Fitch Rates Ephios Bondco PLC 'B(EXP)'; Outlook Stable
Fitch has also assigned Ephios' proposed senior secured notes due 2022 'B+(EXP)'/'RR3' and its planned super senior revolving credit facility (RCF) 'BB-(EXP)'/'RR2'. The new instruments - alongside equity provided by Cinven - will be used to redeem Labco's existing debt, pay for the acquisition as well as for premium and fees. The debt proceeds will be down-streamed by way of intercompany loans to Labco SA, the French holding company, among others, guaranteeing the notes. The final ratings are contingent upon closing of the acquisition and receipt of final documents conforming to information already received by Fitch.
The IDR of 'B(EXP)' reflects Ephios' expected high funds from operations (FFO) adjusted gross leverage of around 8.0x at closing of the transaction, pro forma for acquisitions already completed in 2015. We forecast that this ratio will remain above 6.5x at least until 2018, which we believe is no longer commensurate with an IDR of 'B+', as previously assigned to Labco before the buy-out. The 'B(EXP)' IDR is, however, supported by a business risk profile that is commensurate with a 'BB' category, along with Ephios' high profitability and positive free cash flow (FCF) generation. We also estimate enhanced financial flexibility derived from slightly improved coverage metrics, assuming the company refinances its legacy 8.5% senior secured notes at a lower coupon.
KEY RATING DRIVERS FOR THE IDR
Weak Financial Metrics
Following the cancellation of the IPO in May 2015, we considered Labco's rating headroom was low given the company's high financial leverage. The proposed capital structure backing the Cinven buy-out keeps the FFO adjusted gross leverage materially above 6.5x until 2018 under our forecasts, which was one of our guidelines for a negative action. We believe such high leverage is more commensurate with a low single 'B' IDR. However, such aggressive financial leverage is partly offset by our expectations of Ephios' positive FCF and improved FFO fixed charge cover towards 2.0x by 2018 (up from forecast 1.6x in 2015), thereby supporting a 'B(EXP)' IDR and its Stable Outlook.
Subdued Organic Performance
Fitch expects the pricing environment to remain challenging in Ephios' key markets. Sustained reimbursement pressures by ultimate payers such as governments and insurance companies are likely to constrain organic growth prospects in the medium term. However, as volumes are resilient to economic cycles, underpinned by broadly favourable demographics and socio-economic factors, we expect large European players such as Ephios to withstand the negative impact of tariff pressure on their profitability margins. This will be achieved through economies of scale and operational efficiencies generated within regional and technical platforms.
Successful M&A Key to Deleveraging
Given the weak organic growth environment across France and Iberia, Ephios' continued ability to source and execute low-risk bolt-on acquisitions of laboratories at attractive multiples and extract planned synergies is critical to supporting mild deleveraging prospects and, as a result, the ratings over the long term. Absent such M&A, we expect higher organic growth to come from the UK and Italian businesses but consider their medium-term contribution to the group's EBITDA and impact on deleveraging as limited. Any large, transformational M&A would be considered as event risk.
Leading Clinical Laboratory Services Group
Ephios is the largest clinical laboratory services company in France for routine tests and in Iberia for routine and specialty testing. It is also a pan-European player, with its presence in Belgium and Italy, and to a lesser extent, the UK and Switzerland. In our view, Ephios' earnings profile benefits from this geographical diversity as it reduces the group's exposure to single healthcare systems.
KEY RATING DRIVERS FOR THE INSTRUMENTS
Weak Creditor Protection
The proposed RCF and the senior secured notes will share the same security package, primarily comprising share pledges over Ephios Bondco PLC, Ephios France and Labco SA as well as over subsidiaries representing around 61% of the consolidated EBITDA as of end-March 2015. The RCF will, however, only include a single leverage covenant and the senior secured notes are protected by incurrence-based covenants, subject to permitted baskets.
Going Concern Distressed Valuation
We expect a going-concern restructuring to yield stronger recoveries for creditors than liquidation in a default scenario. We assume a distressed sale of the group as a whole at Ephios France or Labco SA level as a liquidation of individual labs could prove challenging given laboratory ownership regulatory constraints and clinical pathologists' pre-emptive rights in France. Therefore, we have valued the group on the basis of a 6.0x multiple applied to an EBITDA that is 20% below the last 12-month consolidated EBITDA as of end-March 2015, adjusted for acquisitions already completed and adding back UK operations start-up costs.
Above-average Recoveries for Noteholders
The expected ratings of 'B+(EXP)'/'RR3' for the planned senior secured notes reflect above-average recovery prospects for noteholders in a default scenario but also their contractual subordination to the new RCF and certain other obligations of non-guarantor subsidiaries up to EUR20m in the debt waterfall. We have also assigned the proposed RCF expected ratings of 'BB-(EXP)'/'RR2', with 'RR2' being the ceiling for the facility. This is due to the French jurisdiction, as we believe France is the group's "Centre of Main Interest".
KEY ASSUMPTIONS
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions include:
- Low to mid-single digit organic growth in key markets;
- Sustained EBITDA margin around 18.5%;
- Impact of launch of UK activities, strikes in France and increase of VAT in Spain on 2015 EBITDA and FFO margins;
- 8.5% senior secured notes due 2018 refinanced at a lower coupon;
- Up to EUR40m of bolt-on acquisitions per year after 2015.
RATING SENSITIVITIES
Positive: Future developments that could, individually or collectively lead to a positive rating action include:
- Meaningful deleveraging such that FFO adjusted gross leverage (pro forma for acquisitions) falls to and remains below 6.5x, combined with FFO fixed charge cover above 1.8x on a sustained basis;
- Positive FCF as a proportion of sales sustainably in the high single digits;
- More conservative financial policy reflected in lower M&A spending, or conservatively funded growth strategy by existing cash flows or equity funds.
Negative: Future developments that could, individually or collectively lead to a negative rating action include:
- FFO adjusted gross leverage (pro forma for acquisitions) above 8.0x on a sustained basis;
- FFO fixed charge cover (pro forma for acquisitions) below 1.3x on a sustained basis;
- FCF margin falling to slightly positive territory while maintaining a debt-funded acquisition strategy;
- Large, debt-funded and margin-dilutive acquisitions, combined with profitability erosion in key markets, reflecting a more challenging operating environment.
LIQUIDITY AND DEBT STRUCTURE
We expect Ephios' liquidity to be satisfactory. Under the new capital structure, Ephios will have access to a new RCF of EUR140m, which can be used for general corporate purposes as well as for bolt-on acquisitions. The refinancing of the existing debt would enable the group to extend its debt maturities to 2022, allowing the group and its new owners to focus on a successful strategy execution.
FULL LIST OF RATING ACTIONS
Ephios Bondco PLC
- IDR 'B'(EXP), Stable Outlook
- Super senior RCF 'BB-(EXP)'/'RR2'
- Senior secured notes 'B+(EXP)'/'RR3'
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