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AI Aqua Sarl ‘B’ Rating Outlook Revised To Negative On Higher-Than-Expected Leverage

          NEW YORK (S&P Global Ratings) June 20, 2018--S&P Global Ratings today affirmed its 'B' corporate credit rating on Luxembourg-based parent company AI Aqua S.ar.l and revised the outlook to negative from stable. 
          At the same time, we affirmed our 'B' issue-level rating, with a recovery rating of '3', on the company's senior secured facility (consisting of an upsized $115 million revolver due 2021 and a $741 million (outstanding) first-lien term loan due 2023. The '3' recovery rating on the company's first-lien debt indicates our expectations for meaningful (50%-70%; rounded estimate: 50%) recovery in the event of payment default. 
          We also affirmed the 'CCC+' issue-level, with a '6' recovery rating, on the company's $236 million (outstanding) second-lien term loan due 2024. The '6' recovery rating indicates our expectation for negligible recovery (0%-10%; rounded estimate: 0%) in the event of payment default. 
          We expect the company to have $1.1 billion in funded debt at the close of the transaction. 
          The outlook revision to negative reflects the higher than expected pro forma adjusted leverage of more than 8x following a string of acquisitions and weak cash flow generation. AI Aqua was formed in 2016 through a leveraged buyout of Culligan International, a provider of water treatment solutions for both residential and commercial customers. The company has since pursued an aggressive expansion strategy by making several small tuck-in acquisition as well as larger ones such as Australia –based Zip Water Holdings and Paragon Water Holdings in August 2017 and February 2018 respectively. For the most recently announced acquisition of Aqua Vital, a Germany based provider of traditional and point-or-use water coolers, we calculate pro forma leverage will increase following the transaction to roughly 8.8x, which is above the stated downgrade trigger of 8x. While the underlying businesses are growing in the mid-single-digit range, the continued acquisitive strategy and high leverage create more integration and execution risk associated with current and future acquisitions. Additionally, the company's cash flow generation has been weak in light of its aggressive expansion strategy and we are uncertain about how long it will take for the company to improve its free cash flow generation to expected levels, possibly above $50 million annually. The limited track record of cash flow generation and heightened execution and integration risk present risk to our base-case forecast and thus are the reasons for the outlook revision to negative. 
          The negative outlook reflects higher than expected pro forma leverage of more than 8x as well as continued weak free operation cash flow generation, which we believe could slow the pace of deleveraging if is the company is slow to integrate recent acquisitions. In our opinion, this increases the risk that the company could not meet the base-case forecast of reducing leverage to below 8x over the next 12 months. 
          We could lower the rating over the next 12 months if the company is unable to reduce and maintain debt to EBITDA below 8x or if the company does not generate at least $50 million of free operating cash flows (FOCF). We believe this could occur if the company does not integrate its recent acquisitions of Paragon Water Holdings and Aqua Vital, while annual organic top-line growth unexpectedly declines to flat levels compared to our current expectations for ongoing mid-single-digit sales growth in its existing businesses. 
          We could revise the outlook to stable if the company successfully integrates its acquisitions, and improves leverage closer to 7x. In addition to integrating its recent acquisitions and reducing leverage with its full year EBITDA contribution from its acquired businesses, an outlook revision to stable would also be predicated on the company improving its annual FOCF near or above $50 million.