OREANDA-NEWS. S&P Global Ratings today lowered its long-term corporate credit rating on Luxembourg-based heat-exchanger equipment provider Galapagos Holding S. A. to 'B-' from 'B'. The outlook is stable.

At the same time, we lowered the following ratings on the group's debt:

Our issue rating on the super senior secured facilities, comprising a €75 million revolving credit facility (RCF) and a €400 million guarantee facility, to 'B+' from 'BB-'. The '1' recovery rating on these facilities remains unchanged, reflecting our expectations of very high (90%-100%) recovery prospects in the event of a payment default;Our issue rating on the senior secured notes to 'B-' from 'B'. The recovery rating on the notes remains at '4', with recovery prospects in the higher half of the 30%-50% range; and Our issue rating on the senior unsecured notes to 'CCC' from 'CCC+'. The recovery rating on these notes is '6', reflecting our expectations of negligible (0%-10%) recovery. The downgrade reflects our view that recent sluggish performance points to deterioration in Galapagos' business risk profile, and that its credit ratios will remain weak for the next 12 to 18 months.

We now view the group's business risk profile as weak, compared with fair previously. Our initial assumption that Galapagos' business diversity--represented through its subsidiaries Kelvion, ENEXIO, and DencoHappel--had stabilized financial performance by making the company less vulnerable to cyclical downturns is now less valid given the group's divestment of DencoHappel. In our reassessment of Galapagos' business risk, we also factor in the volatility of intrayear results. The group's past results show that economic conditions and exposure to cyclical and mature markets--including power, climate and energy, oil and gas, and marine and chemicals--hamper revenues and operating performance. The high fixed-cost base and significant restructuring charges negatively affect EBITDA. We anticipate that the group's continued restructuring needs will markedly pull down operating performance in 2017, in turn denting profitability in absolute terms and holding margins in check.

The divestment of DencoHappel to Flakt Woods has a positive impact on Galapagos' financial risk profile because the sale proceeds of €192 million will be used for a conditional redemption of a portion of its €325 senior secured notes and reduce the interest burden. The transaction has been cleared by the relevant merger control authorities and is expected to be legally completed on Oct. 12, 2016, at a total purchase price of €255 million.

Despite this disposal, high debt and negative free operating cash flow generation constrain the rating, in our view. Galapagos' adjusted debt reached about €886.3 million on Dec. 31, 2015, with adjustments for operating leases of about €47.1 million, approximately €32.7 million for unfunded postretirement obligations, and about €13.4 million of finance leases. This translates into adjusted debt-to-EBITDA and EBITDA-to-interest ratios of about 6.8x and 2.3x, respectively. Despite management's plans to implement major profit protection measures (such as the cash optimization project with a main focus on trade working capital, capital expenditures [capex], and trapped cash) and other improvement initiatives, we still anticipate negative free operating cash flow generation for the next 12 months.

The stable outlook reflects our view that Galapagos will maintain an adjusted FFO cash interest coverage ratio above 1.5x. We further expect Galapagos will continue aiming to enhance its revenues and optimize its cost base to improve operating and financial performance.

We could lower the rating if Galapagos' adjusted funds from operations cash interest coverage ratio dropped to below 1.5x or if we perceived weakening liquidity. Negative rating pressure would also arise if reported EBITDA fell below €80 million, or if we considered that the capital structure had become unsustainable. This could occur if the group failed to succeed with its restructuring program.

We regard the likelihood of an upgrade as limited at this stage because Galapagos' leverage is high and we see only a distant possibility that the group would significantly strengthen its credit metrics. We note that Galapagos' private equity sponsor ownership contributes an element of uncertainty regarding potential changes to the group's acquisition or disposal strategy, and its financial policy.