DBRS Places SNC-Lavalin Group Inc.’s BBB Ratings Under Review with Developing Implications

DBRS Limited (DBRS) has today placed the BBB Issuer Rating and BBB Senior Debentures rating of SNC-Lavalin Group Inc. (SNC or the Company) Under Review with Developing Implications following the announcement that SNC plans to acquire United Kingdom-based WS Atkins (Atkins), a design engineering and project management consultancy.

The Board of Directors of both companies have agreed that SNC will acquire Atkins for a cash consideration of GBP 2.08 billion (CAD 3.6 billion; hedged), will assume responsibility for Atkins’ GBP 424 million pension deficit (as at September 30, 2016) and GBP 10 million of net debt, thus valuing Atkins at a total enterprise value of CAD 4.2 billion. The transaction is expected to close by the end of Q3 2017.

The acquisition will be financed via a mix of debt and equity. SNC’s largest shareholder, Caisse de dépôt et placement du Québec (CDPQ) will provide over half of the requisite funds. CDPQ will provide a $1.5 billion loan to SNC subsidiary SNC-Lavalin Highway Holdings, which holds SNC’s 16.77% interest in Highway 407 ETR. This loan is secured by the full value of SNC-Lavalin Highway Holdings’ shares and the cash flows generated from such shares. The loan has been structured to be of a non-recourse nature as against SNC, although it reduces SNC’s access to dividends from Highway 407 ETR. CDPQ will also provide $400 million in equity financing via a private placement. SNC will borrow the remainder by way of a GBP 300 million term loan and through the issuance of GBP 350 million of drawings on its existing $4.25 billion credit facility. SNC will also raise $800 million via a public equity offering, with an overallotment option of $80 million.

With revenues of almost GBP 2 billion in the last 12 months to September 2016 and over 18,000 employees worldwide, Atkins is the 11th largest global design firm and the United Kingdom’s largest engineering consultancy. For context, in 2016, SNC’s revenues were CAD 8.3 billion (approximately GBP 4.8 billion), and it employs approximately 35,000 employees worldwide. The achievable annual run-rate cost synergies are estimated at $120 million, to be fully realized as of the end of 2018, assuming the transaction closes on schedule.

While SNC generated 44% of its revenues in 2016 from the oil & gas sector, Atkins generates only about 14% of revenues from energy, with the remainder sourced from infrastructure. Over 40% of SNC’s 2016 revenues were generated in Canada and over half from North America, whereas over half of Atkins’ business is sourced from Europe (mostly in the United Kingdom). Atkins’ business from master service agreements for consulting and advisory services, and fixed-fee advisory and design operations represent lower-risk earnings streams. Overall, DBRS believes that the Atkins business lines represent good complements to SNC’s operations, providing not only scale, but also geographic, sectoral and business line diversification benefits.

Although the acquisition is to be partially financed with equity, and earnings and cash flows should be immediately accretive upon closure, the debt required for the purchase will weaken the financial profile notably. On a pro forma basis using financial data for the last 12 months through September 2016 for Atkins (fiscal year-end is March 31) and FY2016 financials for SNC, the pro forma impact on SNC’s financial profile would be to weaken key metrics to the lower end of the investment-grade range. (Please refer to page 11 of the methodology, “Rating Companies in the Construction and Property Development Industry,” December 2016, which is available on the DBRS website.)

However, SNC’s business risk profile should improve modestly from the addition of Atkins’ complementary businesses. The Company’s balance sheet should be stronger by Q3 2017 (the projected transaction closure date) than it was at year-end 2016. (Note that SNC confirmed that Q1 2017 results were broadly in line with expectations.) Furthermore, DBRS expects that SNC will act to reduce leverage after the transaction closes and thereby demonstrate significant progress in the near term toward reducing its leverage to a level more consistent with the current ratings. DBRS also believes that the decision to retain Atkins’ Executive Director Heath Drewett to lead the Atkins business after the acquisition, consistent with Atkins’ existing succession plans, will mitigate the risk of serious integration problems. Integration risk is also reduced by the relatively small amount of overlap across the companies’ business lines, and the fact that SNC “does not expect [the Atkins business review] to have a material impact on the continued employment of Atkins’ employees.” Therefore, DBRS anticipates that if the transaction closes as represented by the Company, a rating confirmation would be likely. Should SNC’s financial profile not improve as expected post-acquisition, DBRS may consider a negative rating action.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The principal methodology is Rating Companies in the Construction and Property Development Industry (December 2016), which can be found on dbrs.com under Methodologies.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.