Analysts lower outlooks for Allison, say transmission maker vulnerable to default

Local manufacturing stalwart Allison Transmission will have to restructure its more than $4 billion in debt or further cut
expenses if it’s going to weather the recession.

That’s the conclusion of analysts at Moody’s and Standard and Poor’s, which have issued negative outlooks for Allison, the
top commercial truck-transmission supplier.

"The downgrades reflect our concern about Allison’s high leverage, which we believe will increase during 2009 because
of very
weak industry demand," S&P analysts wrote in a research update issued March 10.

The agency lowered its rating from "B+" to "B"—its classification for companies currently able to
meet debt obligations but
vulnerable to default due to "adverse business, financial or economic conditions."

On Jan. 20, Moody’s Investors Service lowered its overall rating from "B2" to "B3," a similar classification.
In March, Moody’s
included Allison on its "Bottom Rung" list of 283 companies most likely to default on debt out of the more than
2,000 it rates.

A former division of General Motors Corp., Allison employs 2,800 people. Most of the work force is at the headquarters and
production facilities in Speedway.

GM sold Allison in 2007 to two private-equity firms, Toronto-based Onex and Washington, D.C.-based Carlyle Group, for $5.6
billion.

The deal was highly leveraged, but Moody’s initial outlook on Allison was stable. At that time, industry observers expected
federal standards for diesel emissions that take effect in 2010 to spur truck buying.

"We, back then, were forecasting a pretty significant pickup in business in the 2010, 2011 time frame," said Dennis
Virag,
president of Automotive Consulting Group in Ann Arbor, Mich. "That may have moved back a year or two. The number of trucks
fleets will be buying will be reduced because of the reduction of shipment of goods."

Allison dominates the U.S. market for commercial-truck transmissions, and supplies military vehicles as well. The company
reported 2007 revenue of $2.4 billion.

Revenue for 2008 was not available. Allison & Carlyle Group declined to comment. Onex did not respond to a request for
information.

According to the Onex annual report, Allison lost $198 million in 2008. Most of that stemmed from a $180 million write-down
in the value of intangible assets, including the Allison Transmission trade name.

While projecting lower cash flow, S&P analysts believe Allison can still hit financial targets required under the terms
of
its senior secured debt, a $3.1 billion loan. The debt is private, so the terms were not disclosed.

Debt bedevils many companies that otherwise would weather the recession more easily, said David Cole at the Center for Automotive
Research in Ann Arbor. "That is tough right now. It’s kind of the curse."

Cole said he sees some inklings of a turnaround in firmer real estate prices, and used-car prices. For trucking, he said,
"The wave of pent-up demand could be substantial. Is there sufficient business and financial support to last through
this
really bleak period?"

Allison recently forecast a 20-percent year-over-year industry decline for commercial vehicle sales in 2009, S&P noted.
In
military sales, the company expects a 40-percent drop.

S&P analysts believe the declines could be even larger. Citing ACT Research in Columbus, they note that in January and
February,
North American orders for buses, shuttles and other medium-duty trucks were extremely weak. Orders totaled 6,010 units in
January and 6,700 units in February, which is about two-thirds lower than a year ago, and about half the monthly average for
2008.

Allison’s financial risk, S&P said, "more than offsets" the company’s potential profitability and market share.

Allison responded to the recession with a round of buyouts and some layoffs early this year. After reducing head count an
estimated 16 percent, the company has about 1,000 salaried employees and about 1,800 union-backed hourly employees.

Moody’s senior analyst Tim Harrod said he considered the recent cost-cutting in his lowered rating, but it’s not enough to
change the outlook.

Because of economic uncertainty and the still-frozen capital markets, prospects for a rating improvement are limited, he said.

"However," he said, "over time, if Allison is able to mitigate operating income erosion with restructuring
actions and operating
efficiencies, it could provide a basis to stabilize the outlook."

Greg Hahn, president of Winthrop Capital Management in Carmel, said he expects Carlyle Group to restructure the main chunk
of debt, a $3.1 billion secured loan.

"The Carlyle Group has enough banking relationships," said Hahn, a former chief investment officer for Conseco Inc.
"They’re
counting on their ability to renegotiate this loan and keep it operating."

The private-equity firm’s strategy likely depended on refinancing in the first place, Hahn said. "The problem is, no
one foresaw
these capital markets as treacherous."

Another $1.1 billion in junk bonds comes due in November 2015.

That debt is split into two notes, one of which allows the company to meet part of its obligation by issuing more notes. The
interest rate on that $550 million "pay-in-kind" note is 11.25 percent. The rate on the other $550 million is 11
percent.

Allison is required to pay down $31 million in principal in the next 12 months. It also needs more than $175 million in cash
this year to cover interest payments, based on the interest rates listed in a September 2008 Lehman Brothers report.

Because the company ended 2008 with $238 million in cash reserves, S&P analysts said the debt is manageable. At the same
time,
they noted, the loan agreement imposes increasingly higher financial hurdles.

Bond investors are shying away from Allison.

The bonds traded around 43 cents on the dollar last week.

"Anytime a high-yield bond trades below 60 cents on the dollar, it’s a high probability of restructuring," Hahn
said. "It’s
extremely significant."

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