Fitch Expects to Rate Johnson Controls Senior Unsecured Notes 'BBB+'(EXP); Outlook Stable

CHICAGO--()--Fitch Ratings has assigned an expected rating of 'BBB+'(EXP) to the senior unsecured notes to be issued by Johnson Controls International plc (JCI) as part an exchange offer launched today. The notes will be exchanged for up to $6.6 billion of existing senior unsecured notes at JCI's subsidiaries including $4.4 billion at Johnson Controls, Inc. (JCI, Inc.) and $2.1 billion at Tyco International Finance S.A. (TIFSA).

Fitch has also assigned an expected rating of 'BBB+'(EXP) to an amended $2 billion bank credit facility, which would become effective upon completion of the exchange offer, under which JCI will succeed JCI, Inc. as principal borrower. In addition, Fitch has assigned JCI an expected Commercial Paper rating of 'F2'(EXP).

The Rating Outlook is Stable.

A full list of ratings follows at the end of this release.

EXCHANGE OFFER AND SOLICITATION

The exchange offer, which had been contemplated by JCI at the time of its merger with Tyco International plc (Tyco) in September 2016, is intended to consolidate JCI, Inc.'s and TIFSA's outstanding debt at the JCI level, which would simplify administrative and financial reporting requirements. The new notes will have interest rates and maturity dates that are identical to the tendered notes.

A related consent solicitation would amend indentures that govern existing debt. The solicitation proposes to eliminate various covenants, event of default provisions and various other terms. As a result, debt that is not tendered under the exchange offer would lack certain important protections, which will be available to note-holders under a new indenture after they accept the exchange offer.

Concerns about the proposed removal of certain terms is mitigated by JCI's solid financial position on a consolidated basis, strategic importance of the legacy JCI, Inc. and Tyco businesses to the combined company, and the future integration of certain parts of the company in order to realize synergies.

Fitch will assign final ratings upon completion of the exchange offer, which expires on Dec. 23, 2016.

Prior to the pending debt exchange, the largest portion of long-term debt is at the operating level, including $4 billion at TSARL and $4.8 billion at JCI, Inc. Each of these entities is owned directly or indirectly by TIFSA or TIFSA's direct parent, Tyco Fire and Security SCA (TSCA). Long-term debt at TSARL and JCI, Inc. is not guaranteed; however, JCI Inc.'s bank facility is currently guaranteed by JCI, TSCA and TIFSA.

Fitch rates debt at the operating and holding company level the same. Fitch considers JCI Inc.'s credit profile to be stronger than TSARL, but the difference is not sufficient to differentiate the ratings. TSARL has higher leverage, which Fitch expects will decline as TSARL directs excess cash flow toward debt reduction. Operating margins at TSARL and JCI, Inc. are roughly similar, and both companies have meaningful service and aftermarket business that mitigates their exposure to cyclical end markets.

Fitch estimates that nearly two-thirds of the merged company's EBITDA will be generated by JCI, Inc. while at least one-third of EBITDA will be at TSARL. Debt/EBITDA at TSARL will be in the high-2x range as estimated by Fitch, compared to a mid-2x range for the merged company and, prior to the debt exchange, around 2x or below for JCI, Inc. However, TSARL should generate sufficient free cash flow (FCF) to reduce debt and leverage beginning in fiscal 2017.

KEY RATING DRIVERS

The ratings incorporate Fitch's expectation that JCI's leverage could be somewhat higher through the first half of fiscal 2018 compared to long-term levels anticipated by Fitch due to integration actions and transaction related costs following the merger with Tyco. After the integration of Tyco is completed, Fitch expects JCI will maintain FFO Adjusted Leverage in a range near 3.5x and that debt/EBITDA could approach 2.5x as defined by Fitch. Other than leverage, some of JCI's characteristics, such as diversification and the overall operating margin when considering expected improvements, are consistent with 'A' category ratings.

Rating concerns include typical integration risks associated with the merger, restructuring costs to realign the combined company, a rapidly evolving automotive battery market served by Power Solutions, and future cash deployment for acquisitions and share repurchases. These concerns are offset by expected cost and tax synergies, which should support future margins and Fitch's expectation that acquisitions in the near term will be limited while JCI aligns the merged company. In addition, Power Solutions' strong competitive position and technical capabilities should enable it to participate in new battery technologies as they develop. Fitch believes legacy liabilities from Tyco's past separations are manageable due to previous actions to address asbestos and income tax litigation.

Fitch estimates JCI could use available cash to reduce debt to the mid $11 billion range during fiscal 2017, compared to $12.9 billion at the end of fiscal 2016 on a pro forma basis excluding Adient.

The ratings incorporate strong market positions within the merged company's fragmented building, fire and security markets, and the leading global market position for automotive batteries in the Power Solutions business. Fitch views leverage metrics as somewhat weak for the 'BBB+' rating; however, this concern is offset by solid market positions, steady FCF expected by Fitch following the merger, and financial flexibility including minimal limitations on available cash associated with the company's Irish domicile.

Fitch expects FCF will be adequate to fund modest discretionary spending for acquisitions, share repurchases and other uses while maintaining steady debt and leverage. Initially, FCF will be reduced during the first one-to-two years by merger related costs including restructuring and integration charges that should decline over time as the integration is completed. Fitch estimates FCF will reach 4% of sales or higher by the end of 2017 or in 2018.

The merger with JCI combined Tyco's fire and security business with JCI's building controls and HVAC business. The company's larger scale and broader technological capabilities should support its competitive position in fragmented markets, some of which are served by other large providers. Product development will be a key differentiator as digital technologies become increasingly important. JCI plans to expand margins over the next several years as it realizes at least $150 million of tax savings and $500 million of cost synergies through improved procurement and by consolidating overhead expenses. These amounts do not include an additional $400 million of productivity improvements underway at JCI and Tyco prior to the merger.

Other benefits from the merger include potential sales synergies, an expanded product and service portfolio, and the ability to provide and integrate data and connected systems. JCI estimates service and after-market business will be just over 40% of total revenue, helping to offset the impact of cyclicality in the company's building markets. JCI's building efficiency business and Tyco complement each other as they serve similar markets but do not necessarily overlap.

JCI has a strong automotive battery business, Power Solutions. Although Power Solutions is unrelated to the other businesses, it has the largest global market share among its competitors, generates solid margins, and is well positioned to generate growth through new technologies and in emerging regions. Approximately three-fourths of revenue is aftermarket business which supports margins and is relatively stable.

KEY ASSUMPTIONS

Fitch's key assumptions include:

--The exchange offer and consent solicitation are completed by the end of calendar 2016;

--Margins improve during the next several years as the merged company realizes tax savings, cost synergies between the legacy Tyco and JCI Building Experience businesses, and ongoing productivity improvements;

--The Power Solutions business maintains its leading global market share including participating in new technologies;

--Debt totals slightly more than $11 billion at the end of fiscal 2017;

--The company's long-term leverage remains within steady ranges, including adjusted debt/EBITDAR in the low 3x range and FFO adjusted leverage in the mid 3x range;

--FCF margin increases to around 4% of revenue or higher as restructuring and other transaction related costs decline and margins increase.

RATING SENSITIVITIES

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

--The integration of Tyco with JCI's Building Experience business leads to substantial gains in market share;

--Higher margins and steady debt levels lead to consistently higher FCF and lower leverage, including FFO adjusted leverage below 3x;

--FCF margin increases to 6% - 7% compared to slightly above 4% projected by Fitch.

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

--Inability to realize expected cost synergies and margin improvement during the next three years;

--Ineffective product development, particularly in the Power Solutions business, leads to loss of market share or lower margins;

--Leverage increases for more than a short period as a result of cash deployment for acquisitions or share repurchases, including FFO adjusted leverage above 4x or gross debt/EBITDA consistently above 2.5x.

LIQUIDITY

Liquidity at Sept. 30, 2016 included cash of $684 million, excluding $2 billion of cash in escrow for Adient debt, and availability under $3 billion of bank credit facilities. The facilities consist of a $2 billion facility at JCI, Inc. (to be transferred to JCI plc upon completion of the debt exchange) and a $1 billion facility at TSARL that each mature in 2020. The bank facilities back commercial paper. JCI's domicile in Ireland should minimize tax liabilities related to foreign earnings and enable the company to maintain relatively low cash levels at or below the $345 million balance reported by Tyco prior to the merger.

Fitch's calculation of debt includes any outstanding factored receivables, including non-recourse facilities. Scheduled maturities of long term debt are well distributed and do not exceed $600 million in any single year before 2026. Maturities are not affected by the exchange offer.

FULL LIST OF RATING ACTIONS

Fitch has assigned the following expected ratings:

Johnson Controls International plc

--Senior unsecured notes 'BBB+'(EXP);

--Senior unsecured revolving credit facility 'BBB+' (EXP);

--Commercial Paper 'F2'(EXP).

Fitch's existing ratings are described below:

Johnson Controls International plc

--Long-Term Issuer Default Rating (IDR) 'BBB+';

--Short-Term IDR 'F2'.

Tyco International Finance S.A.

--Long-Term IDR 'BBB+';

--Senior unsecured revolving credit facilities 'BBB+';

--Senior unsecured notes 'BBB+';

--Short-Term IDR 'F2';

--Commercial Paper 'F2'.

Tyco International Holding S.a.r.l.

--Long-Term IDR 'BBB+';

--Senior unsecured revolving credit facility 'BBB+';

--Senior unsecured term loan 'BBB+';

--Short-Term IDR 'F2';

--Commercial Paper 'F2'.

Johnson Controls, Inc.

--Long-Term IDR 'BBB+';

--Senior unsecured revolving credit facility 'BBB+';

--Senior unsecured notes 'BBB+';

--Short-Term IDR 'F2';

--Commercial Paper 'F2'.

The Rating Outlook is Stable.

Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings.

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

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1015417

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1015417

Endorsement Policy

https://www.fitchratings.com/regulatory

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Contacts

Fitch Ratings
Primary Analyst
Eric Ause
Senior Director
+1-312-606-2302
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Philip Zahn
Senior Director
+1-312-606-2336
or
Committee Chairperson
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Eric Ause
Senior Director
+1-312-606-2302
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Philip Zahn
Senior Director
+1-312-606-2336
or
Committee Chairperson
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com