Fitch Downgrades Baxter International Inc. to ‘BBB+’; Outlook Stable
By Business Wire News
Fitch Ratings has downgraded Baxter International Inc.’s (Baxter) long-term Issuer Default Rating (IDR) by two notches to ‘BBB+’ and assigned a Stable Rating Outlook. In addition, Fitch downgraded the company’s short-term IDR to ‘F2’ from ‘F1’.
Baxter had approximately $10 billion in outstanding debt at March 31, 2015. A full list of Fitch’s ratings actions follows at the end of this release.
KEY RATING DRIVERS
–The ‘BBB+’ rating reflects Baxter’s business profile pro forma for the planned spin-off of the company’s biosciences business. Fitch believes the split makes strategic sense as the two business segments focus on different end markets.
–The Bioscience spin will decrease Baxter’s scale and product breadth. However, Fitch believes the narrower focus of legacy Baxter will help to drive improved operational efficiency and optimal capital allocation over the longer term.
–Fitch expects Baxter to reduce leverage post spin, from a pro forma 2.7 times (x) to roughly 2.0x by the end of 2016. The primary source of this deleveraging will be debt pay down using proceeds from the spin off.
–In addition to the effects of the spin-off transaction, pro forma leverage is elevated due to the lingering effects of the Gambro acquisition, integration of which is essentially complete. Fitch believes Baxter is on track to generate roughly $300 million in annual synergies by 2017 through reducing costs and leveraging scale.
–Post spin, Baxter’s operating profile benefits from good organic growth prospects in its primary business lines, with the renal segment aided by the addition of the Gambro product lines.
–The spin will initially have a negative influence on operating margins and cash flow generation, both because of cost dis-synergies and the lower margins of the remaining business lines. Fitch forecasts Baxter to mitigate these effects through focusing on reducing administrative costs, as well as driving growth of higher margin products.
–Expected cuts in capital expenditures and the dividend will somewhat offset the spin-related headwinds to FCF, and Fitch expects it to be sufficient to fund targeted acquisitions and/or moderate share repurchases.
–Baxter will likely remain acquisitive, but Fitch believes the company will focus on targeted acquisitions that deepen its existing product portfolio or adds adjacencies.
Diversification Versus Focus: The Bioscience spin will result in a post-spin Baxter that is smaller in both scale and product breadth. In addition, the Medical Products business operates with lower margins than the BioScience business, although it also has lower capital expenditure requirements. Fitch believes the narrower focus of legacy Baxter result in improved operational efficiency and optimal capital allocation over the longer-term. Some of the company’s products and franchises will likely garner more resources to foster growth, now that they are not competing with the higher margin bioscience products.
Resulting Operating Profile and Capital Structure Supports ‘BBB+’ Rating: Following the spin of Baxalta, Fitch expects Baxter’s EBITDA margins will range between 16% – 19%, versus about 24% pre-spin, and organic revenue growth (before the effects of foreign exchange) will be in the low- to mid-single-digit range. Costs associated with the spin and operating dis-synergies will be a headwind to margins. In addition, the legacy business has lower margins than the biosciences segment.
Although Fitch expects the company to focus on improving operating margins, the expected deleveraging of the capital structure relies much more heavily on debt paydown than on EBITDA growth, which reduces the risk to the credit profile of the margin headwinds created by the spin-off transaction.
Immediately after the spinoff, Fitch forecasts pro forma leverage (unadjusted gross debt to EBITDA) of 2.7x, about 0.3x higher than the 2.4x level at the end of 2014. The company’s plans to use the majority of proceeds raised through the spin-off to reduce debt is a key factor supporting the credit profile. Initially, Fitch expects Baxter to use the $4 billion cash distribution from Baxalta to fund the tender of certain outstanding debt. The liquidation of a retained 19.5% stake in Baxalta over the next 18 months will provide further opportunities to pay down debt.
After the initial deleveraging is accomplished post the spin-off, Fitch expects leverage of 1.7x – 2.1x for Baxter, potentially increasing to around 2.5x from acquisitions or significant manufacturing capacity expansions, with FCF providing a source of deleveraging post transaction-related jumps in leverage.
Gambro Integration Essentially Complete: Baxter has essentially completed the integration of Gambro AB, which it acquired in Sept. 2013 for approximately $3.9 billion. Fitch expects Baxter will achieve roughly $300 million in annual synergies by 2017 through reducing costs as well as leveraging scale. The acquired Gambro business enabled Baxter to expand both its renal portfolio (particularly in hemodialysis) offering and its geographic reach. Baxter funded the acquisition with approximately $1 billion of international cash balances and $3.5 billion of new debt issuance, resulting in a significant increase in leverage.
Continued Operational Stability: Fitch expects Baxter to generate 2%-3% organic growth in nearly all of its business segments through 2015, although reported growth will likely face significant foreign exchange headwinds. While demand for the company’s products is relatively reliable, revenues are modestly sensitive to the macroeconomic environment through reimbursement rates (pricing) and, to a lesser extent, utilization. Fitch expects that the commercializing of pipeline products will also provide support for longer-term growth and margin stability.
Positive But Lower Free Cash Flow: Fitch expects that legacy Baxter will generate roughly $1.5 billion to $1.6 billion in annual pro forma cash flow from operations during 2015-2016. Operational cash flow in should be sufficient to fund approximately $750 million to $850 million of capital expenditures and approximately $280 million to $300 million in dividends.
Acquisitive Posture to Persist Over Long Term: Fitch expects targeted acquisitions will remain a core element of Baxter’s long-term growth strategy, using cash balances and incremental debt to fund future transactions. Fitch believes the company will focus on platforms that provide enhancements or adjacencies to its existing portfolio. Until Baxter executes on its plans to reduce leverage following the spin-off, there is limited flexibility for leveraging transaction at the ‘BBB+’ rating level.
Fitch’s key assumptions within the rating case for Baxter include:
–Low-single-digit reported revenue growth with organic growth in all business segments being partially offset by negative foreign exchange rate effects.
–Following an initial drop of about 800 bps post spin, Fitch expects a gradually improving operating EBITDA margin, particularly as Baxter drives a mix shift to higher margin products and improves operational efficiency.
–Pro forma annual cash dividends of roughly $300 million and gradually increasing thereafter.
–Pro forma annual FCF (cash flow from operations minus capital expenditures minus dividends) of $200 million to $300 million through 2016 and meaningfully increasing thereafter.
–Targeted acquisitions with no strategic, transformative transactions.
–Moderate share repurchases to offset dilution as the firm deleverages.
–Leverage to decline to around 2.0x during the next 18 months as Baxter applies the majority of proceeds from the spin off transaction to debt paydown.
Positive: While Fitch does not anticipate an upgrade in the near to intermediate term, a positive rating action could result from Baxter committing to and operating with leverage consistently and significantly stronger than 2.0x, while maintaining stable operations sustained with positive organic growth and solid FCF.
Negative: Future developments that may, individually or collectively, lead to a Negative Outlook or one notch downgrade to ‘BBB’ include:
–Debt above 2.5x EBITDA without the prospect for timely deleveraging. In the near-term, the most likely driver of this is scenario in which Baxter does not use a significant amount of the proceeds from the spin off to paydown debt.
–Steady operational improvement during the intermediate term, including organic revenue growth, meaningful margin improvement and significant growth in FCF. Improvements are expected to be driven by increased market penetration, new product introductions, mix-shift to higher margin products and solid cost control.
Adequate Liquidity: Baxter experienced a $357 million drain in FCF during the LTM period ended March 31, 2015 due to a significant increase in working capital requirements and capital expenditures, to support product launches and expanding plasma manufacturing capacity, respectively. However, Fitch anticipates that legacy Baxter will be FCF positive on an annual basis during the forecast period. At March 31, 2015, cash on hand was roughly $3.0 billion, and Baxter had full availability on its credit facilities, amounting to $3.0 billion, which will be reduced to USD 1.5 billion and EUR 150 million at the time of the Baxalta spin-off.
Manageable Debt Maturities: Total debt was roughly $10 billion at March 31, 2015, and resulting leverage was 2.7x. Fitch believes Baxter’s debt maturities are manageable, with roughly $600 million of long-term debt maturing in 2015, $1.1 billion in 2016, $500 million in 2017 and $1.25 billion in 2018 (excluding the completion of any tenders).
FULL LIST OF RATING ACTIONS
Fitch has downgraded Baxter’s rating as follows:
–Long-term IDR to ‘BBB+’ from ‘A’;
–Unsecured bank facility to ‘BBB+’ from ‘A’;
–Unsecured notes to ‘BBB+’ from ‘A’;
–Short-term IDR to ‘F2’ from ‘F1’;
–Commercial Paper to ‘F2’ from ‘F1’.
The Rating Outlook is Stable.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
Bob Kirby, CFA
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
Megan Neuburger, CFA
Alyssa Castelli, +1 212-908-0540
Elizabeth Fogerty, +1 212-908-0526