S&P: Medpace Holdings Upgraded To 'BB-' On Debt Paydown Following IPO; Outlook Stable
At the same time, we raised the issue-level rating on the company's secured debt to 'BB' from 'B+'. The two notch upgrade reflects the higher corporate credit rating as well as our expectation for lower secured debt under a default scenario. As a result, we revised the recovery rating on the senior secured facility to '2' from '3', indicating expectations of substantial (70% to 90%; lower end of the range) recovery in a payment default.
Our rating action follows Medpace's successful IPO, which results in much lower leverage and very strong pro forma cash flow relative to debt. Following the IPO, we are more confident that the company will maintain low leverage. Although we do not expect Medpace to operate with leverage at current levels over time, we believe the risk of releveraging above 4x is low, given our expectation that the company will not make a large, transformative acquisition in the next year given the company's track record and limited target pool. We also view a large debt-funded shareholder dividend as unlikely.
"We expect revenue growth of 10% in 2016, declining in subsequent years as full service competition emerges, and we expect EBITDA margins above 30% due to the company's full-service focus," S&P Global Ratings analyst Matthew Todd said. "We forecast about $80 million in pro forma free cash flow, which we view as very strong relative to the company's debt balance, which is less than $200 million following the IPO. Although we think leverage could rise from current levels to fund tuck-in acquisitions, we think it is likely to be sustained below 4x over time."
S&P Global Ratings now believes Medpace's overall credit quality is more similar to 'BB-' rated peers as opposed to 'B+' rated peers because of its profitability and free cash flow relative to debt, resulting from its focus on higher margins, full service clients, and its strong reputation for therapeutic expertise in oncology, cardiology, and metabolic disease, among others.
Medpace's customer diversity is favorable compared to other CROs because it attracts a greater number of smaller pharma customers, which benefit most from the full service model. This diversity advantage is mostly offset by the higher potential for demand volatility from its clients, given their sensitivity to the external funding environment, which could lead to above average cancellations or project delays. We believe the company's governance is improved as a public company, though the shareholder base is still heavily concentrated with Cinven Partners LLP, the financial sponsor, and management following the IPO.
Medpace's niche focus on full-service clients in a fragmented and competitive clinical trial outsourcing industry constrain the ratings. The company's scale is small compared to other global CROs, as well as compared to large pharmaceutical customers, limiting its negotiating power. In addition, the company is at risk of greater competition from larger providers in the full-service space, though competition has not currently weakened profitability.
Our stable outlook reflects our expectation that Medpace will maintain leverage below 4x, supported by above average revenue growth and strong, stable margins. In addition, we expect the company to generate strong free cash flow of about $80 million, providing cushion for multiple tuck-in acquisitions to add information technology (IT) capabilities, patient records, and therapeutic expertise. In the next 12 months, we do not expect the company to make a transformative acquisition or to borrow additional capital to fund a dividend.
We could lower the corporate credit rating if Medpace demonstrates an aggressive financial policy by adding substantial debt to fund acquisitions or shareholder dividends, raising leverage near 4x. Under this scenario, we would view overall credit quality as more similar to 'B+' as opposed to 'BB-' rated peers. We estimate the company has about $425 million in debt capacity at the current rating, assuming no incremental EBITDA.
We view a downgrade from operational challenges as unlikely in the next year due to the company's backlog of booked business.
The company's ownership structure currently constrains our ratings on Medpace, with the company's financial sponsor and its founder currently influencing its financial policies. We could consider raising the rating on Medpace if financial sponsor, Cinven Partners LLP, and management lower their combined ownership below 40% and the company discloses a financial policy indicating leverage will likely stay below 3x in the long term.