OREANDA-NEWS. Fitch Ratings has assigned an 'A+' rating to Merck & Co.'s (Merck) \$8 billion senior unsecured notes offering. The company intends to use a substantial portion of the net proceeds of the offering to repay commercial paper issued to largely finance the acquisition of Cubist Pharmaceuticals, Inc. (Cubist), which closed on Jan. 21, 2015.

Merck had \$27.8 billion in outstanding debt at Sept. 30, 2014. A full list of Merck's ratings follows near the end of this release. The Rating Outlook is Negative.

KEY RATING DRIVERS

Continued High Leverage: The Negative Outlook mainly reflects that leverage (total debt/EBITDA) has remained above 1.5 times (x) since Merck's \$5 billion, largely debt-funded share repurchases in second-quarter 2013 (2Q'13). The sale of its Consumer Health Business and the largely debt-funded acquisition of Cubist will further stress leverage.

Targeted Acquisitions Anticipated: Fitch believes that Merck will pursue targeted acquistions as opposed to large transformative ones. An improving pipeline and narrowing strategic focus reduces the need and risk to do big deals. The recent Cubist acquisitions is an example of a targeted approach, focusing on the anti-infective segment, primarily serving acute care settings.

Continued Share Repurchases: Fitch expects that Merck will continue with shareholder friendly actions during the near term, some of which may be funded by debt. Merck purchased \$4.7 billion (net of issuances) of its common stock during the first nine months of 2014. The repurchases were executed under a \$15 billion program authorized in May 2013 and a previously authorized program. Merck has approximately \$4.3 billion remaining under the May 2013 share repurchase program.

Patent Exposure Easing: Merck faces a significant number of patent expiries during the next two years. However, roughly only 20% of total firm sales are at risk. In addition, Remicade and PEG-Intron (accounting for about 6.2% of total firm) are biologics and tend not to experience the rapid sales loss to generic competition as do traditional, one small molecule pharmaceuticals.

Expanding Late Stage Pipeline: Fitch expects Merck to continue to build its late-stage pipeline, despite the company's intention to narrow its focus on R&D projects. Merck's late stage pipeline is growing with new molecular entities (NMEs) to treat cancer, bacterial and viral infections, diabetes, cardiovascular disease, central nervous system disorders, osteoporosis, allergies and other maladies. The September 2014 FDA approval of Keytruda was a significant milestone in Merck's development of cancer treatments.

While the majority of these projects are internally developed, Merck has partnered with other innovator firms to take advantage of technological advancements that were discovered externally. The landscape for drug development is expanding, particularly as more is learned about how genetics influence the development, prevention and treatment of disease.

Cost Cutting Continues: In October 2013, Merck initiated a new global restructuring program, in an effort to sharpen its global commercial and research & development focus. Merck is working on reducing costs in the areas of sales, administration and research & development. Merck continues to work towards improving the efficiency of its manufacturing and supply network. The restructuring program is expected to be substantially completed by the end of 2015. Estimated pre-tax restructuring costs are approximately \$2.5 billion - \$3 billion, of which two-thirds will be cash-related. At the end of 2014, Merck has stated that it on track to deliver \$2.5 billion of cost savings compared to its 2012 base by the end of 2015.

Consumer Business Sale: Fitch believes the sale of Merck's consumer products business was a modest negative for its credit profile, given that the proceeds of the sale will not likely be used for debt reduction and the associated loss of segment's EBITDA. While the consumer business accounted for roughly 4% of total firm sales, Fitch estimates the segment's contribution to Merck's total EBITDA is less than that. Ultimately, the benefit of increasing strategic focus modestly outweighs the moderate loss of product diversification and EBITDA.

More Competition for Januvia/Janumet: Despite a good demand outlook for the diabetes treatment market, with a growing number of patients, continued market share gains from some older generic drugs plus an increasing number of new drug launches in the market will offset the tailwind of positive demand growth, resulting in relatively soft sales growth for Januvia/Janumet, Merck's largest selling franchise. Growth has slowed in recent years due to competition (DPP-4 inhibitors, SGLT2 inhibitors, GLP-1 agonists) entering the diabetes market. In addition, concerns over the safety of these drugs (DPP-4 inhibitors) have been a headwind to growth. However, the FDA recently reaffirmed their safety regarding pancreatitis and pancreatic cancer.

KEY ASSUMPTIONS

Fitch's key assumptions within its rating case for Merck include:

--Moderately declining revenues in 2015 mainly due to the consumer health care divestiture and the absence of AstraZeneca revenues. Fitch expects Merck will return to growth in 2016.

--Incrementally improving margins driven by the restructuring initiative, the sale of the lower-margin consumer business and the expected increasing mix of newer products in the portfolio.

--Annual free cash flow (FCF; cash flow from operations minus capital expenditures minus dividends) of \$4.5 billion to \$5 billion during 2015 and increasing thereafter.

--Targeted acquisitions with no strategic, transformative transactions.

--Continued focus on significant share repurchases.

--Leverage to decline to or below 1.5x-1.6x by 2017 through increased operational EBITDA. Merck has roughly \$5.4 billion of debt maturing during the next three years, offering opportunities for debt repayment.

LIQUIDITY

Adequate Liquidity: Fitch looks for Merck to maintain adequate liquidity through strong FCF generation and ample access to the credit markets. FCF for the latest 12 months (LTM) ending Sept. 30, 2014 was \$5.5 billion. At the end of the period, Merck had approximately \$14.2 billion in cash plus short-term investments and full availability on its \$6 billion revolver, maturing in August 2019.

At Sept. 30, 2014, Merck had roughly \$27.8 billion in debt outstanding, with roughly \$2 billion maturing in 2015, \$2.4 billion in 2016 and \$1 billion in 2017. Fitch expects near- to mid-term maturities will be satisfied primarily through refinancing in the public debt markets.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positve rating action, such as a revision of the Rating Outlook to Stable, include:

--Merck pursues a capital deployment strategy that maintained gross debt leverage below 1.5x during the long term, including managing through operational stress such as patent expiries and clearly taking a more conservative approach to its use of debt.
--In the absence of sufficient increases in EBITDA, the company reduced debt to a level that reduced leverage to 1.5x.
--If Merck demonstrated long-term positive sales growth through demand for core drug products and uptake of new medicines generating sufficient cash flow that reduced the need for leveraging transactions to satisfy the returns expected by equity investors.

Negative: Future developments that may, individually or collectively, lead to a negative rating action, such as a one-notch downgrade, include:

--Total debt leverage remaining above 1.5x in the intermediate term.
(i) The high leverage would likely be driven by incremental borrowing to fund acquisitions or share repurchases.
(ii) Leverage pressure could also result from operational weakness due to an inability to succeed in achieving cost containment targets or generating sales growth despite its improving patent risk profile and expanding late-stage pipeline.
--Operational stress that would durably constrain revenue growth, margins and FCF.

DEBT ISSUE RATINGS

Fitch currently rates Merck as follows:
--Long-term Issuer Default Rating (IDR) 'A+';
--Senior unsecured debt rating 'A+';
--Bank loan rating 'A+';
--Short-term IDR 'F1';
--Commercial paper rating 'F1'.

The Rating Outlook on the long-term ratings is Negative.