TEXT-Fitch rates Watson Pharmaceuticals
June 27 - Fitch Ratings has assigned a 'BBB' rating to Watson Pharmaceuticals, Inc.'s (Watson) (NYSE: WPI) new five-year senior unsecured term loan facility with an aggregate principal amount of $1.8 billion. Watson's ratings, including its 'BBB' Issuer Default Rating (IDR), are on Rating Watch Negative. A full list of ratings is shown below. Fitch anticipates that Watson will use proceeds from the new term loan facility to finance a portion of the cost to acquire Actavis Group, a privately-held global generic pharmaceutical company, for an upfront payment of Euro 4.25 billion plus additional consideration. The contingent payment, if fully earned, would result in the delivery of up to 5.5 million shares of Watson common stock in 2013. The company expects to complete the transaction by 4Q'12. Fitch expects that almost 100% of the cost of the acquisition will be funded by debt, thus increasing the total debt level to about $6.8 billion from $1.1 billion. Pro forma gross debt leverage (total-debt-to-EBITDA) is therefore anticipated to rise to 4.0 times (x) at the end of 2012 from 0.9x at Dec. 31, 2011. Fitch expects that debt funding of the acquisition will drive debt leverage to above a level consistent with the 'BBB' IDR. Fitch will resolve the Negative Watch prior to the closing of the acquisition. If the transaction proceeds as planned and Watson finances it entirely with debt proceeds, Fitch expects to downgrade the IDR by one-notch to 'BBB-'. The senior unsecured notes and bank debt ratings are also anticipated to be downgraded to 'BBB-'. Fitch expects to maintain Watson's ratings at investment grade despite the increased debt leverage to fund the Actavis acquisition based on the company's track record of rapid debt pay-down following its last two major acquisitions, the $1.75 billion purchase of Arrow Group in 2009 and $1.9 billion purchase of Andrx Corp. in 2006. Fitch expects that debt repayment will be Watson's top priority for cash deployment following the Actavis acquisition, as opposed to additional acquisitions or returning cash to shareholders through share repurchases. Maintenance of an investment grade rating will depend upon total debt-to-EBITDA falling to at or below 3.0x by the end of 2013. Fitch projects that the combined company's EBITDA will approach $2 billion in 2013. This expectation is supported by incremental sales from Actavis supporting performance following the expected significant drop in Watson's sales of the authorized generic Lipitor in May 2012. Fitch's 2013 EBITDA projection does not assume the realization of significant synergies post the acquisition, which is a source of potential upside. However, Fitch also notes that there is integration risk inherent in the combination of two companies the size of Watson and Actavis, which currently are the fourth and sixth largest generic pharmaceutical firms ranked by global sales. Assuming the combined company produces about $2 billion of EBITDA in 2013, Fitch expects that Watson will have to apply about $800 million of cash to debt pay-down to reduce total debt leverage to 3.0x. Debt reduction could be supported by ample free cash flow (FCF, cash from operations less capital expenditures and dividends). Watson produced FCF of $505 million, representing a healthy 11% FCF margin, in 2011. FCF in 2011 was somewhat pressured by higher than historical capital expenditures as Watson invested in expansion of manufacturing capacity. Fitch expects the combined company to initially generate around $800 million of FCF annually. Watson's next significant debt maturities are $200 million of mandatorily convertible (payable in cash) preferred stock in 2012, and $450 million of senior notes due August 2014. In May, Watson amended its five-year revolving credit facility, executed in September 2011, increasing capacity to $750 million from $500 million. Also in the amendment, the prior maximum leverage covenant of 3.5x will be reset to 4.25x at the close of the acquisition through the end of 2013 and steps down to 3.5x in 2015. At March 31, 2012 Watson's liquidity was provided by $182 million cash on hand, $185 million in availability on its bank credit revolver and latest 12 month FCF of $370 million. Guidelines for Further Rating Actions: An upgrade will not be considered until the company significantly reduces the anticipated high leverage resulting from the purchase of Actavis Group. A reduction in gross debt leverage to near 2.0x would warrant positive rating action. Negative rating pressure would result from leverage above 3.0x at the end of 2013. Failure to achieve this leverage level could arise from stressed profitability due to an inability to execute the integration of the new business or from failure to apply cash to debt reduction. Fitch currently rates Watson as follows: --IDR 'BBB'; --Senior Unsecured Bank Credit Facility 'BBB'; --Senior Unsecured Notes 'BBB'.
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