Fitch Ratings has placed ContourGlobal Plc's Long-Term Issuer Default Rating (IDR) of 'BB-' on Rating Watch Negative (RWN).
Fitch has also placed ContourGlobal Power Holdings S.A.'s (CGPH) senior secured notes and super senior secured revolving credit facility (RCF) of 'BB+'/'RR2' on RWN.
The RWN reflects uncertainty over ContourGlobal's long-term capital structure and financial policy following the recently announced acquisition of the company by funds advised by global investment firm Kohlberg Kravis Roberts & Co. Inc. and its affiliates (collectively referred to as KKR; A/Stable) and the incremental acquisition debt to be serviced by ContourGlobal. If ContourGlobal's leverage post-ownership change is above our rating sensitivity, it could lead to a downgrade. A capital structure in line with the current rating would lead to an affirmation.
Fitch expects to resolve the RWN once KKR provides clarity on the ultimate capital structure and financial policy, anticipated in 2H22. The acquisition is subject to customary shareholder, regulatory and antitrust approvals. Consequently, RWN resolution could take more than six months.
Key Rating Drivers
Post-Acquisition Capital Structure: KKR has not made public its intentions regarding ContourGlobal's new long-term capital structure. Fitch believes that if the sale is completed, ContourGlobal could have a more aggressive capital structure as the new owners plan to raise GBP445 million of incremental debt at newly-formed Cretaceous Bidco Limited (Bidco, wholly owned by funds advised by KKR) to co-fund the acquisition in addition to equity funding.
Over time the acquisition debt will be pushed down to ContourGlobal Plc, taking into account its restricted payment and debt incurrence capacity in the existing debt documentation. The company has considerable headroom to incur additional debt under the debt service coverage ratio covenant of more than 2x, which is included in the bond documentation.
Downgrade Likely on Acquisition Debt: Prior to the acquisition announcement, we projected holdco-only funds from operations (FFO) leverage to average about 4.3x in 2022-2023, resulting in limited headroom below our negative rating sensitivity of 4.5x. We assume that in case of the acquisition debt being pushed down from Bidco to ContourGlobal and the company's cash surplus being used for debt service instead of dividends, FFO leverage may be in line with a one-notch lower IDR as long as it does not exceed 5.5x.
Affirmation Possible: We may affirm the ratings if projected holdco-only FFO leverage and financial policy are in line with the current IDR. This will depend on the amount of debt pushed down from Bidco, level of dividends to Bidco to service the debt remaining at that level, and possible changes to holdco covenants and cash flows, including sale of minority stakes or divestments, level of new equity investments in new assets (Fitch assumes about USD350 million in 2022-2024) and project level refinancing.
In addition, KKR referred to its record of active management, capital support and long-term partnership approach in the acquisition announcement.
Proposed Acquisition Funding: Bidco plans three facilities, acquisition, refinancing and backstop, which could be used to fund the ContourGlobal acquisition. The acquisition tranche comprises GBP325 million, 24-month tranche A, and GBP120 million, 12-month tranche B. The only financial covenant at Bidco level is maximum 7.7x consolidated total net debt to consolidated EBITDA. In addition, KKR, has put a bridge refinancing tranche in place comprising EUR400 million (for ContourGlobal's bonds due 2025) and USD40 million (for remaining Western Generation bridge loan).
Backstop facilities are also planned for EUR80 million revolving credit facilities (RCF), and EUR50 million for the letter of credit facility, should existing lenders withhold consent. The refinancing and backstop facilities, could be reduced or terminated should the company obtain other financing, which will depend on the final group capital structure. ContourGlobal's remaining existing bonds, EUR410 million due in 2026 and EUR300 million due in 2028 are not planned to be refinanced.
Upstream Cash Restrictions: KKR cash restriction at ContourGlobal and Bidco level could be viewed as a prudent approach to reducing leverage. ContourGlobal cannot upstream dividends and restricted payments to Bidco while any bridge loans (acquisition, refinancing and backstop) are outstanding unless the upstreaming of cash is related to debt service obligations of Bidco.
Predictable Cash Flows: The 'BB-' IDR reflects the predictable cash flows from ContourGlobal's portfolio of generating assets, supported by long-term contracts, regulated capacity or regulated cost-of-service payments. The assets have an average remaining contracted or regulated life of about nine years with limited exposure to changes in electricity demand.
Long-Term Re-contracting Risks: The ratings also reflect ContourGlobal's exposure to re-contracting risk, with about 46% of its contract portfolio by capacity due for new contracts in 2022-2025. However, this is partially offset by higher merchant prices in Europe, the importance of its thermal generation portfolio in its key markets and management's proactive measures to manage contract renewals.
For more details on the underlying Key Rating Drivers see 'Fitch Affirms ContourGlobal Plc at 'BB-'; Outlook Stable' dated 4 May 2022 at www.fitchratings.com).
Derivation Summary
Fitch rates ContourGlobal using a deconsolidated approach as the company's operating assets are largely financed with non-recourse project debt. ContourGlobal's operating scale is comparable with that of TerraForm Power Operating, LLC (TERPO; BB-/Stable), NextEra Energy Partners, LP (NEP; BB+/Stable) and Atlantica Sustainable Infrastructure Plc (Atlantica; BB+/Stable).
We view TERPO's and NEP's US-dominated portfolio of renewable assets as superior to that of ContourGlobal, which is 37% renewables with the remaining generation mainly thermal and carries re-contracting risk and political and regulatory risks in emerging markets. We also view Atlantica's portfolio of assets as superior to that of ContourGlobal, given Atlantica's focus on renewables, longer remaining contracted life (17 years versus nine years) and better geographical split (largely North America and Europe). This is mitigated by the larger size of ContourGlobal's portfolio.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
Fitch will update its projections once ContourGlobal's post-acquisition capital structure is unveiled, expected in 2H22. The assumptions below are for the existing rating case, not reflecting the impact of the KKR acquisition.
Equity investments of about USD350 million in 2022-2024, largely for new assets (holdco's share in acquisition funding)
USD110 million proceeds from sale of Brazil Hydro in 2022
Continued solid project level refinancing activity in 2022-2023, but for lower amounts than in a record 2021
Holdco dividends rising 10% a year in 2022-2024 in line with the management's dividend policy
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade is currently unlikely due to the RWN. Fitch will resolve the RWN once it can assess the long-term capital structure, financial policy, and strategy to be implemented by KKR. Holdco-only FFO leverage below 4.5x and FFO interest coverage above 3x on a sustained basis would support the current rating.
The RWN may take more than six months to resolve due to the uncertainties related to the proposed acquisition, including the long-term financial policy and timescales required for receiving shareholder, regulatory and antitrust approvals.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Holdco-only FFO leverage above 4.5x on a sustained basis and FFO interest coverage lower than 3x
Major PPAs experiencing unexpected and material price reduction or termination
More than 40% of total revenue becoming uncontracted
A change in strategy to invest in more speculative, non-contracted assets or a material decline in cash flow from contracted power-generation assets
Future projects experiencing material cost overruns and delays, not being prudently financed or encountering substantial political interference, causing financial distress at the project level or parent level so that ContourGlobal breaches our rating sensitivities on a sustained basis
A material increase in the super senior revolving credit facility and equally ranking letters of credit facilities could be negative for the senior secured rating
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Sufficient Liquidity: At end-December 2021 ContourGlobal had sufficient liquidity at the holdco level with no long-term debt refinancing until 2025, when EUR400 million bonds are due. Project-finance debt maturities at operating subsidiaries, comprising the vast majority of consolidated debt, are evenly balanced due to debt amortisation, with no substantial refinancing risk in 2022-2023.
Holdco level cash was USD49 million at end-December 2021 together with EUR80 million available under an undrawn RCF expiring in December 2023. At this date, holdco had an outstanding USD40 million bridge loan and EUR40 million drawn under the RCF.
Issuer Profile
ContourGlobal is a holding company that operates 6.3 gigawatts of gross generation capacity with about 138 thermal and renewable power generation assets across 20 countries, through its subsidiaries and affiliates. ContourGlobal cash flows in project companies are supported by long-term contracts, regulated capacity or regulated cost-of service payments.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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