TEXT-S&P rates Express Scripts Holding 'BBB+'
Overview -- Express Scripts Holding Co. (formerly Aristotle Holdings Inc., a subsidiary of Express Scripts Inc.) has become the parent company of Express Scripts Inc. and Medco Health Solutions Inc. following the acquisition of Medco by Express Scripts. -- We are assigning a 'BBB+' corporate credit rating to Express Scripts Holding Co. -- Separately, the corporate credit ratings on Express Scripts Inc. and Medco Health Solutions Inc. will be withdrawn at the same time. -- Our outlook on Express Scripts Holding Co. is negative, reflecting numerous integration challenges the company will face while its credit metrics are stretched. Rating Action On May 31, 2012, Standard & Poor's Ratings Services assigned its 'BBB+' corporate credit rating to St. Louis-based pharmacy benefit management (PBM) services provider Express Scripts Holding Co. The corporate credit ratings on Express Scripts Inc. and Medco Health Solutions Inc. will be withdrawn. The rating action follows the acquisition of Medco Health Solutions by Express Scripts and the subsequent failure of an injunction to block the deal by the National Association of Chain Drug Stores, the National Community Pharmacists Association, and independent pharmacies. All of our issue-level ratings for Express Scripts Holding Co. are unchanged. The rating outlook is negative. Rationale The ratings on St. Louis-based pharmacy benefit management (PBM) services provider Express Scripts Holding Co. reflect Standard & Poor's Ratings Services' expectations for low-single-digit organic revenue growth in 2012, with slightly improved margins when adjusted for unusual items. We believe the sluggish U.S. economy will pressure drug utilization and growth in members covered by plan sponsor clients, resulting in relatively low organic revenue growth. Sales will be further pressured by the ongoing conversion of branded drugs to generics, which hurt sales but generally results in increased profits and cash flow. We expect some sales dip from the inability of Express Scripts and customer Walgreens to reach an agreement on a new contract; the old one expired Jan. 1, 2012. While we suspect many Express Scripts' customers using Walgreens pharmacies will seek other in-network pharmacies, some customer loss is likely. Our assessment of Express Scripts includes a "satisfactory" business risk profile and "intermediate" financial risk profile. Adjusted EBITDA margins steadily increased to 5.8% for the year ended 2011 from 5.5% one year earlier, partially because of the trend of drugs going generic and increases in higher-profit mail-order prescriptions. We expect these trends to continue to improve margins in 2012 and beyond. Express Scripts is one of the largest providers in the specialty pharmacy services business; these chronic drugs provide relatively stable revenues, and could be more profitable if biosimilars are readily available in future. Express Scripts' completed its acquisition of Medco Health Solutions Inc. on April 2, 2012 for $29.1 billion. The acquisition introduces integration risk, in addition to a temporarily stretched financial risk profile. Express Scripts will need to rationalize the combined back-office functions, distribution capabilities, and claims adjudication platforms while maintaining its existing customer base. We believe the acquisition can bolster the company's market position and diversify its customer base, and improve Express Scripts' negotiating leverage with manufacturers and retail pharmacies. Express Scripts' "satisfactory" business risk profile (as we define the term) is supported by its solid position in the growing PBM industry and long-term trends toward generic and mail-order drugs. Despite Express Scripts' solid customer retention (in excess of 95%), the industry remains highly competitive. Clients increasingly focus on controlling rising drug spending and expect PBMs to achieve cost savings for them. Pricing could come under pressure as commercial and government payors try to offset rising health care costs, in particular for prescription drugs. Roughly one-third of Express Scripts' clients are up for renewal every year; however, its 10-year contract with WellPoint for the NextRx business skews this estimate downward. We remain alert to potential shifts in the PBM industry, such as direct government negotiations of drug prices, which could reduce the added value PBMs provide and pressure margins. We note, however, that past regulatory efforts did little to slow the PBM industry's growth or profitability. We are not aware of anything in the 2010 Patient Protection and Affordable Care Act that would negatively alter the PBM business model when implemented. In fact, the industry could eventually benefit from approximately 32 million newly insured customers, although we do not expect a significant ramp-up in enrollment before 2014, when federal incentives take effect. Our ratings reflect the company's "intermediate" financial risk profile. Pro forma for the Medco acquisition, we estimate that leverage is above 3x; an intermediate financial risk profile is partially defined as debt to EBITDA of 2x to 3x and funds from operations (FFO) to debt of 30% to 45%. However, we believe the company will quickly repay debt and return to its stated debt-to-EBITDA target of 1x to 2x within 18 to 24 months of the acquisition, which would likely cause us to view the company's financial risk profile as "modest". A modest financial risk profile is partially defined as debt to EBITDA of 1.5x to 2x and funds from operations (FFO) to debt of 45% to 60%. Liquidity We currently view Express Scripts' liquidity as "strong", with sources of cash likely to exceed mandatory uses of cash over the next 12 to 24 months. Relevant aspects of Express Scripts' liquidity are: -- Sources of liquidity will exceed uses by more than 1.5x. -- Sources of liquidity as of March 31, 2012, included cash on hand of $9.6 billion; however, most of this was used to fund the Medco acquisition. -- We expect Express Scripts to maintain roughly $2 billion of cash on its balance sheet. -- We expect more than $3 billion of operating cash flow in 2012, and more than $4 billion of operating cash flow in 2013, the first full year of the combined entity. -- We expect the company to maintain significant availability under its $1.5 billion revolver maturing in August 2016. -- We expect future uses of cash to include annual capital expenditures of about $350 million, although 2012 could be slightly higher because of integration expenses. -- We believe Express Scripts will repurchase very little of its common stock until its debt leverage returns to historical levels after the Medco acquisition. -- The company is subject to 3.5x minimum interest coverage and 3.5x maximum leverage covenants. -- We expect operating performance to remain well above covenant levels, and expect ongoing access to capital markets to accommodate maturing debt. Outlook Our rating outlook on Express Scripts is negative. We believe its decision to partly fund the Medco acquisition with equity will keep debt leverage at a manageable, but high, level in the near term. Still, the company will face a number of integration challenges while its financial risk profile is stretched. We could lower our ratings on Express Scripts if we do not believe debt leverage will fall below 2x within 18 to 24 months after the acquisition. This could be caused by substantial missteps in the integration of claims adjudication platforms or unanticipated contract losses. We could revise our outlook to stable if the company is on a trajectory to reduce debt leverage to 1x to 2x within two years, and rationalizes the combined back-office functions, distribution capabilities, and claims adjudication platforms while maintaining its existing customer base. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 Ratings List Express Scripts Holding Company New Ratings Corporate Credit Rating BBB+/Negative/-- Ratings Unchanged Senior Unsecured BBB+ Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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