%
to 15% range for the near future, with moderate organic growth in
international military sales. A large increase in the percentage of
international and commercial sales in 2012 was partially driven by the
spin-off of Engility Holdings, Inc. (Engility), which reduced L-3's exposure
to the U.S. government spending.
Fitch's rating concerns include:
--L-3's declining revenues, which are expected to remain under modest pressure
for at least the next two years due to lower DoD spending and the continued
withdrawal of the U.S. troops from Afghanistan; and
--The company's cash deployment strategy, which includes a focus on dividends
and share repurchases, though this is mitigated by L-3's commitment to
maintaining a strong credit profile.
Fitch's concern with L-3's underfunded pension plans has lessened, with the
deficit declining to $570 million (81% funded) as of Dec. 31, 2013, from $1.2
billion (63% funded status) in the prior year. Fitch expects L-3's pension
status to improve in 2014 driven by the favorable interest rate environment.
Additionally, the company's strong cash generation mitigates pension concerns
as the required minimum contribution will not constitute a large portion of
L-3's FCF. The pension deficit is also mitigated by the expected
reimbursements from the U.S. government which treats a part of pension costs
of defense contracts as allowable and reimbursable costs.
Fitch expects L-3's credit metrics will deteriorate slightly due to the
announced debt issuance. The company's leverage (debt to EBITDA) has
deteriorated slightly over the past several years fluctuating in the range of
2.2x - 2.4x compared to the range of 2.0x - 2.2x over the prior five years.
Fitch expects the company's leverage will increase to approximately 2.7x after
the issuance of the new notes and the repayment of the convertible securities,
up from 2.4x as of Mar. 28, 2014. Fitch expects L-3's leverage will remain
within the range of 2.6x - 2.7x over the next several years. Despite the
expected leverage deterioration, Fitch believes L-3's credit metrics will
remain adequate for investment grade ratings.
The company's liquidity as of March 28, 2014 was $1.2 billion, consisting of
availability of all of its $1 billion credit facility (expiring in February
2017) and $227 million in cash and short-term investments. Fitch expects L-3
to maintain cash balances of approximately $400-$600 million and liquidity in
the $1.4 - 1.6 billion range over the next several years. L-3 has no debt
maturities through 2015 with the next material debt maturity in 2016 when $500
million of 3.95% senior unsecured notes are due.
The company generated negative $147 million of FCF in the first quarter of
2014, primarily driven by the timing of collections and an increase in
unbilled contracts receivables. L-3's cash generation is seasonal as the
company collects the majority of its cash during the second half of the year.
Despite the seasonality of cash flows, L-3 typically generates positive
quarterly FCF. In the last 12 months (LTM) ending Mar 28, 2014, the company
generated $663 million of FCF. Fitch estimates the company will generate
annual FCF (after dividends) in the range of $700 million - $800 million over
the next several years. L-3 reported approximately $850 million FCF in 2013
and $900 million (includes discontinued operations of approximately $50
million) in 2012.
Fitch's ratings and Outlook for L-3 incorporate expectations of meaningful
cash deployment toward shareholders. In the first quarter of 2014, L-3
deployed $133 million towards share repurchases and $55 million towards
dividend payments. L-3 has increased dividends by twenty cents per share
annually over the past five years. Fitch expects L-3 to maintain its
shareholder friendly cash deployment strategies and to continue increasing its
dividend yield. Fitch expects L-3 to deploy approximately $900 million to $1.1
billion toward shareholders annually.
L-3 contributed $105 million and $173 million to its pension plans in 2013 and
2012, respectively. The company expects to contribute approximately $97
million to its pension plans in 2014 and has already contributed $14 million
during the first quarter of 2014.
Fitch may consider a positive rating action should L-3 improve its credit
profile by decreasing leverage and moderating its shareholder friendly cash
deployment strategies. A negative rating action may be considered if L-3
completes a large debt-funded acquisition which weakens L-3's credit profile
or if there are dramatic changes in U.S. defense spending policies, but an
action would depend on L-3's efforts to reduce costs in line with lower
Fitch rates L-3 as follows:
L-3 Communications Holdings, Inc.
--Convertible contingent debt securities 'BB+'.
L-3 Communications Corporation
--Senior unsecured notes 'BBB-';
--Senior unsecured revolving credit facility 'BBB-'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Subsidiary Linkage' (Aug. 5, 2013);
--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT
Credit Analysis' (Dec. 23, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit
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David Petu, CFA, +1-212-908-0280
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
Craig Fraser, +1-212-908-0310
Brian Bertsch, New York, +1 212-908-0549
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