CHICAGO--(BUSINESS WIRE)--Fitch Ratings has placed St. Jude Medical, Inc.'s (STJ/St. Jude) ratings on Negative Watch. The rating action follows St. Jude's recently announced intention to acquire Thoratec Corporation (Thoratec) for roughly $3.4 billion, net of cash acquired. This is an all-cash transaction, and Fitch anticipates that any rating downgrade would be limited to one-notch, if the acquisition is completed under the current proposed terms.
KEY RATING DRIVERS
The rating action reflects the following:
--Fitch believes STJ's intended acquisition of Thoratec Corporation (Thoratec) is strategically constructive and provides an adjacent product platform to its cardiovascular business, as well as an expansion of its treatment offerings for heart failure patients.
--The acquisition will likely increase leverage (total debt/EBITDA) in the intermediate term, which is already stressed for the company's 'A' rating.
--The stabilizing domestic cardiac rhythm management (CRM) market, new product introductions and emerging market opportunities should support mid-single-digit organic revenue growth for STJ during 2015 and beyond.
--STJ's focus on cost control and improving its sales mix should more than offset pricing headwinds and incrementally improve margins during 2015-2017.
--Decent sales growth and modestly improving margins will likely drive strong and consistently positive free cash flow.
--Fitch anticipates that STJ will maintain adequate liquidity through cash balances, reliably positive FCF and ready access to the credit markets.
ACQUISITION MAKES SENSE
STJ's decision to enter into the mechanical circulatory support market will help to expand the company's presence in treating heart failure patients. The demand for heart pumps should increase over time, given the increasing number of new heart failure patients. In addition, these devices can provide health and economic benefits to patients and payers, to the extent that they can more effectively and safely treat patients.
Thoratec Corporation's (Thoratec) device platforms are adjacent to STJ's current cardiovascular platforms. Potential sales and technological synergies exist with Thoratec's and STJ's product platforms. STJ forecasts only modest operating cost synergies, although STJ should also be able to augment the growth in Thoratec's products through its scale. Thoratec operates in the ventricular-assist heart pump market, which is a duopoly. The company has roughly 58% market share. In addition, Fitch expects Thoratec to enter what will most likely become duopolistic percutaneous heart pump market in the near future.
TRANSACTION WILL INCREASE LEVERAGE
STJ expects to close the transaction in 4Q15, and Fitch will resolve the watch once it more clearly determines the post-acquisition capital structure and operating profile. Nevertheless, leverage will likely increase above what is already a stressed balance sheet for the company's current 'A' rating. Given the size and nature of the acquisition and STJ's expected operating stability, Fitch believes that if a ratings downgrade occurs, it would be limited to one notch.
GROWTH EXPECTED
Fitch looks for STJ to generate mid-single-digit organic revenue growth during the next 12-24 months. New product introductions, growth in recently introduced products and expansion into faster growing product and geographic markets. These underpinnings should more than offset a soft CRM market and foreign exchange rate headwinds.
STJ has recently launched, or will soon launch devices in all four of its business segments [CRM, Atrial Fibrillation (AF), Cardiovascular (CV) and Neuromodulation (NM)]. A number of these devices are differentiated by their clinical effectiveness and safety profiles, as well as by their ability to reduce medical costs compared to competing devices. Fitch believes the company's new product development and commercialization efforts will continue to support favorable pricing and potentially incremental market share gains.
INCREMENTALLY IMPROVING MARGINS
Fitch forecasts incrementally improving margins for STJ, despite some persistent headwinds. STJ margins have remained relatively strong, owing to mix shift to newer and higher margin devices and its ongoing focus on cost control that offset a more challenging hospital reimbursement environment and the ACA excise tax. Longer term, Fitch expects margins will benefit from continued gains in operational efficiency and favorable shifts in product sales-mix.
RELIABLE FCF
Increasing revenue with incrementally improving margins should result in STJ generating $800 million - $1.1 billion of annual FCF (cash flow from operations minus capital expenditures of roughly $250 million minus dividends of roughly $320 million) during the next two years. Cash generation should be sufficient to fund a level of some debt reduction that will likely be needed if the acquisition is executed as announced.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for St. Jude Medical, Inc. include:
--Mid-single organic revenue growth;
--Stressed leverage in the intermediate term mainly because of the proposed Thoratec acquisition;
--Incrementally improving margins with consistently positive and solid FCF;
--Adequate liquidity from balance sheet cash and adequate access to the bank and credit markets.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include the following:
--Fitch does not anticipate an upgrade in the near to intermediate term.
--However, STJ would need to commit to and operate with leverage stronger than 1.3x-1.4x while maintaining relatively stable operations and solid FCF, in order for Fitch to consider a positive rating action.
Negative: Future developments that may, individually or collectively, lead to negative rating action, a likely one-notch downgrade, include the following:
--Debt sustained above 1.6x-1.7x EBITDA without the prospect for timely deleveraging.
--This could result from a scenario in which revenue and margins are significantly stressed (more than Fitch anticipates); resulting FCF weakens; and capital deployment not being adjusted to reduce the company's need for debt financing.
--As such, significant debt-financed share repurchases or acquisitions in the near term would likely prompt a negative rating action, given the limited flexibility associated with the company's current leverage.
LIQUIDITY
At April 4, 2015, STJ had adequate liquidity, comprised of approximately $695 million in cash plus short-term marketable securities and roughly $321 million (net of $ 1,179 million commercial paper borrowings) in availability on its $1.5 billion bank revolving credit facility, which expires in May 2018. STJ generated approximately $780 million in FCF (net of $177 million of capital expenditures and $308 million of dividends) during latest 12 months (LTM), ended April 4, 2015.
The company had approximately $3.5 billion in debt with (including $1,179 million in commercial paper outstanding) approximately $54 million maturing in 2015, $500 million in 2016, $1.18 billion in 2018 and $1.87 billion thereafter. Fitch expects STJ to refinance the majority of its non-bank loan maturities, utilizing its anticipated access to credit markets.
FULL LIST OF RATING ACTIONS
Fitch has placed the following ratings for St. Jude Medical, Inc. on Rating Watch Negative:
--Issuer Default Rating (IDR) 'A';
--Senior unsecured bank debt 'A';
--Senior unsecured debt 'A';
--Short-term IDR 'F1';
--Commercial paper 'F1'.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosures
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=988333
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.