Baker Hughes Debt Rating Lowered

S&P says the oilfield services ginat's $275 million share repurchase program could constrain its ability to reduce debt

On Sept. 10, 2002, Standard & Poor's lowered its corporate credit rating on Texas-based, oil- and gas-field services company Baker Hughes (BHI ) to 'A-' from 'A' and its commercial paper rating to 'A-2' from 'A-1'. At the same time, Standard & Poor's revised the company's outlook to stable from negative.

The rating actions reflect expectations that Baker Hughes will maintain a financial profile more commensurate with the 'A-' rating category. The recently announced $275 million share repurchase program could constrain Baker Hughes' ability to continue its debt reduction initiatives in the near term.

In February 2002, Standard & Poor's revised its outlook on Baker Hughes' ratings to negative due to concerns that the company would continue to underperform rating category benchmarks. Although Baker Hughes has markedly improved its financial profile over the past few years, the company's financial profile had been weak for the 'A' category and its recently announced $275 million share repurchase program is likely to limit near-term capital structure improvement. Nevertheless, Baker Hughes remains well capitalized and has the financial flexibility to handsomely weather industry cycles.

Baker Hughes is among the top-three international oilfield services companies, providing a diversified array of equipment and services that address several phases of the petroleum exploration and production cycle. The company's product breadth and high technology content differentiate it from more limited providers.

However, since the acquisition of Western Atlas Inc. in 1998, Baker Hughes has been burdened with new debt and an ailing seismic business line (which was contributed to a joint venture with Schlumberger in late 2000). Baker Hughes has made notable progress in reducing its debt burden by roughly $1 billion since 1998. Total debt as of June 30, 2002 is roughly 35% of capital.

Nevertheless, Standard & Poor's also is concerned that the timing of the share repurchases could result in an increase in financial leverage. Despite challenging conditions in the North American oilfield services market, Baker Hughes is expected to generate roughly $500 million of operating cash flow in 2002. Assuming business conditions strengthen, the company could generate roughly $700 million to $750 million of annual operating cash flow in the medium term. However, after annual capital expenditures of $300 million to $350 million and annual dividends of about $150 million, the funding of the share repurchase program could require external financing without a sustained upcycle, the timing of which remains uncertain.

Standard & Poor's believes that cash flow and profitability protection measures will remain strong over the medium term, with EBITDA interest coverage averaging about 8.0 times (x) and EBIT interest coverage between 5.0x and 6.0x. Liquidity is considered strong, given the company's operating cash flow, cash on hand of $35 million, and access to $800 million of committed credit facilities as of June 30, 2002 ($262 million expires on Sept. 30, 2000; the remaining balance expires October 2003). Furthermore, debt maturities of $100 million and $270 million in 2003 and 2004, respectively, are manageable. As of June 30, 2002, the company has $140 million of commercial paper and short-term debt supported by its credit facilities.

The stable outlook reflects expectations that Baker Hughes will continue to maintain its conservative financial profile.

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