Fitch Ratings has placed QGOG Constellation S.A.'s (Constellation or HoldCo) 'BB-' foreign and local currency Issuer Default Ratings on Rating Watch Negative. The rating action applies to USD700 million of senior unsecured notes due 2019, which have also been placed on Rating Watch Negative.
The Rating Watch reflects Petrobras' decision last month to temporarily ban all companies associated with the Queiroz Galvao business group from entering into contracts and participating in bidding process with Petrobras. This measure has the potential to impact Constellation cash flow generation given that as long as the ban is in place, the company could have difficulties to renew the contracts for its drilling units with Petrobras. Most of Constellation's on-shore drilling rigs, which were expected to contribute an estimated USD18 million of unencumbered cash flow to HoldCo during 2015, will likely face contract renewal risk as they operate under short term contracts with the majority of them expiring in 2015.
A prolonged ban that results on the company's inability to renew contracts mitigates the expected elimination of structural subordination and rapid deleverage process. Off-shore drilling rigs will also be affected from a prolonged ban as these assets begin coming off contracts in 2016.
KEY RATING DRIVERS
Ban Derails Deleveraging
On a pro-forma basis, consolidated leverage would be 4.4x, not 4.2x, if the ban prohibits the renewal of onshore drilling rigs in 2015. QGOG has consistently deleveraged, as the debt at its OpCos has rapidly amortized and its EBITDA has increased. Fitch initially expected the company to lower its consolidated leverage ratio to below 4.0x by the end of 2015 and to continue its deleveraging process thereafter. The future deleveraging process, although it may continue as Opco Level debt amortizes, may be derailed by the ban if the company is unable to renew its contracts. Total debt as of Sept. 30, 2014 reached USD2.6 billion, while EBITDA was USD610 million. As of Sept. 30, 2014, debt at the OpCo level amounted to approximately USD1.8 billion.
Structural Subordination
The potential retention of cash flows after debt service at the OpCo level makes cash flow to the HoldCo less stable and less predictable than the cash flow from operations of the subsidiaries. Some of the project finance debt at the OpCos have minimum debt service coverage ratios (DSCR) (e.g. 1.2 or above) restricting cash flow distributions to the HoldCo. The company's structural subordination is being progressively eliminated as assets pay-off OpCo level financing. Currently, cash distributions to Constellation continue to be sensitive to the operating performance of the OpCos' (i.e. the rigs') uptime performance. For example, in the case of the Alaskan-Atlantic operating assets, a decline in the uptime rate to 95% or below from the combined 15-year historical average of 96.3% will likely prevent these assets from distributing cash to the HoldCo. Under Fitch's base case assumption of an average uptime rate of 94%, net cash flow distributions to Constellation from its OpCos is expected to average USD200 million to USD300 million over the next three years and will mostly come from its offshore assets.
Adequate Liquidity
Constellation's liquidity is supported by a 12 month debt service reserve account and the company's cash on hand. Both factors mitigate possible disruptions of cash flow to the holding company (HoldCo) from the OpCos due to debt restrictions at the OpCos. As of Sept. 30, 2014, cash and cash equivalent, short-term investments and restricted cash amounted to USD285.7 million, of which approximately USD71.1 million were at the HoldCo level and the balance was at the OpCos. The company also established a three-year USD150 million committed line of credit with Banco Bradesco (Fitch IDR of 'BBB+') to cover working capital needs; as of Sept. 30, 2014 the company had used USD55 million of this credit line.
RATING SENSITIVITIES
Considerations that could lead to a negative rating action (rating or Outlook) include:
--A prolonged ban from entering into contracts or participating in bidding processes with Petrobras.
A positive rating action is not expected in the short to medium term.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 2014).
Additional Disclosures:
An external appeal committee decision resulted in an outcome that is different from the committee decision that was appealed.
Applicable Criteria and Related Research:
Corporate Rating Methodology Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=967876
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Contacts:
Fitch Ratings
Primary Analyst:
Lucas Aristizabal, +1-312-368-3260
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Alexandre Garcia, +5511-4504-2616
Associate Director
or
Committee Chairperson:
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Managing Director
or
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com
