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Fitch Assigns Final Ratings to Johnson Controls plc Notes; Affs & W/Ds Rtgs for JCI, Inc. and TIFSA
December 27, 2016 / 9:57 PM / a year ago

Fitch Assigns Final Ratings to Johnson Controls plc Notes; Affs & W/Ds Rtgs for JCI, Inc. and TIFSA

(The following statement was released by the rating agency) CHICAGO, December 27 (Fitch) Fitch Ratings has assigned final ratings of 'BBB+' to Johnson Controls International plc's (JCI) senior unsecured notes issued under its exchange offer that expired Dec. 23, 2016. The notes are being exchanged for $6.1 billion of senior unsecured notes at JCI's subsidiaries including $4.1 billion at Johnson Controls, Inc. (JCI, Inc.) and $2 billion at Tyco International Finance S.A. (TIFSA). JCI's new notes have interest rates and maturity dates that are identical to the tendered notes. Fitch has also assigned a final rating of 'BBB+' to an amended $2 billion bank credit facility which becomes effective upon completion of the exchange offer under which JCI succeeds JCI, Inc. as principal borrower. Fitch has assigned a final commercial paper (CP) rating of 'F2' to JCI that applies to a $2 billion U.S. program and a EUR2 billion CP program. Fitch expects JCI's initial CP issuance will include the amount used to replace outstanding CP balances at JCI, Inc. In addition, Fitch has affirmed the long-term and short-term ratings for Tyco International Holding S.a.r.l. (TSARL). Fitch has affirmed and withdrawn the 'BBB+' ratings for JCI, Inc. and TIFSA. The affirmation reflects JCI's solid financial position on a consolidated basis and the strategic importance of the legacy Johnson Controls and Tyco businesses to the combined company. The ratings are being withdrawn due to the lack of future financial reporting for JCI, Inc. and TIFSA and the removal of certain standard provisions in the note indentures including limitations on liens, change of control, and events of default. The removal of these provisions, which are available to holders of JCI's new notes, occurred following the receipt of consents related to the debt exchange. The Rating Outlook is Stable. A full list of ratings follows at the end of this release. EXCHANGE OFFER AND SOLICITATION The completion of the exchange offer on Dec. 23, 2016, which was contemplated by JCI at the time of its merger with Tyco International plc (Tyco) in September 2016, consolidates a large portion of JCI, Inc.'s and TIFSA's outstanding debt at the JCI level, and it simplifies administrative and financial reporting requirements. Approximately 93% of notes subject to the exchange offer were tendered. The amount of long-term debt outstanding after the exchange is slightly less than $300 million at JCI, Inc. and approximately $200 million at TIFSA. Fitch estimates that nearly 60% of JCI's consolidated debt is located at the parent level following the debt exchange on a pro forma basis after JCI refinances CP at JCI, Inc., just over 30% is at TSARL, with the remainder distributed among JCI's subsidiaries including JCI, Inc. and TIFSA. KEY RATING DRIVERS The ratings incorporate Fitch's expectation that JCI's consolidated 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 largely 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. Fitch estimates JCI could use available cash to reduce debt to the mid-$11 billion range during fiscal 2017, compared to $12.8 billion at the end of fiscal 2016 on a pro forma basis excluding Adient. Operating margins at the two operating businesses, TSARL and JCI, Inc., are roughly similar, and both businesses have meaningful service and aftermarket business that mitigates their exposure to cyclical end markets. Prior to any future restructuring or realignments, 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. TSARL's initial leverage is higher than leverage for JCI on a consolidated basis, but the difference is not sufficient to differentiate the ratings. Fitch estimates debt/EBITDA at TSARL in 2017 will be in the high-2x range compared to a mid-2x range for the consolidated company. However, Fitch expects debt and leverage at TSARL will decline as excess cash flow is directed toward debt reduction. 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 JCI's 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. 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 JCI's 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. Net pension liabilities totaled $1.9 billion (76% funded) as of Sept. 30, 2016, of which a small portion was allocated to Adient when it was spun off in October 2016. Pension contributions are possible in 2017 but the amount will partly depend on the level of interest rates, which were at low levels at Sept. 30, 2016. 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: --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% as 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. (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 CP. 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 were not affected by the exchange offer. FULL LIST OF RATING ACTIONS Fitch has assigned the following final ratings: Johnson Controls International plc --Senior unsecured notes 'BBB+'; --Senior unsecured revolving credit facility 'BBB+'; --Commercial paper 'F2'. Fitch has affirmed the following ratings: Johnson Controls International plc --Long-Term Issuer Default Rating (IDR) at 'BBB+'; --Short-Term IDR at 'F2'. Tyco International Holding S.a.r.l. --Long-Term IDR at 'BBB+'; --Senior unsecured revolving credit facility at 'BBB+'; --Senior unsecured term loan at 'BBB+'; --Short-Term IDR at 'F2'; --Commercial paper at 'F2'. Fitch has affirmed and withdrawn the following ratings: 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'. 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. Contact: Primary Analyst Eric Ause Senior Director +1-312-606-2302 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Philip Zahn Senior Director +1-312-606-2336 Committee Chairperson Jason Pompeii Senior Director +1-312-368-3210 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings. 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