NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB' rating to Thermo Fisher Scientific's (Thermo Fisher) proposed $800 million senior notes. The Rating Outlook is Negative. The ratings apply to $14.5 billion of debt at Sept. 27, 2014. A full list of ratings follows at the end of this press release.
The proceeds of the proposed notes will be used to fund a portion of $3.1 billion of scheduled debt maturities in the next year, so the issuance has a nominal effect on pro forma leverage.
Key Rating Drivers:
--Thermo Fisher has demonstrated solid and consistently paced improvement in the credit profile since the fourth quarter 2013 (Q4'13) acquisition of Life Technologies, a transaction that added $10.8 billion of debt to the capital structure and resulted in a one-notch downgrade of the ratings.
--Thermo Fisher has applied the majority of free cash flow (FCF; equals CFO less capital expenditures and dividends), as well as about $1 billion in proceeds from business divestitures, to debt reduction in 2014, reducing the post-acquisition debt balance by $2.7 billion.
--At Sept. 27, 2014, Fitch calculates gross leverage of slightly under 4x, versus a pro forma level of 4.5x at the end of 2013. Maintenance of the 'BBB' rating will require Thermo Fisher to reduce leverage to 3x or below by the end of 2015. Fitch projects that meeting this target will require about $1 billion of additional debt paydown.
--Fitch forecasts Thermo Fisher to produce adequate FCF to accomplish this level of debt reduction. It is likely that the company will resume capital deployment for share repurchases and acquisitions during 2015. As long as this does not derail progress in deleveraging, it will not result in a downgrade of the ratings.
--EBITDA growth should also contribute to leverage reduction. The integration of the Life Tech business is proceeding smoothly, demonstrated by Thermo Fisher raising the target for cost synergies; revenue synergies should also be a tailwind to growth in 2015.
Aggressive Capital Deployment Pressures Credit Profile
The ratings continue to have a Negative Outlook, reflecting a pattern of aggressive capital deployment over the past several years that contributed to higher debt levels and deterioration of credit metrics. Although funding sources for the Life Tech acquisition included approximately $3 billion of equity proceeds and $2 billion of cash on hand, debt funding drove pro forma leverage to nearly 4.5x versus a pre-acquisition level of 2.6x.
Prior to the Life Tech acquisition, the company funded three fairly sizeable acquisitions in 2011-2012, as well as a high level of share repurchases. Thermo Fisher also instituted a regular dividend in 2012, which now consumes about $240 million of cash from operations (CFO) annually. Thermo Fisher has not indicated a cash return to shareholder policy in terms of a percent of CFO applied to share repurchases and dividends, but funded a high level of shareholder cash payouts in 2011-2012, spending 70% and 50% of CFO on share repurchases and dividends, respectively, in these years.
Decent Progress on Debt Reduction Plan
Despite funding a high level of business development activities and returns to shareholders, Thermo Fisher has a generally strong track record of maintaining gross leverage within a publicly stated target range of 2.5x-3.0x. The company suspended the share repurchase program upon the announcement of the Life Tech acquisition in Q2'13, and management has made debt reduction the priority for cash deployment during 2014.
While growth in EBITDA should contribute to leverage reduction, Fitch expects that reducing leverage to 3x by the end of 2015 will continue to require the company to apply a sizeable portion of FCF to pay down debt. Fitch forecasts EBITDA of $4.5 billion for Thermo Fisher in 2015. So far, $2.7 billion of cash and asset sale proceeds have been used to pay down debt, meaning the company needs to apply an additional $1 billion to debt reduction to meet the leverage target in 2015.
Fitch thinks this amount of debt reduction is achievable, even if the company resumes share repurchases and acquisitions during 2015. On a stand-alone basis, both Thermo Fisher and Life Tech generated ample and consistent FCF. This provides excellent financial flexibility and is a key support of the credit profile of the combined company. Fitch projects annual FCF generation of about $2.5 billion for the combined company in 2015.
A high level of debt repayment is facilitated by the terms of the debt used to fund the acquisition, including use of commercial paper and considering required bank term loan amortization of $500 million in 2014 and $1 billion in 2015. The financial maintenance covenants in the debt agreements also encourage deleveraging. The term loan and bank revolving credit facility agreements require Thermo Fisher to maintain a consolidated leverage ratio of no more than 4.5x through the end of 2014 and the required ratio steps down incrementally to 3.5x in August 2015.
Life Tech Integration Proceeding Smoothly
Thermo Fisher appears to be making good progress in the integration of the Life Tech. During Q3'14, the Life Solutions Segment, which primarily consists of the Life Tech business, posted organic revenue growth of 3%. This is generally consistent with growth in the broader life sciences industry. Beginning in 2015, Fitch thinks this business could post above-market organic growth given the potential for revenue synergies in end-markets where the companies had significant overlap, including academic, government and biopharmaceutical research settings.
A more immediate influence of the business combination is improved profitability and greater sales predictability for Thermo Fisher. In Q3'14, the company's gross operating margin improved by about 500 basis points (bps) compared to the prior year period, while the operating margin improved by about 250 bps. In part, this reflects Life Tech's high proportion of consumables sales. The addition of the Life Tech portfolio of products increased the proportion of Thermo Fisher's sales that can be classified as 'recurring' consumables or services to 61% from 56%. Sales of consumable products are highly profitable and fairly predictable, since demand is somewhat less susceptible to the headwinds that are influencing sales of larger capital equipment in the life sciences sector, particularly in government and academic research end-markets in the U.S. and western Europe.
The realization of cost synergies is also supporting growth in the operating margin. The company reports that it realized $73 million in cost synergies year-to-date, and expects to realize slightly more than $100 million for the full year 2014. This is somewhat above the original synergy target of $85 million for 2014.
Maintenance of the 'BBB' IDR will require Thermo Fisher to reduce leverage to 3x by the end of 2015. A downgrade could result if it appears likely that the company will not meet this target because cash deployment for acquisitions or shareholder payouts delays debt repayment, if growth in EBITDA is hampered by difficulties in the integration of Life Tech, or operating trends are weaker than expected.
A positive rating action is not anticipated before the end of 2015, since it would require the company to commit to maintain leverage below 2.5x. A revision of the Rating Outlook to Stable could occur before the end of 2015 if Fitch believes the company has made sufficient progress in debt reduction to achieve the 3x leverage target.
Fitch currently rates Thermo Fisher as follows:
--Long-term IDR and senior notes 'BBB';
--Short-term IDR 'F2';
--Commercial paper 'F2'.
--Long-term IDR and senior notes 'BBB'.
The Rating Outlook is Negative.
Life Tech had approximately $2 billion of senior notes due 2015, 2016, 2020 and 2021 prior to the acquisition that remain outstanding. Life Tech is now a wholly-owned operating subsidiary of the parent company, Thermo Fisher Scientific, Inc. The parent company is the issuer and obligor of all other debt in the capital structure. There are no upstream or downstream guarantees of the debt outstanding at either of the parent or Life Tech subsidiary level.
The debt issued by the Life Tech subsidiary is therefore structurally senior to the debt outstanding at the parent level to the extent of the assets of the subsidiary. Despite the lack of guarantees and a potentially stronger financial profile at the Life Tech subsidiary, the ratings are equalized at the parent's 'BBB', rating since Fitch believes there are strong operational and strategic linkages between the parent and subsidiary. Furthermore, Thermo Fisher consolidates the results of the Life Tech subsidiary at the parent-company level. Without stand-alone financials at the subsidiary level Fitch cannot assess its financial status on an on-going basis.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage