Fitch Rates Allison Transmission Initial IDR 'BB-'; Rating Outlook Stable

Fitch Ratings has assigned initial issuer default ratings of 'BB-' to Allison Transmission Holdings, Inc. (ALSN) and its Allison Transmission Inc. (ATI) subsidiary. Fitch also assigns a 'BB' rating to ATI's proposed $500 million seven-year secured term loan B-3, proceeds of which will be used to refinance a portion of ATI's $1.8 billion secured term loan B-1. In addition, Fitch assigns a 'BB' rating to the existing secured term loans B-1 and B-2, as well as the company's secured revolving credit facility, and assigns ATI's senior unsecured notes a 'B+' rating. A full list of ratings follows at the end of this release

Fitch's ratings apply to $2.5 billion in secured term loans, a $400 million secured revolving credit facility and $471 million in senior unsecured notes. The Rating Outlook for ALSN and ATI is Stable.

The ratings for ALSN and ATI reflect the transmission manufacturer's strong competitive position as a supplier of fully automatic transmissions for on-highway, off-highway and military applications, as well as hybrid propulsion systems for busses. ALSN enjoys a very strong position in the North American market, with the majority of school busses, Class 6 and 7 trucks, and Class 8 straight trucks manufactured with the company's transmissions in 2011. The company also has a recognized brand name that commands a price premium from end users. ALSN's position outside North America is considerably smaller, however, as manual transmissions continue to dominate most markets. Acceptance of fully automatic transmissions is growing, though, particularly in emerging markets, and the company has positioned itself to take advantage of opportunities in these regions, most notably in China and India.

The combination of premium pricing and a focus on manufacturing cost control has led to a substantial margin performance and relatively strong free cash flow (FCF), which remained positive even during the downturn of 2008 and 2009. Leverage remains moderately high, however, as a result of substantial bank borrowings incurred with the company's 2007 leveraged buy-out. Since that time, ALSN has been focused on using FCF to reduce debt, including a $355 million decline in debt in the first half of 2012. Relatively low pension obligations and a sufficient liquidity position are other credit positives.

Credit concerns include the highly cyclical nature of the global truck and capital goods industries, volatile raw material costs, relatively little global diversification, the aforementioned moderately high leverage and a concentrated maturity schedule which includes a significant amount of debt due in two years. These concerns are mitigated somewhat, however, by ALSN's strong FCF performance and increasing penetration into emerging markets. Also, ALSN primarily supplies the vocational truck market, which tends to be less cyclical than the linehaul truck market. Nonetheless, a broad-based global downturn in commercial vehicle production would potentially put significant pressure on the company's margins and FCF. Fitch also has some concerns around a continued decline in military-related revenue, given the possibility of significant program cuts in 2013 with a sequestration of U.S. military's budget. However, just 13% of ALSN's revenue in the 12 months ended June 30, 2012, was derived from its military segment, and Fitch believes only a portion of this would be at risk from sequestration.

Outside of external market concerns, the labor agreement covering the company's U.S. hourly employees represented by the United Auto Workers (UAW) expires in November 2012, which increases the risk of operational disruption later this year. However, it is notable that the current UAW labor agreement is already similar to the one negotiated between the union and the three Detroit auto manufacturers in 2011, and ALSN does not have a history of labor-related disruptions. In addition to labor, Fitch also notes that ALSN's ownership structure is highly concentrated, with The Carlyle Group and Onex Corporation each holding a 41.5% stake in the company. It does not appear that this ownership concentration has resulted in any significant actions by the company that would be detrimental to its creditors.

The Stable Rating Outlook on ALSN and ATI indicates that a near-term change in the company's ratings is not likely. Longer term, however, Fitch could consider an upgrade of the IDR to 'BB' if company continues to reduce debt, makes further progress on increasing the globalization of its revenue base, and FCF and margins remain high for an extended period. In particular, a continued strong performance in a slower commercial vehicle market would be a potential driver of higher ratings.

On the other hand, Fitch could consider a downgrade in the ratings on an unexpected sharp decline in North American commercial vehicle production, or if the company increases its debt load. In particular, a significant increase in long-term debt to support shareholder-friendly actions would be viewed negatively, although cash returns to shareholders via FCF could be consistent with the current ratings, provided liquidity remains sufficient for ongoing financial flexibility. Although not expected, a significant increase in debt to support an acquisition might also be a trigger for a negative rating action; while a prolonged production decline caused by a labor disruption tied to the November 2012 UAW contract expiration could also trigger a downgrade.

ALSN's credit profile is characterized by strong margins and FCF generation, but moderately high leverage. Fitch-calculated leverage (debt/Fitch-calculated EBITDA) in the 12 months ended June 30, 2012, was 4.1x, with $3.0 billion in debt and last 12 months (LTM) Fitch-calculated EBITDA of $745 million. The calculated EBITDA margin of 33.1% was very strong for a capital goods manufacturer, however, and Fitch believes ALSN has the financial flexibility to drive leverage below 4x in the next twelve months. Funds from operations (FFO) adjusted leverage was 4.4x and FFO fixed charge coverage was 4.0x in the LTM period ended June 30, 2012, versus 4.9x and 3.1x, respectively, at Dec. 31, 2011. The company's liquidity position at the end of the second quarter was more than sufficient to meet its cash obligations and included $112 million in cash and cash equivalents and $372 million of availability on its $400 million secured revolving credit facility (after accounting for $28 million in letters of credit).

ALSN has been focused on reducing debt over the past several years, with debt (including short-term debt) declining from $4.0 billion at year-end 2008 to $3.0 billion at June 30, 2012. The current figure is down $536 million from the level at June 30, 2011, and down $358 million since year-end 2011. The decline in the first half of 2012 was primarily due to the early repayment of all of the company's 11% senior unsecured notes, which totaled $310 million at year-end 2011. ALSN has the flexibility to further reduce its debt through optional prepayments on its secured term loans or early redemption of all or a portion of its 7.125% senior unsecured notes, and Fitch expects that the company will take advantage of opportunities to reduce its debt over the intermediate term.

The company's credit agreement includes financial covenants that require ALSN to maintain a senior secured leverage ratio below 5.50x. The actual senior secured leverage ratio, which is calculated net of cash, was well below the maximum level at 3.19x as of June 30, 2012. According to the facility's terms, a senior secured leverage ratio below 3.50x suspends certain provisions requiring excess cash flow (as defined in the agreement) to be applied to term loan reduction.

The company is currently seeking commitments from banks on a proposed $500 million secured term loan B-3 that will be entered into through an amendment to the existing credit facility agreement. Terms and conditions of the amended facility are expected to be substantially similar to those in the current version of the credit agreement. Proceeds from the term loan B-3 will be used to prepay a portion of the $1.8 billion outstanding on the company's secured term loan B-1. The term loan B-3 will mature in August 2019 and augments the B-1 loan that matures in August 2014 and the $797 million term loan B-2 that matures in August 2017.

At June 30, 2012, ALSN had no short-term debt outstanding, and current maturities of long-term debt totaled only $8.0 million. However, even with the proposed reduction to the B-1 term loan, ALSN's maturity schedule remains very uneven, with the large maturity coming due in 2014 when the remaining principal balance of the B-1 loan is due. Although the current term loan B-3 transaction is expected to reduce the amount of the B-1 maturity by about $500 million, the company will still have an estimated $1.3 billion in debt that matures in August 2014 and nearly $800 million maturing in August 2017.

LTM FCF was $379 million at the end of the second quarter, leading to a relatively strong 16.9% FCF margin. Funds flow from operations (FFO) was $529 million in the LTM period, with working capital using a fairly modest $5.8 million. LTM capital spending was $132 million, equal to 5.9% of revenue, which was higher in relative terms than the company's spending in recent years as it continues to invest in its geographical footprint and new product programs. The company has guided to full-year 2012 capital spending in the range $115 million to $130 million. Fitch expects FCF to remain solid over the intermediate term and FCF margins to remain strong by industry standards as growth in operating cash flow more than offsets an expected rise in capital spending. Fitch notes, however, that ALSN instituted a dividend in the second quarter of 2012 that will reduce annual FCF by about $44 million going forward.

ALSN's defined benefit pension obligations are relatively modest, with an underfunded status of only $16 million as of year-end 2011. The company's U.S. hourly pension plan was closed to new entrants in 2008, and benefits for U.S. hourly employees who retired prior to October 2, 2011, are covered under General Motors Company's (GM) hourly plan. ALSN completed the transfer of obligations and assets tied to those retirees from its hourly plan to GM's plan during the second quarter of 2012. Fitch does not currently view ALSN's pension obligations as a meaningful credit risk.

The secured revolver and term loans that comprise ATI's credit facility are rated one notch above ATI's IDR at 'BB', reflecting their collateral coverage, which includes virtually all of ATI's assets. Fitch notes that property, plant, and equipment and intangible assets (including ALSN's intellectual property) comprised $2.4 billion of the $5.1 billion in assets on ALSN's consolidated balance sheet at June 30, 2012. With secured loans accounting for over 85% of the debt in the capital structure (assuming a fully-drawn revolver), ATI's senior unsecured notes are rated one notch lower than ATI's IDR at 'B+'.

WHAT COULD TRIGGER A RATING ACTION

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--A meaningful reduction in leverage;

--Increased global revenue diversification;

--Continued strong margin performance;

--Ongoing positive FCF generation, especially in a weakened demand environment.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--A sharp decline in commercial vehicle production, especially in North America;

--A significant increase in debt;

--An increase in leverage to support shareholder-friendly actions;

--A merger or acquisition that results in higher leverage over an extended period of time;

--A prolonged downturn in production caused by a labor disruption.

Fitch has assigned the following ratings to ALSN and ATI:

ALSN

--IDR 'BB-'

Rating Outlook Stable.

ATI

--IDR 'BB-'

--Secured term loan rating 'BB';

--Secured revolving credit facility rating 'BB';

--Senior unsecured rating 'B+';

Rating Outlook Stable.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 8, 2012);

--'Evaluating Corporate Governance' (Dec. 13, 2011)

--'2012 Outlook: U.S. Diversified Industrials and Capital Goods' (Dec. 14, 2011).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460

Evaluating Corporate Governance

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=657143

2011 Outlook: U.S. Diversified Industrials

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=591965

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