CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the following ratings of Quest Diagnostics, Inc. (Quest):
--Issuer Default Rating (IDR) at 'BBB+';
--Senior unsecured debt rating at 'BBB+';
--Bank loan rating at 'BBB+'.
The ratings apply to $2.99 billion of outstanding debt. The Rating Outlook has been revised to Negative from Stable.
The rating action follows Quest's announcement of a definitive agreement to purchase Athena Diagnostics (Athena), a genetic testing firm specializing in neurological disorders, for $740 million in cash. Athena is a subsidiary of Thermo Fisher Scientific. The transaction is expected to be completed in the second quarter. Fitch sees leverage no longer indicative of the current rating category at the end of 2011 from incremental debt to be used for the acquisition, the recently-completed purchase of equity from GlaxoSmithKline plc totaling $835 million, as well as a potential legal settlement with the California Department of Health Services of $240 million. The Negative Rating Outlook reflects the uncertainty of the ultimate capital structure upon the consummation of acquisitions including Athena in addition to intentions for and timing of debt reduction, in light of underlying operational pressures during this timeframe.
Fitch recognizes that Quest has a history of reducing leverage to historical levels of 1.5 times (x) to 2.25x within 12 to 18 months following a leveraging transaction; most recently demonstrated when the company quickly dropped leverage after the purchases of AmeriPath and HemoCue in 2007. As such, Fitch anticipates that leverage could fall into top-end of the historical range by the end of 2012, including issuance of new long-term debt this year and a pay down of at least half of the term loan facility due 2012. Over the course of the Rating Outlook horizon, Fitch will moniter the capital structure post acquisition and the company's debt reduction commitment over the next two years, balanced against capital deployment directed to further share repurchases and asset purchases..
Quest's strong liquidity provides an opportunity to decrease the debt load over the next 12 to 18 months. Free cash flow is solid with free cash flow margins hovering in the range of 9% to 11.5% since 2006. Free cash flow was around $841 million in 2010 representing a margin of 11.4%. Quest management expects to generate operating cash flow of $1.1 billion in 2011, and spend capital of $220 million. External sources of committed liquidity have been somewhat compromised from funds needed for the recent share repurchases derived from borrowings under a $525 million receivable program and a $750 million revolving credit facility due May 2012, both of which had full capacity at the end of 2010. Cash and equivalents at the end of 2010 were $449 million.
Pressures on top-line growth arose during 2010 due to lower volume impacted by decreased physician office visits and a business mix shift, which resulted from a slowdown in higher margin anatomical pathology demand dampened by increased competition from physician in-sourcing of pathology work coupled with an increase in lower-margin drug screening. As such, EBITDA margin compressed by 90 basis points to 21.8% as increased investment has been dedicated to improving customer service levels offset by ongoing cost reduction efforts since 2007. In 2010, Quest twice reduced headcount to manage expenses as a result of the current revenue pressures. Fitch estimates continued margin decline in 2011, somewhat exacerbating the rise in leverage from a higher debt level.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Relared Research:
-- 'Corporate Rating Methodology' dated 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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