Fitch Downgrades Teva to 'BBB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has downgraded the ratings of Teva Pharmaceutical Industries Limited (Teva) to 'BBB+' from 'A-'. The Rating Outlook is Stable.

A full list of rating actions follows at the end of this release.

The downgrade is driven by Fitch's view that free cash flow (FCF) will be insufficient in 2013-2014 to repay maturing debt, resulting in a further extended de-leveraging timeframe following the 2011 Cephalon acquisition to beyond 2014. Fitch's forecast for depressed FCF, despite the expectation for cost savings, stems from the confluence of previously-announced significant cash outflows for litigation, tax settlements, and accelerated restructuring activities and of branded and likely near-term generic competition to Copaxone. Furthermore, Fitch identifies material execution risk with respect to the firm's accelerated 'Re-Shape' program and R&D productivity, given the significance of the program's success to the firm's longer-term credit profile. This risk is heightened, in Fitch's view, by the firm's current lack of a permanent CEO.

KEY RATING DRIVERS

-- Teva is the largest generic drugmaker and one of the largest pharmaceutical firms in the world. As such, the company benefits from considerable scale, global presence, and good diversification (except Copaxone).

-- FCF is expected to be significantly pressured in 2013-2014 by more than $3.5 billion in non-recurring cash outflows for litigation and tax settlements and accelerated restructuring activities. Fitch forecasts FCF of approximately $450 million to $800 million in 2014, compared to $2.6 billion for fiscal 2012 and $1.9 billion for the latest 12 month (LTM) period ended Sept. 30, 2013.

-- Reduced FCF will be insufficient to repay maturing debt as previously expected, especially if the firm consummates what Fitch deems as likely M&A in order to shore up a relatively weak medium-term growth profile. Fitch expects gross unadjusted debt-to-EBITDA to be maintained between 2.0x and 2.5x over the ratings horizon.

-- Fitch's outlook for the global generic pharmaceutical industry is generally favorable. Aging populations and price-conscious payers in developed markets and generally improving access to healthcare in emerging markets should support demand growth. Pricing could be pressured, particularly by payers in Western Europe and consolidating purchasers globally, over the near-to-medium term.

-- Fitch sees Teva's stated strategic objectives as appropriate and realistic, and capable of driving growth beginning in the 2016-2018 timeframe. However, material execution risk with respect to Teva's accelerated 'Re-Shape' program and R&D focus is exacerbated by the firm's current lack of a permanent CEO.

RATING SENSITIVITIES

Maintenance of a 'BBB+' credit profile will generally require a sustained commitment to and successful execution of the firm's outlined strategic objectives over the ratings horizon. Significant cost savings, particularly in the generics business, and key investments in growth areas will be important to the company's longer-term growth and profitability.

Teva has ample flexibility at the 'BBB+' ratings to consummate targeted M&A transactions that contribute to the firm's medium-to-longer term growth profile. This view holds in the scenario that Copaxone faces generic competition in May 2014. Fitch notes that the timing of a generic launch, the number of generic entrants, and the pace of generic conversion is at this time relatively uncertain.

A negative rating action could be caused by more severe Copaxone share losses leading to materially lower margins and weaker cash generation than currently expected by Fitch. A material departure from or failure to execute on the firm's outlined strategic objectives could also weigh on the ratings. Furthermore, a transformative M&A transaction or additional unexpected cash outflows (e.g. sizeable shareholder-friendly payments, additional litigation or tax settlements) requiring debt funding such that gross unadjusted debt-to-EBITDA would be sustained above 2.5x would likely cause a downgrade to 'BBB'.

A positive rating action is not expected over the ratings horizon given the number of known headwinds and remaining uncertainties currently facing the firm.

PRESSURED CASH FLOWS HINDER DEBT REPAYMENT

Significant cash outflows related to litigation and tax settlements and accelerated restructuring activities yield Fitch-forecasted FCF of approximately $450 million to $800 million in 2014, depending on the timing of a generic Copaxone launch. More than $3.5 billion of cash payouts in 2013-2014 for litigation ($1.6 billion - $2.1 billion), tax settlements (approx. $718 million), and restructuring (approx. $800 million) are the primary drivers of these lower FCF figures.

Fitch had previously expected Teva to use cash flows to repay approximately $1 billion of debt in each of 2012-2014, leading to gross unadjusted debt-to-EBITDA below 2.0 by year-end 2014. But FCF is likely to be insufficient to repay the majority of the $1.1 billion notes that matured in November 2013 and $750 million due in March 2014. Refinancing these issuances will cause gross unadjusted debt leverage to be sustained between 2.0x and 2.5x through 2014 - more than three years following the close of the Cephalon deal in October 2011.

INCREASING COPAXONE COMPETITION

Relatively new therapies for the treatment of multiple sclerosis (M.S.), notably newer oral therapies, are expected to continue to eat into Copaxone's market share in 2014 at a pace slightly ahead of Fitch's initial expectations. However, the potential for AB-rated generic competition from as many as four firms in May 2014 poses a greater risk to the longevity of Teva's largest drug franchise. Fitch sees management's public comments pertaining to an expected 10% market share loss to oral therapies and a potential 25% share loss to generics in 2014 as reasonable.

There remain considerable uncertainties with respect to both the occurrence and impact of a potential generic launch, i.e. the success of converting patients to and maintaining pricing of Teva's yet-to-be-approved three-times-weekly version of Copaxone; and the FDA's approval, the successful launch, and the pace of market acceptance of generic versions of Copaxone. Fitch thinks it is possible that the outcome of these uncertainties could drive Copaxone share losses, particularly to generics, and pricing pressures greater than those outlined publicly by the firm in 2014-2015.

It is also possible that the launch of a generic Copaxone could be delayed beyond the May 2014 expiration of market exclusivity. But Fitch believes that even in this scenario it is unlikely that Teva will be able to adequately reduce debt before facing severe profit losses at some point soon thereafter.

APPROPRIATE STRATEGY WITH HIGHTENED EXECUTION RISK

Fitch thinks the strategic objectives outlined by Teva first in December 2012, and accelerated in October 2013, are appropriate and capable of driving longer-term growth. Targeted cost savings are, in Fitch's view, realistic and achievable and will offset some of the effects of Copaxone losses. However, Fitch expects that a sizeable portion of cost savings - the bulk of which will be realized in Teva's generics business - will be reinvested over the life of the program and will not, therefore, sufficiently bolster profitability in 2014-2016.

Successful execution of the outlined R&D strategy could drive significant growth in the outer years of the rating horizon, in Fitch's view; but not in time to offset expected Copaxone losses in 2014-2016. Biosimilars and complex generics are key areas of growth which Teva in uniquely positioned to achieve. The company's JV with Proctor & Gamble should also provide an area of near-to-medium term growth, albeit relatively smaller compared to the firm as a whole.

Material execution risk around achieving these objectives is heightened by the current lack of a permanent CEO. The eventual hiring of a new permanent CEO opens the possibility for an altered strategic plan, though Fitch thinks this is unlikely.

LIQUIDITY STRETCHED BUT AMPLE FOR 'BBB+'

Teva maintains a $3 billion unsecured revolver due 2017 and had $1.15 billion of cash on hand at Sept. 30, 2013. Fitch expects Teva to carry a balance on its revolver at year-end 2013 due to the repayment of the $1.1 billion of notes that matured in November 2013.

The firm's maturity schedule is well-laddered, though likely requiring some refinancing in 2014 to maintain adequate cash on hand. Debt maturities are estimated as follows: approx. $0.8 billion in 2014; $1.2 billion in 2015, $1.5 billion in 2016, $650 million in 2017, and $8.5 billion thereafter.

Fitch has taken the following ratings actions:

-- Downgraded the Issuer Default Rating (IDR) of Teva Pharmaceutical Industries Limited to 'BBB+' from 'A-';

-- Downgraded the senior unsecured notes ratings to 'BBB+' from 'A-';

-- Downgraded the senior unsecured bank facility rating to 'BBB+' from A-';

-- Assigned a 'BBB+' IDR to Teva Pharmaceuticals USA, Inc.;

-- Assigned a 'BBB+' IDR to Teva Capital Services Switzerland GmbH;

-- Assigned a 'BBB+' IDR to Teva Finance Services B.V.;

-- Assigned a 'BBB+' IDR to Teva Finance Services II B.V.;

-- Assigned a 'BBB+' IDR to Teva Pharmaceutical Finance, LLC;

-- Assigned a 'BBB+' IDR to Teva Pharmaceutical Finance II, LLC;

-- Assigned a 'BBB+' IDR to Teva Pharmaceutical Finance IV, LLC;

-- Assigned a 'BBB+' IDR to Teva Pharmaceutical Finance, B.V.;

-- Assigned a 'BBB+' IDR to Teva Pharmaceutical Finance II, B.V.;

-- Assigned a 'BBB+' IDR to Teva Pharmaceutical Finance III, B.V.;

-- Assigned a 'BBB+' IDR to Teva Pharmaceutical Finance IV, B.V.;

-- Assigned a 'BBB+' IDR to Teva Pharmaceutical Finance V, B.V.

The issuers being assigned IDRs are co-borrowers or issuers of already-rated debt instruments.

The Rating Outlook is Stable.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (Aug. 5, 2013);

--'2014 Outlook: Global Branded Pharmaceuticals' (Dec. 10, 2013);

--'2014 Outlook: U.S. Healthcare' (Nov. 25, 2013);

--'Trekking the Path to Biosimilars - The Destination' (Oct. 4, 2013);

--'Global Pharmaceutical R&D Pipeline' (Sep. 23, 2013);

--'Fitch: At-Risk Settlement Could Pressure Teva's Ratings' (June 13, 2013);

--'Global Pharmaceuticals Sector and Company Overview' (Jan. 29, 2013);

--'Rating Pharmaceutical Companies' (Aug. 9, 2012).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

2014 Outlook: Global Branded Pharmaceuticals (Manageable Risk Profile)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=725275

2014 Outlook: U.S. Healthcare -- Secular Challenges Require a Compelling Value Proposition

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724141

Trekking the Path to Biosimilars -- The Destination

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=719802

Global Pharmaceutical R&D Pipeline (Novel Drug Approvals Ease)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=718317

Rating Pharmaceutical Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684459

Global Pharmaceuticals Sector and Companies Overview

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=699671

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=811468

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Contacts

Fitch Ratings
Primary Analyst
Jacob Bostwick, CPA, +1-312-368-3169
Associate Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Michael Zbinovec, +1-312-368-3164
Senior Director
or
Committee Chairperson
Michael Weaver, +1-312-368-3156
Managing Director
or
Media Relations:
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Jacob Bostwick, CPA, +1-312-368-3169
Associate Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Michael Zbinovec, +1-312-368-3164
Senior Director
or
Committee Chairperson
Michael Weaver, +1-312-368-3156
Managing Director
or
Media Relations:
Brian Bertsch, New York, +1-212-908-0549
brian.bertsch@fitchratings.com