Fitch Places St. Jude Medical on Rating Watch Negative
Fitch will resolve the Rating Watch as more details regarding the transactions become available. However, given the currently available information and assuming Abbott acquires both Alere and St. Jude, Fitch will likely downgrade St. Jude to 'BBB'.
St. Jude had approximately \\$6.43 billion in outstanding debt at Jan. 2, 2016. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
Sound Acquisitions/High Leverage: Abbott's planned acquisition of St. Jude for an equity value of roughly \\$25 billion (\\$46.75 in cash and 0.8708 shares of Abbott common stock per share of St. Jude) plus approximately \\$5.7 billion net debt (which will be assumed or refinanced) is a good strategic fit. St. Jude will expand Abbott's market presence in segments that Abbott currently operates, by providing it with broader product offerings. The acquired portfolio, in aggregate, will also offer organic growth potential.
The acquisition will significantly increase Abbott's debt, with leverage forecasted (assuming Abbott also acquires Alere) to remain above 3.0x through 2019. Fitch expects Abbott will reduce leverage to durably below 3.0x thereafter, through a combination of debt reduction and increased EBITDA. Operating margins will likely improve because of favorable shifts in sales mix, good cost control and synergies. FCF should stay significantly positive (excluding one-time restructuring costs). The potential 'BBB' post-transaction rating for St. Jude assumes that Abbott will pursue a more conservative approach to capital deployment, with share repurchases, dividend increases and acquisitions remaining modest.
The transaction is likely to close near year-end 2016, pending regulatory approvals and St. Jude shareholder approval. The addition of St. Jude's products will significantly expand Abbott's medical device portfolio, particularly in the area of cardiovascular disease. The deal will position Abbott as the number-one or number-two player in many of the sub-segments of the cardiovascular device market. The combination provides minimal overlap in product categories and offers Abbott a larger presence in the faster growing device areas of atrial fibrillation, structural heart and neuromodulation.
Abbott estimates it will realize roughly \\$500 million in annual synergies by 2020 from the St. Jude acquisition. Broader portfolios within the sub-segments of cardiovascular should provide Abbott with increased bundling/shelf space opportunities when contracting with hospital management and purchasing groups. Cost-related synergies in the areas of sourcing plus some overlap in sales force and administrative functions should be attainable. In addition, Abbott has a demonstrable record of accomplishment of acquiring and successfully integrating acquisitions.
Thoratec Acquisition Strategically Sound: St. Jude's entered the mechanical circulatory support market through the acquisition of Thoratec on Oct. 8, 2015. The transaction will help to expand St. Jude's presence in treating heart failure patients. Thoratec's device platforms are adjacent to St. Jude's current cardiovascular platforms. Potential sales and technological synergies exist between the two's product platforms.
St. Jude forecasts only modest operating cost synergies, but it should also be able to augment the growth in Thoratec's products through its scale. The acquisition was a cash transaction valued at approximately \\$3.4 billion, net of cash acquired. The transaction further stressed leverage, and Fitch believes that leverage will remain above 1.7x during the intermediate term.
Growth Expected: St. Jude will likely generate mid-single-digit organic revenue growth during the next 12-24 months. Growth will be supported by new product introductions, growth in recently introduced products, and expansion into faster growing product and geographic markets. These factors should more than offset a soft CRM market and foreign exchange rate headwinds.
St. Jude 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.
Improving Margins: Fitch forecasts improving margins for St. Jude, despite some persistent headwinds. They have remained relatively strong, owing to mix shift to newer and higher margin devices and its ongoing focus on cost control which offset a more challenging hospital reimbursement environment. 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 improving margins should result in St. Jude 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 roughly \\$2.3 billion of debt reduction.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for standalone St. Jude Medical, Inc. include:
--Mid-single-digit organic revenue growth;
--Stressed leverage in the intermediate term mainly due to the proposed Thoratec acquisition;
--Improving margins of 50-75 basis points by 2017 with consistently positive and solid FCF of \\$800 million - \\$.1 billion annually;
--Adequate liquidity from balance sheet cash and adequate access to the bank and credit markets;
--Roughly \\$2.3 billion in debt reduction within approximately two years of the acquisition.
RATING SENSITIVITIES
Fitch will resolve the Rating Watch once more details regarding the transaction are available. However, given the currently available information and assuming Abbott acquires both Alere and St. Jude, Fitch believes St. Jude's ratings would likely move to 'BBB'.
The following rating sensitivities are for standalone St. Jude.
Positive: Future developments that may, individually or collectively, lead to positive rating action include the following:
An upgrade is not anticipated in the near to intermediate term. However, St. Jude would need to commit to and operate with leverage stronger than 1.6x-1.7x 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 include the following:
--Debt sustained above 2.0x-2.1x EBITDA without the prospect of timely deleveraging.
--Stressed leverage could result from a scenario in which revenue and margins are significantly stressed (more than Fitch anticipates), resulting in weakening FCF, 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 forecasted leverage during the next two years.
LIQUIDITY
At Jan. 2, 2016, St. Jude had adequate liquidity, comprising approximately \\$667 million in cash plus short-term marketable securities and roughly \\$996 million (net of \\$504 million commercial paper [CP] borrowings) in availability on its \\$1.5 billion bank revolving credit facility, which expires in August 2020. St. Jude generated approximately \\$531 million in FCF (net of \\$186 million of capital expenditures and \\$322 million of dividends) during latest 12 months (LTM), ended Jan. 2, 2016.
The company had approximately \\$6.43 billion in debt with (including \\$504 million in CP outstanding) approximately \\$1,163 million maturing in 2017, \\$173 million in 2018, \\$658 million in 2019 and \\$4.32 billion thereafter. Fitch expects St. Jude 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 on Rating Watch Negative:
St. Jude Medical, Inc.
--Long-term Issuer Default Rating (IDR) 'A-';
--Senior unsecured bank debt 'A-';
--Senior unsecured debt 'A-';
--Short-term IDR 'F2';
--CP 'F2'.
Fitch expects that Abbott would pay down St. Jude's outstanding CP upon the close of the transaction.
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