From Standard & Poor's RatingsDirect

Operational performance of the rated European business services companies -- the outfits that offer temporary workers, serve food in dining halls, and provide security personnel -- is in general expected to be stable in the near term. The companies in this group that carry credit ratings from Standard & Poor's have relatively stable demand for their services, and are mostly large diversified industry leaders.

In addition, positive industry characteristics include the prospect of continued growth due to ongoing outsourcing, as well as flexible cost bases and low capital intensity, which help generate healthy free operating cash-flow. These factors are to some extent offset by the industry's generally relatively low barriers to entry, which leads to fragmented markets and price competition.

There has been some increase in acquisition activity among rated companies in recent months. Staffing company Adecco S.A. has announced the acquisition of Germany-based competitor DIS. Rentokil Initial has announced its intention to increase acquisition activity, and recently bought U.S.-based pest control company JC Ehrlich. ISS A/S recently acquired the remaining 51% of the shares in Australia-based facility service provider Tempo Services, while Intertek Group almost doubled its spending on acquisitions in 2005, mostly in the second half of the year.


  With the exception of Rentokil Initial, the increased acquisition activities have so far not resulted in any material changes in Standard & Poor's view of the companies' financial profiles, nor led to any rating actions. Rentokil Initial's ratings were, however, lowered in November, 2005, partly reflecting the risk that cash-flows from acquisitions would not offset expected increased debt levels.

Following strategic reviews, there has also been increased disposal activity among rated companies in recent months. Securitas AB has announced a proposal to distribute its security systems, alarm, and cash-handling divisions to existing shareholders by way of a dividend, with the intention of increasing its focus on its core security service operations (primarily manned guarding).

Rentokil Initial has in recent months disposed of conferencing businesses, and is in the process of disposing of its manned guarding businesses, as well as closing its money-losing British linen and workwear activities. Compass Group PLC has announced plans to sell its travel concession business.


  Overall, the disposals do not materially affect the groups' business risk profiles, as the companies retain wide customer and geographical diversity in their main operations. In the cases of Securitas and Compass the loss of cash-flows from disposed businesses are expected to be mitigated by lower debt levels.

As business service companies' operations are primarily locally based (with local resources), the impact from the fluctuations in the U.S. dollar in recent years is mostly in the form of translation effects for those companies with large sales in U.S. dollars or dollar-linked currencies.

Foodservice companies should continue to display sustained organic growth of 5%-7% per year in the medium term, as current low outsourcing rates in health care, education, and defense offer scope for greater market penetration. Strong competition and obligations to provide healthier food in the education sector in Britain are, however, still putting pressure on margins, as evidenced by Compass' dismal operating performance in Britain in fiscal 2005.


  While 2005's Hurricane Katrina in the U.S. is expected to have a negligible effect on the main players' operating performance in fiscal 2006, any sign of a bird flu pandemic may provoke material disruptions in operations. Sourcing and other costs linked to bird flu are, however, not expected to significantly affect margins in fiscal 2006 if the bird flu scare remains relatively contained.

There have been no recent changes in the European market environment for cleaning and hygiene services (including washroom services). Markets vary significantly between countries, however. Overall, current growth rates are relatively modest, affected by the general soft macroeconomic conditions, and markets and prices are competitive, reflecting the fragmented nature of these segments.


  There is also an ongoing trend of combining these services with other facility services (for example, property and office support services) into integrated service contracts, a market which is growing faster than that for facility services. The companies most affected by these markets are ISS A/S and Rentokil Initial, and, to a lesser extent, Sodexho.

The European security services (primarily guarding) markets showed good growth during 2005 (about 3%-4%), and no major changes are expected in the near term. In general, growth is supported by outsourcing, high crime rates, increased attention to corporate crime, and a growing demand for specialized services. Airport security services are, however, facing increased costs from EU requirements for increased training. The rated companies affected by security services markets are Securitas and, to a much lesser extent, Rentokil Initial.

Below is a list of rated European companies in the sector, along with S&P's overview for each. Ratings are as of March 30, 2006:

Adecco S.A. (BBB-)

Adecco posted organic growth of about 6% in 2005, with general staffing showing some signs of weakness due to a soft and competitive French market. The group's EBITDA margin improved to 4% in 2005, vs. 3.8% in 2004, with an encouraging 20 bp improvement in gross margin to 16.9%.

Although the €700 million DIS acquisition is expected to leave the group's credit measures still strong for the rating at year-end 2006, the proposed replacement of Adecco's current CEO and CFO by DIS' may, however, result in some concerns over future management's ability to run a large multinational corporation and over the group's maintenance of a moderate financial policy in the medium term.

Compass Group PLC (BBB+)

Compass reported disappointing results for fiscal year ended Sept. 30, 2005, with a sharp 9% decline in EBITA linked to Middle-East defense contracts and operating underperfomance in Britain. Although the trend of deteriorating profitability has been visible in Britain over the past two years, we expect the company to rapidly restore operating margin in Britain.

The sale of Compass' Travel Concession business--representing about 16% of total sales and EBITDA and 20% of capital investments--is expected to take place in mid-2006. We expect the group to use the sale proceeds to significantly reduce debt.

Gate Gourmet Holdings (B-)

In March, 2006, Gate Gourmet successfully completed its debt restructuring through the issuance of Swiss franc 600 million (about $460 million) senior secured debt. The group's financial profile remains highly leveraged, however. Although the group expects weak cash flow generation in 2006, largely as a result of one-time restructuring costs and a large catch-up pensions payment, liquidity is expected to remain adequate.

Intertek Group (BBB-)

Near-term operating profits are expected to be negatively impacted by losses of inspection contracts in Venezuela and Nigeria, but the group's overall operating performance should continue to show relative stability in the near term. Increased acquisition activities are expected to continue to be largely covered by internally generated funds.

ISS A/S (B+)

Near-term operating performance is expected to remain stable. Acquisition activity should remain at a relatively high level, although individual acquisitions are expected to be relatively small in size.

Rentokil Initial (BBB)

Operating performance is expected to stabilize in 2006, and retention rates should gradually improve. The disposal of the manned guarding businesses have not materially affected the group's credit profile. Acquisition activity is expected to increase, and the group recently acquired JC Ehrlich, a U.S.-based pest control company.

Securitas AB (BBB+)

Operating performance in the European security services operations improved in the fourth quarter of 2005 after the negative impact in the previous two quarters from contract losses in the European airport security service business. Margins in the U.S. security services operations are also gradually improving. Near-term operating performance is expected to remain stable, although free operating cash flow is likely to see a seasonal decrease in the first quarter of 2006.

Sodexho Alliance S.A. (BBB+)

Sodexho recorded an acceleration in organic growth to 5.1% in the first quarter of fiscal 2006 on the back of strong heath-care markets in the U.S. and Continental Europe, ahead of the group's guidance for fiscal 2006 of 4.5%-5% growth. The continuing improvement at its British subsidiary, which has returned to sales growth during the past quarter, should contribute to an EBITA increase of more than 5% at the end of fiscal 2006.

We are currently reviewing the group's relationship with its core shareholder and family-owned holding company, Bellon. The review may raise some corporate governance and financial policy concerns over the existing Sodexho-Bellon relationship.

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