Fitch Rates St. Jude Medical, Inc.'s Debt Offering 'A'

CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A' rating to St. Jude Medical, Inc.'s (STJ's) $500 million offering of five-year senior unsecured notes. The net proceeds of the issuance are expected to be used for general corporate purposes, which may include the repayment of certain indebtedness and the repurchase of outstanding common stock in conjunction with STJ's issuance of shares to partially fund its acquisition of AGA Medical Holdings, Inc. (AGAM).

On Oct. 18, 2010, Fitch affirmed STJ's ratings following the company's announcement that it would acquire AGAM for approximately $1.3 billion, including roughly $225 million of AGAM debt. The acquisition was subsequently completed on Nov. 18, 2010. AGAM develops, manufactures and sells medical devices to treat structural heart disorders. Fitch believes the acquisition is strategically sound, given the new market opportunities that AGAM's business offers STJ's cardiovascular segment.

STJ financed the transaction with approximately 50% stock (issued by STJ) and 50% cash (existing cash balances and CP borrowings). In the near term, STJ plans to repurchase $600 million of shares to offset the acquisition-related issuance, leaving an additional $300 million of availability on its share repurchase program. The company also intends to pay down some of the related borrowings within the next 12-18 months. Fitch expects leverage could reach 1.6 times (x) to 1.8x during the next six to nine months, while subsequently decreasing to 1.1x-1.3x within 12-18 months.

The key rating drivers for this credit are leverage measured as total debt-to-EBITDA, relative margin stability and free cash flow. While the 'A' leverage range is approximately below 1.5x, a temporary acquisition-related increase in leverage followed by timely reduction is consistent with STJ's 'A' credit rating. Margin variance of less than 200 basis points and material free cash flow generation are also acceptable for this rating level.

Fitch expects that STJ will generate consistent, profitable growth. Near-term margin pressure from the company's investment in remote-monitoring technology and a 2.3% federal excise on U.S. medical device sales beginning in 2013 is expected to be somewhat offset by the company's cost reduction efforts and potentially favorable shifts in mix. As such, Fitch expects STJ to produce reliable growth in free cash flow, which should be sufficient to fund targeted acquisitions and share repurchases. While the final rules and regulations have not been written for the recently enacted health care reform legislation, Fitch believes its implementation will pose incremental pressure on margins, beginning in 2013 and an incremental increase in volume, beginning in 2014.

STJ's four business segments (Cardiac Rhythm Management, Cardiovascular, Atrial Fibrillation and Neuromodulation) participate in sectors of health care that are expected to generate consistent long-term growth. Through a series of targeted acquisitions and internal developments, STJ has developed its business segments into enterprises that are expected to remain competitive in their respective market sectors for the foreseeable future.

While investments and reform-related taxes are expected to moderately pressure margins in the near term, Fitch believes STJ's focus on cost reduction, tax optimization and the development of new value-added, higher margin devices will help mitigate this risk. Longer-term, an improving sales mix and efficiency gains are expected to support incremental margin expansion. Revenue growth, margin support and manageable capital expenditure requirements should drive consistent fee cash flow of $650 million-$800 million in 2010.

The recently enacted healthcare reform legislation is expected to result in moderate volume increases in 2014-2016, when the bulk of the increase in the number of insured is expected to occur. The 2.3% excise tax on U.S. medical device sales, which begins in 2013, will likely have a negative impact on margins and the industry's ultimate cost structure.

The legislation also expands the role of government as a payer for health care services. While device manufacturers are generally not reimbursed by the U.S. government, the industry's customers, hospitals, are expected to receive a larger portion of their revenue from Medicaid. The expected shift in payer mix will likely pressure hospital margins, and it is reasonable to assume that they would push back against device makers when negotiating device prices. In addition, the relative level of reimbursement rates among various devices and procedures could also shift volume to less costly alternatives.

Fitch believes STJ will remain acquisitive, focusing on targets or products that offer innovation and growth, as technological advancement in the device sector is still relatively fragmented. Share repurchases are also expected to continue, especially in the absence of viable acquisition targets.

At the end of third-quarter 2010, STJ had approximately $852 million in cash plus short-term marketable securities and full availability on its $1 billion bank revolving credit facility, which expires on Dec. 13, 2011. Additionally, STJ had approximately $1.99 billion in debt with approximately $78 million maturing or amortizing in 2011, $450 million in 2013 and $700 million in 2014.

Fitch rates STJ as follows:

--Issuer Default Rating (IDR) 'A';

--Senior unsecured bank debt 'A';

--Senior unsecured debt 'A';

--Short-term IDR 'F1';

--Commercial paper 'F1'.

The ratings apply to approximately $1.99 billion of debt, and the Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 16, 2010).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646

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