How It Works

Typically, the equity contribution from the financial investor is significant, reaching up to 49% of the share capital or even one share less than 50%. The corporate entity typically retains more than 50% of the equity, thus preserving control and full accounting consolidation. In many cases, all or a portion of the investor's equity contribution is funded through "back-leverage," referring to loans from third parties that reside outside of the JV structure, often held at a holding company level (see graph). Additionally, shareholder agreements for these types of transactions often contain stronger than typical minority rights, generally in the following areas: (1) Priority over distributions, including potential increases in the distributions to the minority shareholder over time; (2) Priority rights at default or exit; (3) stronger protections against material breaches of operating terms, and (4) expected base level of compensation in the form of an internal rate of return (IRR) for the minority shareholder.

S&P Global Ratings expects that these types of transactions will become more prevalent as companies look to fund large capital projects, infrastructure-related spending, domestic "reshoring" of supply chains, or green energy investments without materially affecting their leverage. In turn, financial investors are looking to deploy large amounts of capital with steady rates of return, while carving out strong minority protections for themselves and increasing their return on capital through "back leverage".

These structures also provide an avenue for private credit providers to gain exposure to investment-grade credit and expand beyond their former focus on leveraged loans.

We generally analyze key features of these transactions through the lens of our Ratios & Adjustments methodology which includes a holistic adjusted debt principle. More specifically, we look to analyze whether contributed equity from financial investors will truly behave as equity, or if certain provisions and shareholder features could lead to credit deterioration or probable calls on cash for the IG issuer.

The following article answers key investor questions on these evolving structures, specifically around when S&P Global Ratings would make debt adjustments at the level of the majority shareholder.

How are these financial JV structures different from typical JVs?

Traditional JVs are set up between two or more non-financial corporates or utilities for operational purposes (e.g., to share in development costs, produce new revenue streams, or penetrate new markets). Typically, JV partners bring complementary capabilities, share in capital requirements, and bear proportionate degrees of operational risk. To the contrary, in these evolving structured minority sale transactions, the purpose of the JV is strictly financial in nature. The rationale for the majority shareholder (e.g., an IG corporate issuer) is to reduce capital outlays, typically for large capex projects, reducing the impact to their balance sheets from raising new incremental debt. In some cases it allows them to accelerate investment plans compared to what can be funded purely with free cash flow, or for liability management and debt repayment.

The minority shareholder, which is generally an alternative asset manager investing on behalf of institutional investors, limited partnerships, and insurance companies, is looking to get exposure to investment-grade credit and partake in the annuity generation of stable assets, both regulated and unregulated. These asset managers advertise a longer-time horizon than is typical in the private equity space, yet we do not view their equity positions as permanent capital--unlike a traditional JV where the strategic partnership may remain in place indefinitely.

In which industries are these transactions most prevalent? Does the strategic nature of the assets contributed to the JV affect potential debt adjustments or change our view of the credit profile?

To date, most of these transactions have been concentrated in more stable, capital-intensive industries such as telecom, oil and gas, and real estate. The type of assets, whether core to the majority shareholder's strategy or non-core in nature, typically do not factor into whether we will make an initial debt adjustment. This is because features in the shareholder agreement are the driving factor as to whether the JV structure will lead to any mandatory debt-like obligations, and not the assets themselves. That said, if the assets are more strategic in nature, this could create greater incentive for the majority shareholder to exercise a call option in the future that we would factor into our base case over time.

Additionally, the strategic nature of the assets might factor into our view of the overall credit profile in other ways, such as through our scope of consolidation, financial policy or assessment of other modifiers, or business risk considerations. For example, given that in most cases we would look to deconsolidate debt, EBITDA, and cash flows corresponding to the minority shareholder, forgoing a high percentage of cash flows from core assets could hurt consolidated metrics. Additionally, if the IG issuer chooses to frequently use these types of JV structures as a recurring form of financing, not only would that affect consolidated financials, it could also lead to a negative assessment of financial policy. This is because even if features don't lead to debt-like adjustments, we believe these structured transactions reduce financial flexibility and disadvantage existing unsecured lenders. In extreme cases, this could lead to structures where the preponderance of debt is located at the parent level, while cash flows are concentrated at JVs with sizable minority shareholders. This would require greater scrutiny of parent-level liquidity and leverage and could lead to a number of adjustments, including notching down existing unsecured debt, negative assessments within our business risk profile (due to reduced control over core assets), lower management and governance scores, or negative comparable ratings analysis (CRA) treatment.

In what types of situations would S&P Global Ratings make initial debt adjustments? How are the executory and non-executory nature of contracts in such financial JV structures viewed?

While not an exhaustive list, we generally would make an initial debt adjustment at the majority shareholder under the following types of circumstances:

• The majority shareholder guarantees payments to the JV, which in turn could support distributions to the minority shareholder (and ultimately timely servicing of "back-leverage").
• There is an unequal sharing of downside risk in terms of JV operating performance, such as a requirement for the majority shareholder to make shortfall payments in the case that distributions to the Class B shareholder fell below an IRR.
• Loans used to upstream proceeds from the JV to shareholders that contain debt-like features and minority shareholder enforcement rights.
• Put options or other exit rights that trigger cash payments outside of the majority shareholder's control.
• Other contractual terms which create liabilities with no direct offsetting operating benefit.

Under the first two buckets, we would almost always make a debt adjustment if the majority shareholder guaranteed some form of payment to the JV partner. This would essentially lead to an unequal sharing of downside risk, and distributions that are not fully discretionary and variable with JV operating performance. We typically treat such guaranteed payments or mandatory minimum distributions to the JV partner as debt-like because they are a form of mandatory recoupment of the investment made by the JV partner including a return on the investment.

Another potential area of adjustment would be around mechanisms used to upstream proceeds from the JV to the majority and minority shareholders, which could come in the form of a shareholder loan for tax-related purposes. In these situations, we would look to analyze key features of the loan in terms of debt-like provisions and enforcement rights.

Other areas where initial debt adjustments are likely would include any put rights held by the minority investor or other rights (see example of "earn-ins" below) that create mandatory cash payments regardless of performance. Finally, contractual commitments, such as off-take agreements, could lead to debt-like adjustments at the majority shareholder depending on their nature. More specifically, we generally distinguish between executory and non-executory contracts in our analysis based on whether the contract includes contract minimums or unconditional obligations for the issuer and if there is a counterparty performance requirement. For example, in a purchase commitment, a company can walk away without any financial liability or mandatory minimum payment because a counterparty must still perform an action such as produce a certain number of units. Generally, it is a commitment to purchase goods or services at market rates in the future, if business needs arise. We do not treat such purchase commitments as debt-like, but rather as an operating cost or capital expenditure in the period the commitment is fulfilled by the company.

In contrast, non-executory contracts do not require any counterparty performance such as production; however, they do guarantee a minimum offtake of goods or services and/or mandatory minimum payments to the other party, if the contract is not executed as per the terms, e.g., take-or-pay contracts. We treat the contract minimums, financial penalties, or mandatory minimum payments to walk away as debt-like in our analysis because they are incurred liabilities that provide no future offsetting operating benefit to the issuer.

Table 1

How does S&P Global Ratings view "back leverage," and in what situations would this be added to third-party debt to the majority shareholder's balance sheet?

Transactions with elements of back leverage involve a financial investor selling debt to third parties backed by their equity stake in the JV, with the goal of boosting their returns and/or funding additional transactions with other corporates. This debt typically sits at a holding company level above the JV assets, or at the level of the financial investor. Third-party lenders typically receive a pledge of the financial investor's assets, including their equity interest in the JV, and may also hold various consent rights, such as protection against priority debt being raised at the JV entity. However, they do not receive security over the JV's underlying assets themselves.

When it comes to back leverage, generally we do not make an adjustment for this debt at the majority shareholder (e.g., IG corporate issuer). However, in certain situations we could look beyond contractual terms and consider shareholder incentives. For example, although back leverage lenders typically don't have direct recourse to the JV assets, in the event of a default on the back-leverage loans, third-party lenders could become the new minority shareholder in the JV (assuming the equity in the JV had been pledged). If we believe such a scenario could accelerate a buyout of the minority interest by the majority shareholder, we could factor this into our ratings. More specifically, we would include the estimated purchase amount of the minority interest (as opposed to the "back leverage" amount) within our base-case forecast. We believe these situations would be rare and case-specific, and factored into our cash flow forecasts over time (e.g., such as in conjunction with a deterioration in JV operating performance), as opposed to an initial debt adjustment at the commencement of the transaction.

Priority Over Distributions

How does S&P Global Ratings view dual-class shares in minority sale transactions?

Nearly all structured minority sale transactions contain dual class shares, where the majority shareholder (e.g., IG corporate issuer) holds Class A shares and the financial investor holds Class B shares (see graph). While these dual classes might rank equal to each other in terms of liquidation preference, they could allow for differential rights in terms of dividend distributions. For example, Class A shares might receive 40% or less of JV distributions (despite having 51% or greater economic interest), while Class B shares might receive 60% or more. Additionally, we have seen cases where after a certain amount of time, such as five to 10 years, distributions to the Class B shareholder significantly increase, say to 75% or higher. We recognize that uneven distributions or material increases over time, when coupled with a call option, could create incentives for the corporate entity to take-out the minority investor.

While, we typically only add a liability derived from a redeemable minority interest when the redemption is outside of the issuer's control (e.g., put option), a "highly incentivized" call option would likely become part of our base case over time. For example, if we believe a call option in year 5 is highly likely to be exercised (because of uneven distributions or a material increase in distributions to class B shareholders in year 5), we could start factoring this cash outflow into our base case as early as year 2 (as we generally calculate credit metrics by weighting the previous two years, the current year, and the forecasted two years). How that call is likely to be funded by the IG corporate would therefore become a key focus of our forecast.

Uneven distributions could also factor into our scope of consolidation, which we explain further below.

How does S&P Global Ratings account for these transaction within its scope of consolidation?

Within our general ratings analysis, most often we use the same scope of consolidation as we use in the parent's consolidated financial statements. This is because accounting consolidation and the underlying analytical principle of our group rating methodology both rely on the concept of "control," which refers to the parent's ability to dictate a group member's strategy and cash flow. However, within these structured minority sale transactions, we typically use proportionate consolidation to strip out the minority stakeholder's share of debt, EBITDA, and cash flows, as long as the adjustment is material to the IG issuer's credit metrics. In cases where the cash leakage is material, we believe proportionate consolidation better reflects economic reality, due to significant minority shareholder(s) and their influence on dividend policy, whether direct through board representation on the JV or implicit due to the nature of these transactions.

As noted above, in cases where there is a significant difference between economic interest and distribution splits, we would likely base our proportionate consolidation on cash flow as opposed to other factors like ownership, control, or EBITDA. As an example, if the majority shareholder (e.g., an IG issuer) has a 50.1% economic interest in the JV, but only receives 25% of JV distributions, we would likely only consolidate 25% of the JV for balance sheet, income statement, and cash flow purposes. In our view, this better reflects the cash flows that are truly available to service existing debt at the parent.

Lastly, in cases where we make a debt adjustment at the level of the majority shareholder, we would likely follow the full consolidation accounting treatment for the JV and give the IG issuer the full benefit of JV EBITDA and cash flows to service the debt.

Priority Exit Rights

How does S&P Global Ratings view various "exit rights" when analyzing a JV structure?

Exit rights are mechanisms that allow investors to sell their stakes in the JV under predefined conditions. In analyzing whether to make an analytical adjustment, we primarily consider the expected time horizon of the committed equity, and whether the majority shareholder could be forced into an action that negatively affects credit quality. For financial investors, while we believe an exit at some point is inevitable, the timing and conditions of such an exit could lead to unanticipated calls on cash or increased debt for the majority shareholder. Some of the key exit rights we analyze within these JV structures include "drag-along" rights, which allow for the majority shareholder to force the minority shareholder into a sale, or "tag-along" rights, which allow the minority investor to tag along in a sale at the same price and terms. Typically, we do not make debt adjustments for these rights, however, in cases where the financial investor can "drag" the IG corporate issuer into a sale of the JV, we would view this more negatively and consider whether this would lead to a buyout of the minority interest within our financial forecasts.

Additionally, we have seen "earn-in" features that protect minority shareholders from underperformance at the JV relative to original expectations. For example, if the JV underperforms an agreed upon base case by a certain threshold, minority shareholders would be entitled to compensation upon an exit or IPO. Typically, the additional compensation would be capped at a certain percentage and only payable in shares, with the minority investor taking full market valuation risk. Assuming this feature only leads to the minority investor getting more shares at exit, subject to valuation, we would typically not make a debt adjustment. However, in cases where this true-up is settled in cash, or not subject to market valuation, an analytical adjustment could become more likely based on the probability of occurrence and expected funding mechanism.

Stated IRR For Minority Investors

How does S&P Global Ratings view the presence of an internal rate of return (IRR) for the minority investor?

In these transactions, typically there is a stated IRR for the minority investor within the shareholder agreement. However, the achievement of the IRR is generally not guaranteed and fully dependent on the performance of the JV. In other words, the minority investor also bears the downside risk. Accordingly, we typically do not make a debt adjustment in these situations. In most cases, if the majority shareholder chooses to exercise a call option prior to an agreed-upon date, the call price must factor in the stated IRR. However, again typically we do not adjust, as the majority shareholder is choosing to exercise an option and the value of the minority stake at that point might very well justify the IRR. Only when the IRR becomes guaranteed, directly or indirectly, would we look to make a debt adjustment.

Treatment Of Material Breaches Of Operating Terms

How does S&P Global Ratings view protections against material breaches that could force a buyout of the minority stake?

We would typically not make a debt adjustment for features that would allow the minority investor to "put" their stake to the majority shareholder, assuming the latter is in material breach of contractual terms. This is because we typically only add a liability derived from redeemable minority interest when the redemption is outside of the majority shareholder's control. However, in this case the put option is only triggered through the failure of the majority shareholder to comply with contractual obligations. Accordingly, we would view this as more of an event risk that would fall outside of our base-case forecast. That said, on an evidence-basis, we could look to analyze material breach terms more closely to understand the likelihood of a breach occurring, along with stated grace periods and remedies. If we believed contractual terms were excessively burdensome and put the majority shareholder at heightened risk of non-compliance, we could factor this into our view of financial policy or governance assessment--or in extreme cases, through a debt adjustment.

What are examples of public transactions where S&P Global Ratings has made debt adjustments and why?

While there are relatively few public cases of these structured minority sale transactions to date, they have been growing at an exponential rate. The most prominent example, and one of the first of these transactions, was Intel Corp.'s JV with the infrastructure affiliate of Brookfield Asset Management for fabrication facilities in Chandler, Ariz. Under the terms of the shareholder agreement, the companies will jointly invest up to $30 billion, with Intel funding 51% and Brookfield funding 49% of the total project costs. In this scenario, Intel bears the construction and wafer production risks, as well as the JV's commitment to make minimum dividend distributions to Brookfield. For this reason, we will accrue as debt totaling about $15 billion to Intel's financials based on the timing and amount of Brookfield's capital contributions to the JV. This debt adjustment reflects Intel's guarantee to the JV for its minimum dividend distributions.

It's important to note that we do not adjust for the back-leverage raised to fund Brookfield's equity contribution, which sits at a holdco entity above the JV. The adjustment is only for the minimum commitments paid by Intel, regardless of JV performance, which we view as a debt-like obligation. Additionally, we expect to lower the debt adjustment over time as the JV begins to make cash distributions to Brookfield. Finally, given the debt adjustment, we fully consolidate the JV's full EBITDA with Intel's operating results, similar to the company's accounting treatment.

In the case of Intel's JV with Apollo for Fab 34 located in Leixlip, Ireland, we did not make any debt adjustments to Intel's financials, although we deconsolidated the minority owner's share of EBITDA and cash flows. In this case, Intel doesn't guarantee any minimum dividend distributions from the JV to Apollo entities. While Intel has a wafer purchase agreement with the JV, we view this to be an executory contract, meaning if the JV doesn't produce wafers then there is no obligation for Intel to make payments. Intel has a similar wafer purchase commitment at the Brookfield JV, which we also did not adjust for.

It's worth noting that the shareholder agreement also contains payment of liquidated damages to Apollo in various circumstances if Intel fails to meet minimum volume commitments. In addition, under various ancillary agreements, Intel or Intel Ireland may be required to pay liquidated damages or termination payments under various scenarios, including underperformance or termination, an amount up to 140% of Apollo's purchase price. While we recognize these features have debt-like characteristics, we view this more of an event risk and do not make an adjustment for the following reasons: The Irish fab is important to Intel and its operating history suggests minimal operating risk in building and operating the fabs, there is a counterparty performance requirement, and minimum volume commitments within the wafer purchase agreement are sufficiently below Intel's wafer production level at other 100%-owned fabs.