OREANDA-NEWS. Fitch Ratings has revised the Outlook on French clinical pathology laboratory group Cerba European Lab SAS (Cerba) to Negative from Stable. Its Issuer Default Rating (IDR) and senior secured notes ratings have been affirmed at 'B+' and 'BB-'/'RR3', respectively

The revision of the Outlook follows the announcement that Cerba has agreed to acquire Novescia, a private laboratory testing network in France, for EUR275m. The completion of the acquisition is subject to certain conditions.

While the acquisition would increase Cerba's scale and strengthen its position on the French laboratory testing market, the Negative Outlook primarily reflects our expectation of weaker financial metrics resulting from the company's intention to fund up to the entire consideration with additional debt (both secured and unsecured) as well as with cash on hand.

Adjusted for the transaction, we estimate Cerba's funds from operations (FFO) adjusted gross leverage would likely exceed 6.5x and FFO interest coverage decrease towards 2.0x, reducing its rating headroom under the 'B+' IDR. In our view, the Negative Outlook also reflects the initial EBITDA margin dilution and the risks associated with the integration of a larger target than what Cerba is accustomed to as part of its 'buy and build' strategy. An inability to integrate its acquisitions, including that of Novescia, and to extract planned synergies, leading to sustainably weaker credit metrics by 2017, could lead to a downgrade of the IDR to 'B'.

KEY RATING DRIVERS

Reduced IDR Headroom
Following the acquisition of Novescia, we expect FFO adjusted gross leverage to remain above 6.5x for 2015-2016 (adjusted for 12 month-contribution of acquisitions). In our view, Cerba's weaker credit metrics over the near term reduce rating headroom at 'B+', relative to immediate peers within the healthcare sector, including Labco SA (B+/Stable). In addition, we expect free cash-flow (FCF) generation to remain constrained in the low mid-single digits (as a percentage of revenue), as a result of higher cash interest, resulting from its debt-funded acquisition growth strategy.

Successful Integration Critical for Deleveraging
In an environment of persistent pressure on reimbursement tariffs from public entities, we believe that Cerba is reliant on successfully integrating its acquisitions and extracting the planned synergies (both at Novescia and at smaller bolt-on acquisitions) to support mild deleveraging prospects over the medium term. We consider the operational execution risk of the Novescia acquisition to be potentially higher than smaller bolt-on acquisitions for which the company has a good track record.

Continued Expansion in Routine Labs
The ratings reflect Cerba's ability to take advantage of the fragmentation of the French routine market. Cerba's acquisitive strategy enables it to broaden its network around regional platforms while realising synergies and increasing scale. We expect Cerba to continue with this strategy over the medium term and forecast the company will spend up to EUR50m p.a. on small bolt-on acquisitions over the next three years. A larger acquisition such as that of Novescia would be considered as event risk.

Leading Clinical Laboratories Player
Cerba is one of the largest medical diagnostics groups in Europe. Its resilient like-for-like performance, which Fitch expects to continue, is underpinned by growing volumes and fairly stable profit margins. The group benefits from a sound reputation for scientific expertise and innovation at the specialised end of the market (37% of 2013 reported revenue, excluding inter-company sales).

Business and Geographical Diversification
The group's activities in its Central Lab division globally (12% of sales) and its presence in the Belgian and Luxembourg routine markets (23% of sales) provide some diversification and reduce exposure to the French healthcare system. We consider that upon expiry of the three-year agreement reached in October 2013 between the French clinical pathology laboratories unions and the authorities (with the objective to achieve annual market growth of 0.25%), Cerba would be at risk of further tariff pressure.

RATING SENSITIVITIES

Future developments that could lead to a negative rating action include:
- Inability to integrate Novescia and extract the planned synergies such that the FFO adjusted gross leverage remains above 6.5x and FFO interest coverage remains around 2.0x by 2017 (pro forma for acquisitions)
- Further aggressively funded acquisition policy

Future developments that could lead to the Outlook being revised to Stable include:
- Ability to integrate Novescia and smaller bolt-on acquisitions swiftly such that FFO adjusted gross leverage falls below 6.5x and FFO interest coverage increases towards 2.5x by 2017 (pro forma for acquisitions)
- EBITDA margin above 23% along with FCF in the mid to high single digit on a sustained basis