Published: May 01, 2014
During the weeks leading up to the public announcement of a major acquisition, the senior managers of a publicly rated company will be focused on transaction related aspects such as valuation and purchase price, financing, due diligence, statutory filings, legal agreements, employee and customer strategy, IT plans, and shareholder and debt holder approvals. In this intense period, the credit rating process may consciously or inadvertently become a secondary priority. This is a risky strategy as it increases the possibility of a negative rating action and is sub-optimal from a workflow perspective. This article sets out an approach for dealing with the rating agencies and the process for evaluating the potential impact on a company’s credit rating. Although the focus is on acquisitions, the main messages also apply to other major events that companies may initiate such as disposals, changes in business or geographical mix, and changes in capital structure. This article applies to companies that have at least one ‘solicited’ public credit rating for which they pay a fee to a rating agency, supply it with information during regular meetings and calls, and have a confidentiality agreement in place.
1. Before the public announcement of an acquisition
When a company announces a material acquisition, the company’s rating agency is likely to publish a press release setting out their initial view on the transaction, including the rating action if and when the transaction completes. Therefore the company should contact the rating agency well before any public announcement about the acquisition to get an understanding of the potential rating agency action.
The company’s managers should contact their usual rating agency analyst and provide an outline of the proposed transaction. They should also use the opportunity to:
a. Seek feedback from the agency analyst about the potential impact of the transaction. The analyst cannot give advice and also cannot speak for the rating committee, which will make the decision about the rating impact, although the analyst should at least be able to state how the agency will apply their rating criteria for such a transaction and potential areas of focus
b. Ask the rating agency analyst about the agency process including the information that they require and the timing of agency announcements. In particular the company should confirm how much time that it will have to review agency draft press releases and when they will be provided to the company
c. Confirm details about the agency Rating Evaluation Service/Rating Assessment Service (RES/RAS) including the cost and timing, see below.
The company should approach the agency only when there is a high degree of certainty that the acquisition will go ahead and when the main parameters of the transaction structure have been set. However the company should not leave it too late especially if it wants to make use of the RES/RAS product as it could take two or three weeks for agency feedback.
After the initial contact with the rating agency analyst, the senior management of the company should meet with the agency to explain in detail the transaction including the rationale, benefits and risk management, and to gain feedback although this may be limited unless the RES/RAS product is used. See below for further details on the information provision.
The agency will use the information provided to set out their view in their public announcement. Usually this will be in the form of a ‘Watch’ or ‘Review’ statement as the acquisition may still require shareholder/regulatory approvals and financing. The company and the agency should agree the process for making their respective public announcements on the day that the acquisition is announced to the market. Typically the company will make their announcement first followed shortly afterwards by the agency announcement.
The agency press release will be given to the company as a draft so that it can check it for accuracy and to ensure that it doesn’t contain information that should still remain confidential on the date of publication. The company should also carefully review the opinions in the press release and if it disagrees will need to decide whether to appeal the agency decision. It will need to discuss with the agency whether the agency will allow the appeal under their processes.[[[PAGE]]]
2. After the acquisition has been announced and before completion
The company should meet with the agency again before completion to inform it if there have been any changes in the transaction structure or process and to understand if the views of the agency are still in line with its earlier announcements and feedback. The company should use the opportunity to again set out the rationale and benefits of the acquisition and how it will manage the potential risks.
Prior to the day of completion, the company and the agency should co-ordinate their public announcements and the company should review the draft press release provided by the agency.
3. After completion of the acquisition
After completion of the acquisition, the company should continue to update the agency about the acquisition, for example on the progress on integration and actual performance against the forecasts presented to the agency. Some of these updates should be given during the regular meetings with the agency.
Regular communication with the rating agency analysts, especially before major events, helps to strengthen the long-term relationship with the agency as well as provide the opportunity to gain valuable feedback from the agency analysts.
A material acquisition could result in a downgrade if the rating agency believes that the risk profile of the company will increase, for example, because of increased financial leverage or if they believe management doesn’t have the experience to manage the integration. Prior to any public announcement and before approaching the rating agency, the company should model the potential impact of the transaction on its rating. It may choose to use a ratings advisor to help with this. The company can use the following sources to help with its analysis:
There can be no certainty that the in-house modelling of the acquisition will be accurate, since the decision of the rating committee cannot be predicted with total confidence. However this is still an essential exercise as it will provide information to management on the feasibility of the transaction and which options are available to it. Additionally it will be valuable preparation for the meeting with the rating agency.
All the major rating agencies have a product which will provide the company with a confidential rating committee decision on the outcome of a proposed acquisition. Standard and Poor’s calls it a Ratings Evaluation Service (RES) while Moody’s and Fitch call it a Ratings Assessment Service (RAS). This product also allows the company to model a number of scenarios such as differing amounts of leverage. The exact cost of the service depends on the complexity of the acquisition, required time for response and the number of scenarios but is of the order of €150,000. After the company has provided the information on the acquisition and scenarios, it could take the agency two or three weeks to come to a decision, although they can provide it sooner if required depending on their capacity. The agency will provide the rationale behind its decision as well as the rating outcome.
It is vital that the company chooses the optimal combination of scenarios in order to maximise the information received from the RES/RAS process. If all scenarios give the same rating outcome then it is likely that the scenarios have all been too cautious or too risky.
Although the RES/RAS product offered by the rating agencies is similar, there may be some differences and so the company should confirm the following with each agency:
1. For which type of acquisition can the product be used e.g., hostile or friendly, rated target or unrated target?
2. In the case of a friendly takeover, what permission is required from the target if any?
3. As the RES/RAS report is confidential, how widely can the results be disseminated amongst the company’s advisers?
4. What are the conditions under which the company can go back to the agency with further scenarios after the results of the first set of scenarios?
The company should provide comprehensive information to the agency ahead of the public announcement in the form of a presentation during a physical meeting with the rating agency analysts so that there are no misunderstandings or information gaps. This is the case whether the RES/RAS product is used or not. The meeting also allows the agency analysts to ask questions and fully explore the transaction with the senior management of the company.
Prior to the meeting, the company should get a question list from the agency so that the company can prepare for the meeting. The answers to the agency questions should be seen as the minimum requirements for the presentational materials. The company should ensure that all relevant information including all the advantages of the transaction is fully detailed.
The company should tailor the information provided to the rating agency, for example by using the agency rating criteria, and not simply copy the information to be provided to other stakeholders such as equity investors who will have a different perspective.[[[PAGE]]]
The materials presented to the agency will include:
The agency will use their normal criteria in analysing the acquisition but will have additional areas of focus, see Table 1.
The rating agency process should be tied into the other transaction work streams at the company during the acquisition process:
1. Deal team members
The team member responsible for the rating agency process should be clearly identified and held accountable for all aspects of the process including the evaluation of rating impact and communication with the rating agency
2. Key agency dates
The key rating agency dates (initial agency contact, agency meetings, agency rating committee dates, and agency announcements) should be noted and put in the overall transaction timetable
3. Financial Models
The typical rating agency ratios (for example interest coverage, leverage) should be included at the outset in the financial models built to analyse the acquisition
4. Presentation materials
The key presentation slides for the rating agency meeting should be identified early in the process and they should be produced at the same time, if possible, with other work stream materials to avoid duplication of effort.
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