Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve

Primary Credit Analysts: Taron Wade, London (44) 20-7176-3661; taron.wade@standardandpoors.com Raam Ratnam, London (44) 20-7176-7462; raam.ratnam@standardandpoors.com G.Andrew A Stillman, CFA, London (44) 20-7176-7036; andrew.stillman@standardandpoors.com Secondary Contact: Paul Watters, CFA, London (44) 20-7176-3542; paul.watters@standardandpoors.com

Table Of Contents
Heightened IPO Activity In Europe, With 2014 Likely To Be Even Stronger Higher Valuations, Pent-Up Private Equity Demand, And Economic Recovery Are Behind The Uptick Credit Metrics Improve After IPO Reductions In Private Equity Ownership Are Credit-Positive IPO Revival Set To Continue In 2014 Related Criteria And Research

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Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve
The IPO market in Europe has been grabbing headlines recently as more companies line up to tap the public markets. Private equity firms seeking exits from their investments are at the forefront of this trend. Standard & Poor's Ratings Services believes the reasons for this market revival are threefold. First, buoyant equity markets are making valuations attractive. Second, there is pent-up demand from private equity owners who have had few opportunities to exit their investments in recent years, and who want to take advantage of improvements in companies' operating performance. And third, the economy is gradually improving in Europe. We typically view IPOs as positive for credit quality, as they generally result in debt reduction, and the adoption of more prudent financial policies arising from a reduction in financial sponsors' ownership stakes. Overview The IPO market is resurging in Europe, with 13 billion in new equity floated in 2013, matching the 10-year average, according to S&P Capital IQ data. Business services and consumer-facing firms such as retail and leisure--the majority of which are private-equity owned--are leading this revival. Financial sponsors are looking for exits as part of phased ownership reductions. Typically, we see an improvement in the creditworthiness of companies tapping the IPO market. However, this is more likely to translate into upgrades for speculative-grade companies--those with corporate credit ratings of 'BB+' or lower.

Heightened IPO Activity In Europe, With 2014 Likely To Be Even Stronger

IPOs raised close to 13 billion in equity last year, matching the 10-year average in Europe in terms of both the number of deals and their total value (see chart 1). The market revival is set to continue this year, with about 14 private-equity owned companies eyeing offerings in 2014, according to S&P Capital IQ LCD. However, we are still some way off from the European IPO market's 10-year peak of 36 billion in 2007. For the moment, most of the activity is coming from private equity exits. Since the 2008-2009 global financial crisis, 80% of the rated companies that have completed an IPO have been private-equity owned. This compares with only 36% of rated companies in 2003-2008.

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Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve

Chart 1

Higher Valuations, Pent-Up Private Equity Demand, And Economic Recovery Are Behind The Uptick
From our perspective, there are three main reasons for the IPO market revival. First, the equity markets are proving buoyant, making valuations attractive for companies looking to list. The FTSEurofirst 300 index rose by 15.3% in 2013, on top of a 16.6% rise in 2012. The index is now 86.4% above its level at the start of 2009, but still about 17% below its 10-year market high in mid-2007. Valuations vary by sector, however, and there are certain sectors where investors believe future growth prospects are strong. These sectors include commercial and professional services; health care; information technology; consumer staples; and cable (see table 1). Even in the consumer discretionary and retail sectors, which have struggled throughout the economic downturn and where valuations are not as high, some companies are pursuing IPOs. Such companies have demonstrated strong cash generation and revenue growth despite the difficult economic environment (see chart 2). For example, we raised our long-term corporate credit rating on U.K. visitor attractions operator Merlin

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Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve

Entertainments PLC (Merlin) to 'BB' from 'B+ in February after it completed its IPO, partly to reflect our belief that the company will adopt a more moderate financial policy as a public company. The upgrade also reflected the resilience of Merlin's profitability to ongoing pressure on consumer spending and its recent debt reduction.
Table 1

Price-To-Earnings Ratio By Industry

CY2010 CY2011 CY2012 CY2013 Latest Commercial and professional services Health care Information technology Industrials (excludes services) Consumer staples Cable Materials Consumer discretionary (excludes cable) Transportation Utilities Real estate Telecommunications services Energy CY--Calendar year. 21.1 16.5 18.7 16.6 17.0 15.5 13.3 13.6 11.3 12.1 8.5 10.8 9.9 19.5 14.6 15.9 13.6 16.9 15.8 10.8 11.5 12.8 10.7 11.7 12.2 6.9 23.3 18.8 19.1 15.8 18.2 15.4 16.0 11.2 11.0 12.0 14.4 13.1 7.2 25.3 20.5 21.5 20.6 19.2 15.9 16.9 15.6 16.2 15.3 14.4 16.0 9.8 23.3 21.3 20.3 19.6 18.2 17.0 16.9 15.3 14.6 14.2 12.2 10.8 7.6

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Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve

Chart 2

The second cause we see of the recent IPO surge is pent-up demand from private-equity owners who are taking advantage of investor demand and improvements in companies' valuations and operating performance to exit their investments. For example, Denmark-based facility services provider ISS A/S is planning to float shares in a primary share issuance, after its attempt to do so in 2011 was cancelled at short notice due to market volatility. There is market optimism that the renewed IPO activity could lead to an uptick in overall mergers and acquisitions (M&A) activity as it will free up capital for private-equity firms to invest in new transactions. In some industries, such as cable and telecommunications services, companies are undertaking IPOs partly to raise funds for acquisitions. For example, France-based telecommunications holding company Numericable Group S.A.--a subsidiary of Altice S.A.--which completed an IPO in late 2013, recently expressed an interest in merging with Vivendi S.A.'s mobile operator SFR. However, the downside of this strategy is that improving asset valuations may make some M&A deals too expensive. The third reason we see for the pick-up in IPO activity is underlying optimism that Europe is emerging from recession and that the economy is starting to grow. Our view is that the recovery will remain uneven across Europe. Overall, we predict that real GDP will expand by just 0.9% in 2014. (For more details, see "Economic Research: These Green Shoots Will Need A Lot Of Watering," published Dec. 12, 2013, on RatingsDirect.)

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Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve

Credit Metrics Improve After IPO

Companies floating on the public markets are capitalizing on their stronger operating performance and taking the opportunity to establish more predictable financial policies. Deleveraging and a phased reduction in private equity ownership as a result of an IPO often lead to higher ratings for companies. We also see improvements to companies' management and governance frameworks in preparation for the greater oversight and fiduciary responsibilities that come with a public listing. Looking at the number of rated companies that completed IPOs over the past 10 years shows that IPOs tend to be credit-positive events: Of the 18 publicly rated companies that have completed IPOs since 2003, we have upgraded 10, and affirmed the ratings on eight. However, companies that we did not upgrade tended to have higher ratings before their IPOs. Of the companies whose ratings remained the same post IPO, over one-half had ratings of 'BBB+' or higher (see table 2).
Table 2

Issuers Rated By Standard & Poor's At Time Of Initial Public Offering 2003--Jan. 31, 2014
Target/Issuer Merlin Entertainments PLC (LSE:MERL) Numericable Group S.A. (ENXTPA:NUM) Deutsche Annington Immobilien SE (DB:ANN) KION GROUP GmbH (DB:KGX) Evonik Industries (DB:EVK) Kabel Deutschland Holding AG (DB:KD8) New World Resources N.V. (LSE:NWR) Strabag SE (WBAG:STR) Codere S.A. (CATS:CDR) Gerresheimer AG (DB:GXI) Rexel S.A. (ENXTPA:RXL) Smurfit Kappa Group PLC (ISE:SK3) Piaggio & C. SpA (BIT:PIA) Kloeckner & Co. S.E. (XTRA:KCO) Aroports de Paris (ENXTPA:ADP) Legrand S.A. (ENXTPA:LR) Electricite de France S.A. (ENXTPA:EDF) Telenet Group Holding N.V. (ENXTBR:TNET) Current S&P entity issuer credit rating BB B+ BBB BBBBB+ BBB+ CCC BBBD BBBBB BB* BBB+ A AA+ B+ Private equity owned (Y/N) Y Y N Y Y Y N N N N Y Y N Y N Y N Y Industry classifications Consumer discretionary Consumer discretionary Real estate Industrials Materials Consumer discretionary Materials Industrials Consumer discretionary Health care Industrials Materials Consumer discretionary Industrials Industrials Industrials Utilities Consumer discretionary Pre-IPO rating B+ NR NR B BBB+ B+ BBBB+ BBB+ B B+ B+ B+ AABB+ AAB+ Post IPO rating BB B+ BBB BBBBB+ BBBBBBBBBBB BB+ BBBBBB AABBBAAB+

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Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve

Table 2

Issuers Rated By Standard & Poor's At Time Of Initial Public Offering 2003--Jan. 31, 2014 (cont.)
Elia System Operator S.A./N.V. (ENXTBR:ELI) Belgacom S.A. (ENXTBR:BELG) AA N N Utilities Telecommunications services AAAAAA-

*Upgraded to 'BB+' on Feb. 28, 2014

Moreover, Standard & Poor's is rating more companies at the time of their IPO compared with the past 10 years. Of all the companies that have completed IPOs and requested ratings since 2003, we only rated 55% of them at the time of the offering. However, from January 2013 to the end of January 2014, 86% of companies already had ratings or were assigned ratings at the time of their IPO. We believe the increase reflects investors displaying a greater appetite for companies with positive operating performance trends and future growth prospects. Financial sponsors are also becoming more comfortable with disclosure in the European markets, evident from both public listings and the increase in high-yield bond issuance, both of which require shareholders to be less sensitive about public disclosure.

Reductions In Private Equity Ownership Are Credit-Positive

Our corporate rating methodology defines a company as financial-sponsor owned when 40% or more of the equity is owned by three or less financial sponsors who we consider control the company solely or together. Financial sponsors include private equity firms, but not infrastructure and asset-management funds, which maintain longer investment horizons. We view financial sponsors as entities that follow aggressive financial strategies in using debt and debt-like instruments to maximize shareholder returns. Typically, these sponsors dispose of assets within a short to intermediate time frame. Accordingly, the financial risk profile we assign to companies that are controlled by financial sponsors ordinarily reflects our presumption of an opportunistic approach to recapitalizing the business to maximize shareholder returns (see table 3). The extent of the financial sponsor ownership and our opinion on the future direction of the financial policies are very important from a rating perspective for speculative-grade companies. We consider that a reduction in a financial sponsor's ownership stake is generally beneficial for a company's credit profile. For example, our upgrade of Merlin after the completion of its IPO and subsequent debt reduction was partially due to the fact that private equity financial sponsors Blackstone Group LP and CVC Capital Partners reduced their equity positions in Merlin to 21.1% and 11.6%, respectively, as part of the IPO. Since these firms now have less than a 40% stake in Merlin, we no longer consider their ownership level to be a significant rating factor for the company. The reduction in both the financial sponsors' shareholdings and Merlin's debt, together with the appointment of four nonexecutive directors to Merlin's board should, in our opinion, lead the company to pursue a more moderate and predictable financial policy, particularly with respect to shareholder returns. However, if financial sponsor ownership is above the 40% threshold, we could still upgrade a company if we re-assess its financial policy as Financial Sponsor-4 ('FS-4') or 'FS-5' rather than 'FS-6' or 'FS-6 (minus)' (see table 4, in conjunction with our "Corporate Methodology," published Nov. 19, 2013). A financial sponsor-owned entity could

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Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve

receive an assessment of 'FS-5' in a small minority of cases. This assessment applies only when: we project that the company's leverage will be consistent with a '5' ("aggressive") financial risk profile; we perceive that the risk of releveraging is low, based on the company's financial policy and our view of the owner's financial risk appetite; and liquidity is at least "adequate." In even rarer cases, we could assess the financial policy of a financial sponsor-owned entity as 'FS-4'. For example, we placed ISS on CreditWatch positive in February 2014 after its IPO announcement to signal a possible upgrade following our review of the company's financial policy and capital structure post IPO. We estimate that if ISS used all the proceeds of the IPO to repay debt, the company's pro forma Standard & Poor's-adjusted debt to EBITDA for 2014 could drop toward 3x, with funds from operations (FFO) to debt rising to the low 20% area. These metrics are commensurate with a "significant" financial risk profile. Accordingly, we may revise our current financial policy assessment of 'FS-5' for ISS following the IPO. If we consider that ISS will continue deleveraging post the IPO, limit acquisition spending, and introduce a stable dividend policy, we could revise the financial policy assessment to 'FS-4'. (For more details, see "ISS A/S 'BB' Ratings Placed On CreditWatch Positive On Announced IPO And Proposed Deleveraging," published Feb. 20, 2014, on RatingsDirect.)
Table 3

Financial Policy Assessments

Assessment Positive What it means Indicates that we expect managements financial policy decisions to have a positive impact on credit ratios over the time horizon, beyond what can be reasonably built in our forecasts on the basis of normalized operating and cash flow assumptions. An example would be when a credible management team commits to dispose of assets or raise equity over the short to medium term in order to reduce leverage. A company with a 1 financial risk profile will not be assigned a positive assessment. Indicates that, in our opinion, future credit ratios wont differ materially over the time horizon beyond what we have projected, based on our assessment of managements financial policy, recent track record, and operating forecasts for the company. A neutral financial policy assessment effectively reflects a low probability of event risk, in our view. Indicates our view of a lower degree of predictability in credit ratios, beyond what can be reasonably built in our forecasts, as a result of managements financial discipline (or lack of it). It points to high event risk that managements financial policy decisions may depress credit metrics over the time horizon, compared with what we have already built in our forecasts based on normalized operating and cash flow assumptions. We define a financial sponsor as an entity that follows an aggressive financial strategy in using debt and debt-like instruments to maximize shareholder returns. Typically, these sponsors dispose of assets within a short to intermediate time frame. Accordingly, the financial risk profile we assign to companies that are controlled by financial sponsors ordinarily reflects our presumption of some deterioration in credit quality in the medium term. Financial sponsors include private equity firms, but not infrastructure and asset-management funds, which maintain longer investment horizons. Guidance If financial discipline is positive, and the financial policy framework is supportive

Neutral

If financial discipline is positive, and the financial policy framework is non-supportive. Or when financial discipline is neutral, regardless of the financial policy framework assessment. If financial discipline is negative, regardless of the financial policy framework assessment

Negative

Financial Sponsor*

We define financial sponsor-owned companies as companies that are owned 40% or more by a financial sponsor or a group of three or less financial sponsors and where we consider that the sponsor(s) exercise control of the company solely or together.

*Assessed as FS-4, FS-5, FS-6, or FS-6 (minus).

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Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve

Table 4

Financial Risk Profile Implications For Sponsor-Owned Issuers

Assessment FS-4 What it means Financial risk profile set at '4' Guidance Issuer must meet all of the following conditions. Other shareholders must own a material (no less than 20%) stake. We anticipate that the sponsor will relinquish control over the medium term. For issuers subject to standard volatility, debt to EBITDA is less than 4x, and we estimate that it will remain less than 4x. For issuers that are subject to medial volatility, debt to EBITDA is below 4.5x and we forecast it to remain below that level. Or for issuers subject to low volatility, debt to EBITDA is less than 5x and our estimation is it will remain below that level. The company has indicated a financial policy stipulating a level of leverage consistent with a significant or better financial risk profile (that is, debt to EBITDA of less than 4x when applying standard volatility tables, 4.5x when applying medial volatility tables, or less than 5x when applying low volatility tables). We assess liquidity to be at least adequate, with adequate covenant headroom. Issuer must meet all of the following conditions. For issuers subject to the standard volatility table, debt to EBITDA is less than 5x, and we estimate that it will remain less than 5x. For issuers that are subject to the medial volatility table, debt to EBITDA is below 5.5x and we forecast it to remain below that level. Or for issuers subject to the low volatility table, debt to EBITDA is less than 6x and our estimation is it will remain below that level. We believe the risk of leveraging beyond 5x (standard volatility issuer), 5.5x (medial volatility issuer), or 6x (low volatility issuer) is low. We assess liquidity to be at least adequate, with adequate covenant headroom. Standard & Poor's debt to EBITDA is greater than 5x (when applying the standard volatility table), greater than 5.5x (when applying the medial volatility table), or greater than 6x (when applying the low volatility table). However, we believe leverage is unlikely to increase meaningfully beyond these levels. In determining the anchor the financial risk profile is a '6', but we believe the track record of the financial sponsor indicates that leverage could increase materially from already high levels.

FS-5

Financial risk profile set at '5'

FS-6

Financial risk profile set at '6'

FS-6 (minus)

Financial risk profile set at '6', and anchor reduced by one nothc (unless this results in a final rating below 'B-')

IPO Revival Set To Continue In 2014

We expect the recent resurgence in IPO activity to continue throughout the year, barring any potential economic or market shocks. We believe that companies and private-equity owners will continue to take advantage of the opportunity to divest investments that have performed well, including those that are leaders in their market segments and would therefore not be as suitable for trade sales or secondary buyouts.

Related Criteria And Research

Related Criteria:
Corporate Methodology, Nov. 19, 2013 Companies Owned By Financial Sponsors: Rating Methodology, March 21, 2013

Related Research:
ISS A/S 'BB' Ratings Placed On CreditWatch Positive On Announced IPO And Proposed Deleveraging, Feb. 20, 2014 Visitor Attractions Operator Merlin Entertainments Upgraded To 'BB' On IPO And Debt Reduction; Outlook Stable, Feb. 7, 2014 Economic Research: These Green Shoots Will Need A Lot Of Watering, Dec. 12, 2013 Inside Credit: European Leveraged Issuance Is On The Up, But Recaps Are Pushing Credit Quality Lower, Dec. 10,

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Inside Credit: Private-Equity Owners Lead The European IPO Resurgence As Company Valuations Improve

2013 Inside Credit: Telecoms Buck The Trend As Caution Prevails In European M&A, Oct. 30, 2013 Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.
Additional Contact: Industrial Ratings Europe; Corporate_Admin_London@standardandpoors.com

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