Fitch Affirms Boston Scientific's IDR at 'BBB-'; Outlook Stable
KEY RATING DRIVERS
--Fitch believes that BSX's acquisition of AMS Men's Health businesses (AMS) makes strategic sense but increases leverage in the short term. BSX intends to reduce leverage to current levels within 12-18 months of the transaction's closing.
--BSX's \$600 million legal settlement with Johnson & Johnson (JNJ) reduces long-term liability risk but also short-term liquidity. While Fitch expects free cash flow (FCF) to remain positive, payment of the settlement will moderate near-term FCF and cash available for debt reduction.
--BSX's implantable cardioverter defibrillator (ICD) and drug-eluting stent (DES) segments will continue improving as procedure volumes stabilize, the company introduces new products into the space that offer opportunities for incremental share gains and margin support, and growth in emerging markets begins to contribute more significantly to revenues.
--BSX's business segments outside of the ICD and DES product lines generate roughly 59% of total sales and are expected to deliver solid single-digit growth in the aggregate.
--Fitch forecasts that after paying down roughly \$400 million in T/L borrowings during 2015, BSX will focus cash deployment on targeted acquisitions in areas that offer innovation and growth, with share repurchases suspended until leverage declines to below 2.4 times (x).
AMS STRATEGICALLY FITS BUT INCREASES LEVERAGE
BSX intends to acquire Endo International plc's AMS businesses for roughly \$1.66 billion cash up front and potential \$50 million earn-outs in 2017. The company intends to finance the transaction with the issuance of \$1.6 billion of new debt. The transaction is expected to close late-second quarter 2015 (2Q'15)/early-3Q'15. Fitch expects pro forma leverage immediately following the transaction to increase above 2.6x and subsequently decline to below 2.4x by year-end 2016 through a combination of increased EBITDA and debt reduction.
BSX will be working on deleveraging while FCF will face some short-term headwinds from litigation payments. Fitch believes this risk is mitigated by the company's improving operations in essentially all of its business segments. As such, Fitch expects FCF to remain positive despite settlement payments. In addition, share repurchases will likely be suspended and acquisitions moderated until leverage returns to 2.4x.
Fitch believes the acquisition is strategically constructive, as the AMS business will diversify BSX's product portfolio, increase BSX's scale and product depth in urology, and offer cost- and potential revenue synergies.
While some integration risk is present, Fitch expects the process will be manageable. BSX already has a strong market presence with urologists, and the acquired products will be marketed to those same physicians. Cost savings from some headcount reduction in sales and administration, as well as potential to improve manufacturing efficiencies, appear straightforward and achievable.
DECLINING LITIGATION RISK
BSX's legal settlement with JNJ calls for BSX to pay \$600 million to JNJ during 2015. BSX will make two \$300 million payments, primarily using balance sheet cash without taking on any additional long-term debt. The agreement removes the potential for any further litigation regarding this matter. While Fitch views the settlement as a positive development in terms of reducing the uncertainty surrounding the litigation liabilities, the \$600 million payment will reduce the availability of cash in the short term.
BSX continues to make progress in resolving litigation issues, resulting in an improved litigation risk profile compared to five years ago. However, some financial risk related to other litigation remains, and the company will need to plan accordingly for any potential settlements, as it sets its priorities for cash deployment.
IMPROVING ICD AND DES SEGMENTS
Improvement in the ICD and DES businesses is expected to continue during the intermediate term. The changing trend is supported by the stabilization of surgical procedures, driven by favorable comparisons of a multi-year period of soft procedure volumes resulting from the publication of negative clinical data identified in two large retrospective studies. BSX has and will continue to introduce new products into these two markets, offering the company a number of opportunities to increase share and revenue. Longer term, BSX's investment in emerging markets will likely support modest but steady revenue growth.
FCF ALLOWS FOR DEBT REDUCTION
Fitch forecasts that BSX will generate \$650 million to \$750 million of FCF (cash flow from operations minus capital expenditures minus dividends) during 2015, after the \$600 million settlement payment to JNJ, representing strong growth relative to the \$850 million generated during 2014. Moderately improving sales and margins aided by continued cost controls and new product introductions are expected to drive growth in cash flow from operations. Capital expenditure requirements for 2015 are forecasted to be manageable in the range of \$270 million - \$290 million. This level of FCF will allow the company to apply some cash to debt reduction following the AMS acquisition. Fitch expects both debt reduction and growth in EBITDA to contribute to deleveraging post the acquisition, with \$45 million - \$50 million annual synergies by 2018.
In addition to its solid cash generation, the company's liquidity profile is otherwise decent. At Dec. 31, 2014, BSX had \$587 million in cash/short-term investments; full availability on its \$2 billion revolver maturing on April 18, 2017; and full availability on its \$300 million 364-day accounts receivable facility, maturing in June 2015. The company had approximately \$4.2 billion in debt, with roughly \$400 million maturing or amortizing in 2015, \$680 million in 2016, and \$330 million in 2017. Fitch anticipates that BSX will refinance its maturities rather than pay them down with the exception of some modest debt reduction post the AMS acquisition.
STEADY PERFORMANCE IN REMAINING SEGMENTS
Endosurgery, neuromodulation, peripheral interventions and electrophysiology are expected, in the aggregate, to deliver mid-single-digit growth. These segments generate roughly 59% of BSX's total firm sales. The related surgical procedures in these segments are experiencing decent growth and not as highly priced as the CRM and DES segments. Given the relatively smaller dollars at stake for these segments (relative to CRM and DES), consumers and health insurers do not appear as focused on the price of these devices. In addition, Fitch expects BSX will continue to launch new products in these respective markets. As such, Fitch believes that segment margins will remain somewhat stable.
CASH DEPLOYMENT FOCUSED ON GROWTH AND SHAREHOLDERS
Aside from paying down some borrowings in the near term, Fitch believes BSX will focus cash deployment on targeted acquisitions in areas that offer innovation and growth. Secondly, the company will likely consider further share repurchases in lieu of debt reduction once it returns to its current leverage ratio of 2.4x and assuming its operating profile continues to improve. Currently, instituting a cash dividend does not appear to be a priority.
Fitch's key assumptions within for our 'BBB-'/Stable Outlook rating case for BSX include:
--Low to mid-single-digit revenue growth, excluding AMS' revenue contribution during 2015-2016;
--Incremental margin improvement driven by new product introductions, ongoing focus on costs, and acquisition-related cost savings by 2018;
--FCF of \$650 million to \$750 million during 2015 which includes the \$600 million legal settlement paid to JNJ;
--Leverage to decline to or below 2.4x by 2016 through increased operational EBITDA and modest debt reduction;
--Only targeted business development initiatives and no meaningful share repurchases until leverage drops below 2.4x.
Positive: Future developments that may, individually or collectively, lead to positive rating action include the following:
--Continued operational improvements that support long-term positive revenue growth and margin stability/improvement;
--An operational profile that could lead to significant and durable increases in FCF;
--Cash deployment policy and resulting capital structure that would durably sustain leverage below 2.2x-2.3x.
Negative: Future developments that may, individually or collectively, lead to negative rating action include the following:
--Material and lasting deterioration in operations and FCF;
--Persistent increase in leverage approaching 3.0x;
--Leveraging acquisitions without the prospect of timely debt/leverage reduction;
--Large legal settlement(s) that would need to be funded with significant debt issuance(s).
Fitch has affirmed the following ratings for BSX with a Stable Outlook:
--Long-term IDR at 'BBB-';
--Unsecured bank credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-'.