German Sanitary Service Provider Freshworld Holding III GmbH (ADCO) Rated 'B(Prelim)'; Outlook Stable

  • Funds advised by Apax Partners, a global private equity firm, have agreed to acquire a majority stake in German headquartered mobile sanitary service provider ADCO, via Freshworld Holding III GmbH.
  • Freshworld Holding III GmbH intends to issue a €475 million senior secured term loan B via Freshworld Holding IV GmbH to fund the acquisition. The financing package will also include a €105 million revolving credit facility (RCF).
  • We are assigning our preliminary 'B' long-term issuer credit rating to Freshworld Holding III GmbH, the new parent company, and to Freshworld Holding IV GmbH, its wholly owned subsidiary. We are also assigning our preliminary 'B' issue rating and '3' recovery rating to the proposed term loan B and RCF.
  • The stable outlook reflects our view that ADCO will maintain its leading market position, resulting in revenue growth in the mid-single-digit range, while S&P Global Ratings-adjusted EBITDA margin will benefit from cost savings, increasing to 27%-28%.
DUBLIN (S&P Global Ratings) Sept. 27, 2019--S&P Global Ratings today took the rating actions listed above. Apax Partners announced on Aug. 5, 2019, that funds it advises were in exclusive negotiations to acquire a majority stake in ADCO Group from its existing shareholders. The existing shareholders will re-invest their remaining 24.9% shareholding. To finance the transaction, Freshworld Holding IV GmbH, ADCO's new intermediate holding company, plans to issue a €475 million senior secured term loan B. The investors will make a significant equity contribution, largely taking the form of preference shares and shareholder loans, both of which we treat as equity and exclude from our leverage and coverage calculations. The transaction is subject to customary regulatory approvals, and we expect it will close by end of October 2019.
ADCO is the leading service provider in the German mobile sanitation market with greater than 60% market share in toilet cabins. It also benefits from leading positions in several other European countries, such as Poland. The German market accounts for about half of ADCO's revenues and reported EBITDA, which highlights its limited geographic diversification. The German market is a mature market characterized by high awareness and high penetration of mobile sanitary solutions, leading to moderate growth prospects, albeit with stability supported by strict regulatory requirements imposed on construction and event site operators.
The rental-based business model of ADCO Group requires sizable investment outlays and we view product differentiation as limited, therefore competition is primarily on price, assuming a certain service level requirement is met, although some end-markets such as premium events attribute higher importance to quality. We believe that the cost position of ADCO is superior to that of local competitors due to ADCO's large scale (for example, it has 147,000 cabins in Germany versus 3,000-7,000 for a regional player in Germany), high route density, and broad geographic coverage. These are important competitive factors because large customers prefer to work with one provider across the whole country while proximity to the deployment site reduces transportation and servicing costs, thus providing economies of scale benefits compared with smaller players. In addition, ADCO has in-house product development and manufacturing capabilities, which drive innovation and enhances the ability of ADCO to adapt more rapidly to changing customer preferences. ADCO manufactures around 80% of its cabins in-house and services and retrofits all its own trucks, neither of which are sold to third parties to preserve the company's competitive advantage.
Historically, ADCO has pursued an aggressive tuck-in acquisition strategy, making over 50 acquisitions over the past two decades. We expect the company to continue to make bolt-on acquisitions to further expand market share, improve route density across Europe, and continue to add complementary product and service offerings.
In our view, one of the key risks the company faces is that more than half of its business is tied to the cyclical construction markets in Germany and its second key market, Poland (over 60% of 2018 revenues). Contracts tend to be project based, short-term in nature and nonrecurring. However, during the last recession when construction actively significantly weakened, the company unlike its closest rated peer, U.S.-based mobile sanitary services provider USS, which went through a selective default on its term loan in 2010, was able to efficiently manage its cost base. As a result, revenues and margins only declined moderately. ADCO's mixed exposure to residential, nonresidential, infrastructure new build, and renovation projects also helped mitigate the downturn. Furthermore, stringent EU regulation means that construction and event sites have to provide a prescribed level of sanitary services and noncompliance carries the risk of fines and the immediate closure of the construction site.
We also note that mobile sanitary services generally take up only a small amount of the total construction budget, which we also view as favorable.
Our assessment of ADCO's financial policy is constrained by its high leverage after the acquisition by Apax Partners funds. We project S&P Global Ratings-adjusted debt to EBITDA at about 6.0x by the end of 2019. In addition, we view the financial policy of private-equity owned companies as aggressive, since they often pursue debt-financed acquisitions or shareholder distributions.
Free operating cash flow (FOCF) has been negative in the past, although we acknowledge that over the past few years the company has invested heavily in its cabins, containers, and trucks. However, we believe the company would have the flexibility to reduce capital expenditure in a weaker economic environment, although this could have a long-term impact on service quality and brand reputation. The additional debt servicing cost following the acquisition will also add pressure to FOCF. Despite this, we expect that cost rationalization and operating improvement initiatives will increase margins and contribute to positive free cash flow generation.
The final rating will depend on our receipt and satisfactory review of all final transaction documentation. Accordingly, the preliminary ratings should not be construed as evidence of final ratings. If we do not receive final documentation within a reasonable time frame, or final documentation departs from materials reviewed, we reserve the right to withdraw or revise our ratings. Potential changes include, but are not limited to, use of loan proceeds, maturity, size and conditions of the loans, financial and other covenants, security, and ranking.
The stable outlook reflects our view that ADCO will maintain its leading market position in the mobile sanitation industry. Total revenue growth remains robust, in 3%-6% range, reflecting continued demand in residential and nonresidential construction end markets, positive traction in sales initiatives, and ongoing contributions from bolt-on acquisitions. The adjusted EBITDA margin will benefit from cost savings, increasing to 27%-28%, enabling positive, albeit low FOCF generation.
We could lower the preliminary rating if ADCO underperforms our forecasts and is unable to implement cost efficiencies. Furthermore, a downgrade could result if the company experiences a signification drop in EBITDA margins due to loss of market share or weakening demand from a more challenging construction industry environment, resulting in higher leverage and negative FOCF on a sustained basis. Additionally, if the group undertook material debt-financed acquisitions, or cash returns to shareholders, we could also lower the rating.
We see limited near-term upside potential for the preliminary rating due to minimal FOCF and relatively high adjusted leverage. However, if the group experienced stronger-than-expected EBITDA margin growth, such that our adjusted leverage fell below 5.0x on a sustained basis, combined with solid and stable positive FOCF, we could consider a positive rating action.
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