Fitch Affirms Magnesita's IDRs at 'BB' Following Merger Announcement; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed Magnesita Refratarios S.A. (Magnesita)' Long-Term Foreign- and Local-Currency Issuer Default Rating (IDR) at 'BB' and National Scale Ratings at 'AA-(bra)' following the announcement that RHI AG (RHI) and the controlling shareholders of Magnesita have reached an agreement to combine their operations, creating a leading global refractory company. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

Fitch views this proposed transaction as positive for Magnesita's business profile as it would enhance the company's market position and geographic and product diversification. These factors should improve the company's pricing position in the very fragmented refractory industry and allow it to better withstand downturns in the steel cycle. Production costs and overhead costs should also decrease due to synergies from a merger of the second and third largest companies in the industry.

The exposure of a combined company to the steel industry, with expected revenues projected to remain around 70%, remains a credit constraint, as is a slight uptick in leverage due to the additional debt needed by RHI to fund the transaction. As of June 30, 2016, on proforma basis, including a complete tender by the minority shareholders of Magnesita, the merged entity's consolidated net leverage is projected by Fitch to be 3.9x. This compares with Fitch's forecasted stand-alone net leverage for Magnesita to be 3.4x in 2016 and 3.1x in 2017.

The transaction will be funded by a mix of equity and debt. RHI will acquire a controlling stake of at least 46%, but no more than 50% plus one share of the entire share capital in Magnesita, for EUR 118 million and 4.6 million new shares to be issued by RHI Magnesita. RHI will also follow up with a complete tender offer to Magnesita's minority shareholders in an amount of around BRL814 million (EUR279 million). The transaction is expected to close by end of 2017, subject to shareholders and certain regulatory approvals, and other customary conditions. Both companies will remain completely separate and independent until then.

KEY ASSUMPTIONS

--Magnesita will continue to operate and search for funding on a stand-alone basis, with no credit support from RHI.

--Low-digit revenue growth from 2016 onward;

--Softer but still resilient EBITDA margins - EBITDA margin in the 14% - 15% range);

--Capex at around BRL220 million in 2016, with a slight decline to BRL207 million in 2017 and BRL230 million in the next two years;

--Dividends at 25% from 2017 onwards;

--Cash balance remains sound compared to short-term debt;

--Reserve life replenished annually;

--No large-scale M&A activity.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--An upgrade is unlikely in the medium term due to the sluggish outlook for the global steel industry and Magnesita's still weak operating cash flow basis compared to issuers in the 'BB' rating.

Negative: Future developments that may, individually or collectively, lead to a negative rating action:

--Prolonged downturn in the cyclical steel and cement markets that hampers production volumes globally more than expected;

--Market share erosion in Brazilian market;

--EBITDA margins declining below 14% on a sustained basis;

--Failure to reduce net adjusted leverage below 3.5x;

--Deterioration of adequate liquidity compared to short-term debt, leading to refinancing risk exposure;

--Large debt-funded M&A acquisition that adversely impacts Magnesita's capital structure on a sustained basis.

LIQUIDITY

Magnesita's liquidity is adequate. As of June 30, 2016, the company had BRL2.6 billion of debt, of which BRL536 million is due in the short term, while cash and marketable securities was solid at BRL752 million. The company's cash position is enough to meet all current debt maturities through 2017. Fitch expects the company to access the credit market during 2017 in order to refinance maturities coming due in 2018 and 2019. Positively, Magnesita has demonstrated proven access to export credit lines that could also be an alternative source of future funding. The company's inability to carefully avoid refinancing risk within the near term, may pressure its ratings.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Magnesita Refratarios S.A.

--Long-Term Foreign Currency IDR at 'BB';

--Long-Term Local Currency IDR at 'BB';

--National Long-Term rating at 'AA-(bra)';

--Local Debentures Issuance at 'AA-(bra)'.

Magnesita Finance Ltd.

--Senior unsecured ratings at 'BB'.

The Rating Outlook is Stable.

Date of Relevant Rating Committee: [06, October, 2016.]

Additional information is available on www.fitchratings.com.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012789

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or
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or
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or
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Contacts

Fitch Ratings
Primary Analyst
Debora Jalles
Director
+1-312-606-2338
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Alejandra Fernandez
Director
+562-499-33-23
or
Committee Chairperson
Joe Bormann, CFA
Managing Director
+1-312-368-3349
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com