Moody's Updates Johnson Controls (JCI), Downgrades Tyco (TYC) Ratings

August 31, 2016 2:02 PM EDT

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Moody's Investors Service ("Moody's") downgraded the senior unsecured rating of Tyco International Finance S.A. ("TIFSA") to Baa1 from A3 and affirmed its P-2 short-term rating;, and upgraded the senior unsecured rating of Johnson Controls, Inc. ("JCI") to Baa1 from Baa2 and affirmed its P-2 short-term rating. Moody's also assigned first time ratings to Tyco International Holdings S.a.r.l. ("TSARL") with a senior unsecured rating of Baa1 and P-2 short-term rating. The rating outlook for all issuers is stable. The action on TIFSA completes the review of its senior unsecured rating initiated on January 25, 2016 upon the announcement of the agreement to merge with JCI.

Tyco and Johnson Controls are expected to close their merger on or about September 2, 2016.


..Issuer: Tyco International Finance S.A.

....Multiple Seniority Shelf, Downgraded to (P)Baa1 from (P)A3

....Senior Unsecured Regular Bond/Debenture, Downgraded to Baa1 from A3


..Issuer: Tyco International Finance S.A.

....Senior Unsecured Commercial Paper, Affirmed P-2

..Issuer: Johnson Controls, Inc.

....Senior Unsecured Commercial Paper, Affirmed P-2


..Issuer: Johnson Controls, Inc.

....Issuer Rating, Upgraded to Baa1 from Baa2

....Senior Unsecured Medium-Term Note Program, Upgraded to (P)Baa1 from (P)Baa2

....Senior Unsecured Regular Bond/Debenture, Upgraded to Baa1 from Baa2


..Issuer: Tyco International Holdings S.a.r.l

....Senior Unsecured Bank Credit Facility, Assigned Baa1

....Senior Unsecured Commercial Paper, Assigned P-2

Outlook Actions:

..Issuer: Tyco International Finance S.A.

....Outlook, Changed To Stable From Rating Under Review

..Issuer: Tyco International Holdings S.a.r.l

....Outlook, Assigned Stable

..Issuer: Johnson Controls, Inc.

....Outlook, Changed To Stable From Positive


Moody's believe that the combination of Tyco's fire and security and JCI's building efficiency businesses will improve the competitive position and earnings of these businesses, as benefits from integration are realized with passing time. The ratings are balanced by the execution risk in the integration of the operations and the potential for some continuing pressure on top line growth as global economic growth remains tepid and the US dollar relatively strong.

Tyco will pay JCI shareholders $3.9 billion pursuant to the merger agreement. A new unrated $4 billion term loan arranged by TSARL will fund this payment. Tyco International plc, the guarantor of TIFSA's rated debt will change its name to Johnson Controls (JC plc). The re-named ultimate parent company will not guarantee JCI's existing notes but will continue to guarantee TIFSA's notes. There will be no contractual support of TSARL's obligations from any entity of the combined company. Only TSARL's cash flows or proceeds from dispositions of its assets or business will service its debt.

The ratings are based on TSARL and of Johnson Controls separately, but for Johnson Controls with the addition of TIFSA's $2.1 billion of public debt. Moody's anticipates that JCI's registered notes will be exchanged for notes of TIFSA ("the Exchange") within months of the merger, in order to streamline the debt capital structure. Doing so would reduce the extent of structural subordination of TIFSA's debt vs obligations of TSARL and of JCI that will exist when the merger closes.


TSARL is the direct intermediate holding company parent of Tyco's operating subsidiaries. The Baa1 rating reflects Tyco's considerable scale, global presence, diversified customer base and leading positions in fire protection and security products and services. Moody's expects steady profitability and annual free cash flow of between $400 million and $700 million in upcoming years. The merger initially boosts TSARL's funded debt and financial leverage. However, Moody's expects improved reported operating and free cash flow from fiscal 2017 since Tyco resolved two major contingencies in the past 12 months, the IRS dispute over deductibility of interest on intercompany debt and asbestos claims of former subsidiary, Yarway. Although Debt to EBITDA will be about 2.9x initially, Moody's expects the company to reduce the term loan obligation with all of free cash flow, leading to stronger metrics by the end of calendar 2017. Moody's estimates de-leveraging of about half a turn per year before the application of proceeds of any asset sales.


The Baa1 rating assigned to the existing TIFSA notes is based on a more streamlined debt capital structure that Moody's anticipates will be in place by March 2017, if not by December 2016.

Adding the $4 billion of TSARL debt to Tyco's pre-merger organization and capital structures subordinates TIFSA's notes. The TIFSA notes will also be subordinated to the existing JCI notes prior to the Exchange. We anticipate about $4.8 billion of JCI notes following the spin-off of JCI's automobile supplier business, Adient, expected to occur in October 2016. Following the Exchange, which is likely to occur soon after the Adient spin; the extent of subordination of the pre-merger TIFSA notes will meaningfully decrease as holders of the higher amount of TIFSA debt will then have a direct claim on the earnings and assets of the JCI operations.

Excluding JCI but including the TSARL debt, Debt to EBITDA will be about 4 times at 30 September 2016 using only TSARL's earnings, high for the Baa1 rating category. Moody's estimates Debt to EBITDA of about 3.2x pro forma following the Exchange and about 2.5x at the end of fiscal 2017, using the earnings of only the JCI operations. Interest only debt service of the existing TIFSA debt will be funded from dividends from TSARL before the Exchange and from TSARL and JCI operations following the Exchange.

Johnson Controls

The upgrade of JCI to Baa1 reflects the progress the company has made in expanding its position in the building efficiency segment, while at the same time divesting its highly cyclical and low-margin automotive parts operation. Moreover, the integration with Tyco will enable JCI to offer customers a much more competitive suite of product offerings, and achieve considerable cost efficiencies.

JCI's Baa1 rating anticipates that the Exchange of JCI debt for TIFSA debt will take place shortly. This exchange will effectively increase the amount of adjusted debt supported by the JCI assets by $2.1 billion (from $6.5 billion to $8.6 billion), and will increase its June 30, 2016, pro-forma ratio of debt to EBITDA (reflecting Moody's standard adjustments) from 2.6x to approximately 3.3x. Notwithstanding this near-term rise in leverage, we expect that revenue and cost synergies will enable JCI to reduce leverage to under 3 times by 2017.

The stable outlooks across the companies reflect Moody's expectation of strengthening credit metrics at TSARL and at the rest of the company. Earnings will improve with achievement of cost synergies, which, at the company's estimate of $500 million (about 1.5% of consolidated revenues), are modest; the removal of JCI's lower margin automotive supply business; importantly, the prioritization of the payoff of the TSARL term loan to further rationalize the debt capital structure and move towards eliminating the structurally senior position of TSARL's debt; and from revenue synergies from cross-selling, which Moody's did not include in its financial models.

The rating of TSARL could face upwards pressure with the pay down of the unrated term loan. The TSARL rating could be downgraded if its free cash flow is sustained below $300 million per year, leading to a delayed de-levering of the capital structure. The rating of the TIFSA notes could be downgraded if a debt exchange does not occur. The rating of the TIFSA and JCI notes could be downgraded if the JCI operations underperform our expectations, leading to less than $200 million of free cash flow, Debt to EBITDA being sustained above 2.5x and EBITA to Interest being sustained below 6x beyond fiscal 2018.

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