OREANDA-NEWS. Fitch Ratings has placed the ratings of Baxalta Incorporated (Baxalta; NYSE: BXLT), including the 'BBB+' long-term Issuer Default Rating, on Rating Watch Negative. The rating action follows Baxalta's announcement that it has agreed to be acquired by Shire PLC (Shire; NASDAQ: SHPG) for roughly $32 billion, including $12 billion in cash and $20 billion in Shire stock.

A full list of rating actions, which apply to approximately $5 billion of debt as of Sept. 30, 2015, follows at the end of this release.

KEY RATING DRIVERS

Transaction Significantly Increases Leverage: The cash component of the purchase price will initially be financed with a new one-year $18 million term loan that Shire plans to refinance fairly quickly. Fitch estimates that initial pro forma gross leverage without synergies could be roughly 4.7x, which is significantly higher debt leverage than both Baxalta's projected stand-alone levels of roughly 2.5x for full-year 2015 and the longer-term run rate of roughly 2.25x that Fitch views as supportive of current 'BBB+' ratings for a firm with Baxalta's stand-alone business profile.

Shire expects that net leverage following the deal's completion will be less than 5.0x and plans to reduce this ratio to between 2.0x-3.0x by year-end 2017, through debt reduction and earnings growth. This projection appears attainable based on projected cash flows that could exceed $6 billion by 2018. Nevertheless, Fitch believes that even if net leverage is reduced to 3.0x 12-18 months after the deal closes, this level is outside the range that Fitch views as commensurate with Baxalta's existing ratings.

Shire Historically More Aggressive Than Baxalta: Fitch notes that Shire has historically exhibited a more aggressive approach to business development than Baxalta demonstrated prior to its spin-off from Baxter International Inc. on July 1, 2015. Baxalta's historically conservative approach to capital management and business development was a key consideration when Fitch assigned first-time ratings to Baxalta in May 2015.

Conversely, Shire has now completed or announced eight acquisitions since calendar year 2013, including the November 2015 announcement that the company will purchase Dyax Corp (DYAX: SHPG) in a debt-funded transaction for approximately $5.9 billion. While Shire has not experienced any notable problems integrating its acquisitions to date, Fitch views the company's willingness to employ significant leverage to pursue targets of meaningful size as indicative of a likely shift in strategy from the more conservative approach expected of Baxalta.

Transaction Boosts Competitive Position: The combination with Shire will meaningfully strengthen Baxalta's scale and the diversification of products both in the market and under development. The combined identity would be the global leader in rare diseases, and significantly enhances the depth and breadth of each company's product offerings. Joining with Shire will roughly double Baxalta's annual revenues, which currently total roughly $6 billion.

Prior to the announcement, Baxalta was expecting approximately 20 new product launches generating more than $2.5 billion in sales by 2020. Combined with Shire's drug development pipeline, this number improves to more than 30 new launches with $5 billion in planned sales by 2020. There is no notable overlap in the therapeutic areas that each company addresses, so the combination will significantly reduce Baxalta's reliance on its three key therapeutic areas of hematology, immunology, and oncology which currently account for about 90% of total revenues.

KEY ASSUMPTIONS

Fitch's key assumptions for Baxalta on a standalone basis before the acquisition by Shire include:

--Fitch's estimated debt leverage of roughly 2.5x for 2015 is moderately higher than the target for the 'BBB+' ratings. EBITDA growth and stable debt levels should drive debt-to-EBITDA closer to 2.3x by the end of 2017, which Fitch views as supportive of a 'BBB+' rating.
--Fitch's outlook for operating EBITDA margins at around mid-30% and a manageable debt load should lead to strong cash generation, which will further benefit when capital expenditures decrease to normalized levels beginning in 2016.
--Fitch expects that free cash flow (FCF) will be modest in 2015 but build fairly quickly to approach $800 million by year-end 2018.

RATING SENSITIVITIES
Negative: If the acquisition is completed as currently contemplated, a downgrade of the rating is likely to be limited to one notch, but there are several issues that will influence the post-acquisition credit profile, including:

--The capital structure of the combined company - If the Baxalta notes remain outstanding, this includes where the debt is held and Fitch's perception of the strength of the operational, strategic and legal linkages with Shire, including any formal guarantees of the Baxalta debt. All series of Baxalta's senior unsecured notes include an offer to purchase at 101% upon a change of control event and a subsequent downgrade to non-investment grade. However, Fitch believes that Shire is committed to maintaining investment-grade ratings and expects the transaction to be funded in a manner to maintain at least a 'BBB-' rating;
--The amount of debt used to fund the transaction - Fitch expects Shire will fund the cash consideration for the acquisition with a combination of debt and cash on hand;
--The pricing of the debt used to fund the acquisition, which will affect interest coverage levels and FCF generation of the combined company;
--Fitch's view of the operational risk inherent in the integration of Baxalta and any potential upside to financial results to be realized through synergies - Shire has so far identified $500 million of cost synergies to be realized in the two to three years post transaction;
--Shire's plans to apply cash to debt reduction in the 18-24 months post transaction.

Positive: Fitch does not anticipate a positive rating action in the near term.

LIQUIDITY
Fitch expects Baxalta to maintain a solid liquidity profile through strong FCF generation and ample access to the credit markets. Baxalta had cash on hand of approximately $1.3 billion at Sept. 30, 2015. Going forward, roughly half of Baxalta's cash flow will be generated in the U.S., which Fitch expects will be more than sufficient to service the company's U.S. operations in addition to annual interest expense, and dividends, which are expected to consume about $300 million of cash from operations annually.

Baxalta's strong margins and manageable debt load are supportive of the expectation for strong cash generation, which will further benefit when capex decreases to normalized levels beginning in 2016. Baxalta's pro forma capex has been elevated in recent periods due to capacity-expansion projects, most notably the construction of a plasma manufacturing facility in Georgia. This project is expected to be largely complete in 2015, after which Fitch expects capex to fall closer to a run-rate between $600 million-$800 million versus roughly $1 billion in 2014 and $1.2 billion in 2015.

FULL LIST OF RATING ACTIONS

Fitch has placed the following ratings on Negative Watch:

Baxalta Incorporated
--IDR at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper program at 'F2';
--Senior unsecured debt at 'BBB+'.