Schaeffler Finance B.V. -- Moody's assigns B1 rating to Schaeffler's notes issue

RATINGS RATIONALE

The B2 corporate family rating is supported by Schaeffler's solid business profile evidenced by (i) leading market positions in the bearings and automotive component and systems market with number one to three positions across the wide ranging product portfolio in a relatively consolidated industry; (ii) its leading mechanical engineering technology platform supporting a competitive cost structure and the development of innovative products; (iii) a well diversified customer base, especially in the industrial division but also to the extent possible in the consolidated automotive industry and a sizable aftermarket business accounting for around 24% of revenues in the twelve months ended 31 March 2012.

The rating also benefits from (iv) Schaeffler's proven business model with a good track record of operating performance and margin levels well above the automotive supplier industry average; (v) an experienced management team as well as (vi) a good innovative power evidenced by a high number of patents, founded on a notable amount of R&D expenses of above 5% of revenues per year.

The rating is constrained by (i) the combined high indebtedness and leverage of the operating level ("Schaeffler Group" or "Schaeffler AG") and the holding level, the latter of which also includes the junior debt incurred by parent companies of Schaeffler AG; (ii) the organizational and legal complexity and evolving structure of Schaeffler in its current state as well as (iii) Moody's expectation that debt levels will not be materially reduced over the short to medium term as (iv) free cash flow generation as adjusted by Moody's is anticipated to remain negative in 2012 mainly driven by high interest expense, again increasing capital expenditure and dividend payments to the holding level - despite strong operating performance.

Proceeds from the announced bond issue will be used to repay part of Schaeffler's bank loans under the senior facility agreement of January 2012.

Debt outstanding under the company's bank loan is secured by pledges over Continental shares held by Schaeffler AG, material group companies, cash pool accounts and receivables. The B1 rating for the issued bonds is at the same level as the bank debt, as these bonds rank pari passu with the debt under the senior loan facilities.

The stable outlook incorporates Moody's expectation that Schaeffler will (i) be able to demonstrate further improvements in its operating performance after a strong year 2011; (ii) be able to limit its cash burn below EUR100 million in 2012 and start to generate positive free cash flows thereafter and (iii) apply these to debt reduction.

The ratings could be upgraded over the next 12-18 months should Schaeffler be able to (i) further reduce its absolute debt levels by applying free cash flows to debt reduction that would also contribute to (ii) a sustainable reduction of its high leverage (Debt/EBITDA) of 4.8x in FY 2011 to no more than 4.5x in 2012 in a more challenging environment. These performance achievements should go along with unchanged or improved market positions and technological leadership positions.

The ratings could come under pressure in case of (i) a significant weakening in Schaeffler's operating performance and cash flow generation evidenced by EBIT margins below 10% and free cash flow generation to stay negative beyond 2012; (ii) inability to sustain its leverage of 4.8x in 2011 over the coming years as well as (iii) weakening of its liquidity profile including the possible failure to perform within the currently comfortable headroom under its financial covenants.

Moody's considers Schaeffler Group's short term liquidity over the next 12 months to be good. Based on Moody's calculation the company has access to cash sources of more than EUR2.5 billion comprising a cash balance of around EUR290 million (thereof a minor portion of restricted cash), expected FFO, and two revolving credit facilities of more than EUR1.0 billion currently mostly undrawn. Cash uses consisting of working capital requirements, capex, working cash for day to day needs as well as cash needs upstreamed to the holding level for payment of taxes, interest payment and operating / advisory costs should be fully covered by the sources mentioned above. Given the expected limited free cash flow generation in the next couple of years, the ability to refinance existing debt when it comes due will be a key challenge for Schaeffler Group. The bank loans provide for certain financial covenants on leverage, interest coverage and cash flow coverage as well as restrictions on Capital expenditures and dividend payments that according to Moody's understanding currently provide sufficient headroom.

STRUCTURAL CONSIDERATIONS

When assessing the structure of Schaeffler's liabilities Moody's includes the junior debt located at the level of Schaeffler Verwaltungs GmbH and Schaeffler Holding GmbH & Co. KG. This debt is secured by pledges over Continental shares held by Schaeffler Verwaltungs GmbH and by the two independent banks as well as shares in Schaeffler AG. This assessment is consistent with our approach when assessing the corporate family rating of Schaeffler AG given the absence of a complete ring-fencing between Schaeffler AG and its subsidiaries from the holding level.

Moody's views the junior debt as legally and structurally subordinated to the senior debt at Schaeffler AG level as well as to trade claims, pension obligations and lease rejection claims at operating entities. Based on Moody's recovery analysis the debt outstanding under the Senior Facilities Agreement of January 2012, the existing EUR2.0 billion worth of notes issued in February 2012 as well as the announced senior secured notes to be issued by Schaeffler Finance B.V. and guaranteed on a senior basis by Schaeffler AG and certain subsidiaries of Schaeffler AG are rated one notch above the corporate family rating as a result of a recovery rate calculated at 65%, higher than the group average assumed to be 50% in Moody's LGD model. Consequently, the Senior term loan facility C2 has a B1 rating with a LGD3 at 35%, the EUR2.0 billion outstanding bonds have a B1 rating with a LGD3 at 35% and the announced senior secured notes to be issued have been assigned a B1 rating with a LGD3 at 35%.

The principal methodology used in rating Schaeffler was the Global Automotive Supplier Industry Methodology published in January 2009. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

Headquartered in Herzogenaurach, Germany, Schaeffler is a leading manufacturer of rolling bearings and linear products worldwide as well as a renowned supplier to the automotive industry. The company develops and manufactures precision products for everything that moves -- in machines, equipment and vehicles as well as in aviation and aerospace applications. The group operates under three main brands -- INA, FAG and LuK. In FY2011, Schaeffler generated revenues of approx. EUR10.7 billion.

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Falk Frey Senior Vice President Corporate Finance Group Moody'sDeutschland GmbH An der Welle 5 Frankfurt am Main 60322 Germany JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 Matthias Hellstern Associate Managing Director Corporate Finance Group JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 Releasing Office: Moody's Deutschland GmbH An der Welle 5 Frankfurt am Main 60322 Germany JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 (C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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