Fracking fractures Ecolab's debt plan

  • Article by: PETER RAWLINGS , Bloomberg News
  • Updated: October 28, 2012 - 5:38 PM

Last year's acquisition of Nalco added leverage. Now, another deal, for oil services company Champion, adds even more.

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A Champion Technologies delivery worker in Oklahoma. Ecolab Inc. is buying the company for $2.2 billion.

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NEW YORK - Ecolab Inc., the specialty chemicals maker based in St. Paul, is delaying a plan to reduce its debt as it expands in fracking, the business of wresting natural gas from shale that has been linked to groundwater contamination, high ozone levels and illnesses.

The company, which said in an Aug. 2 regulatory filing it has $6.3 billion of total debt, will put up $1.7 billion in cash for its latest takeover, the purchase of Champion Technologies Inc. for $2.2 billion announced Oct. 12. The deal will raise leverage -- the ratio of debt to EBITDA, or earnings before interest, taxes, depreciation and amortization -- to about 3.7 times from 0.7 at the end of 2010, according to Moody's Investors Service.

The deal, combined with share buybacks, will undermine the company's goal of trimming its debt load. Net debt quadrupled last year after the purchase of water treatment firm Nalco Holding Co. as Ecolab tries to become the largest North American producer of energy-field chemicals.

"Their track record with regard to post-acquisition debt reduction does not inspire confidence," said Carol Levenson, director of research at Gimme Credit. "This is a company that increased its debt sixfold to make an acquisition and then instead of paying down some of the debt announced a big share buyback and then another $2.2 billion acquisition."

Moody's placed Ecolab's Baa1 rating under review for a downgrade due to the company's share buybacks and the "delay in improvement in credit metrics that was expected following the Nalco acquisition," analyst William Reed said in an Oct. 15 statement.

The chemical maker's leverage is "not likely to approach 3 times until the end of 2013," Reed wrote, its actions with regard to its credit suggest a risk profile "suited for a Baa2 rating."

Ecolab made "a very strategic acquisition with Champion," Michael J. Monahan, a company spokesman, said in a telephone interview. The deal will create "a marginal change in the debt metrics" in exchange for a purchase that will increase earnings "from the start."

The largest North American specialty chemicals company will "generate reasonable amounts of free cash flow in the future," analysts at Standard & Poor's wrote in an Oct. 12 report, affirming Ecolab's BBB+ rating, as "management will prioritize debt repayments" in using future excess cash.

Bonds have fallen

Ecolab's bonds have fallen 1.39 percent on a total-return basis since it announced the Champion Technologies deal. Shares in the company are up 9.3 percent in the same period, to $69.56 at the close on Friday.

Daniel Schmechel, Ecolab's chief financial officer, said on an Oct. 12 conference call to discuss the purchase with analysts and investors that the company plans to "return to A range" credit metrics within three years. Management seeks to reduce total debt to between 35 and 45 percent of capital, according to a presentation accompanying that call.

The measure stood at 52.6 percent on June 30, prior to the Champion purchase, according to data compiled by Bloomberg. That's up from 29.6 in September 2011, before the Nalco purchase, and compares with an average of 30 for the specialty chemical industry globally.

"They would have preferred to have paid off more debt before doing this," Shlomo Rosenbaum, an analyst at Stifel Nicolaus & Co.'s Baltimore office, said in a telephone interview. The timing of the purchase was dictated by Champion's decision to sell, he said. "The thing is, you can't be afraid to do something when there's an opportunity there."

Chief Executive Douglas Baker said during the Oct. 12 conference call that the company had been on track to reduce its leverage to 2.6 times by the end of 2012.

Strength in energy services

Ecolab acquired Nalco in December 2011, using a provision in that company's bonds to redeem $528.5 million of debt at a discount of about 7 percent. So-called equity clawbacks enabled Ecolab to call 35 percent of Nalco's debt at face value plus one year's interest with proceeds from a stock offering. Ecolab also issued $3.75 billion of new bonds at the time of that takeover.

The acquisitions are part of Ecolab's plan to strengthen its energy services business. Nalco was strongest in international offshore drilling, Mike Ritzenthaler, a research analyst at Piper Jaffray & Co. in Minneapolis, said in a telephone interview. Champion complements that business well, as "they do the most work in North American onshore," he said, "primarily fracking and oil sands."

In fracking, or hydraulic fracturing, companies blast millions of gallons of water, sand and chemicals to free oil and natural gas from rock formations. Production of gas from shale using methods such as hydraulic fracturing has quadrupled during the past four years, according to the American Exploration & Production Council, a trade association of natural gas and oil companies.

"The harder the oil is to get to, the more profit per barrel goes to Ecolab," said Piper Jaffray's Ritzenthaler. More complex energy extraction methods, such as those used in fracking, deep-sea drilling or oil sands production tend to use more chemicals, he said.

The U.S. Environmental Protection Agency said Oct. 10 that tests of drinking water near a natural-gas drilling site in Wyoming supported a finding establishing the first link by the federal government between hydraulic fracturing and tainted water. Industry-funded studies say fracking poses no threat to groundwater or air quality.

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