TEXT-S&P assigns Therakos 'B' corporate credit rating
Overview -- U.S.-based health care company Therakos Inc. is issuing $290 million of debt to partly fund its leveraged buyout (LBO) by the Gores Group. -- We are assigning Therakos our 'B' corporate credit rating, reflecting limited scale and narrow focus along with pro forma debt to adjusted EBITDA of 5.4x. -- We are also assigning the $245 million first-lien credit facilities our 'B' issue-level rating and '3' recovery rating, and assigning the $80 million second-lien debt our 'CCC+' issue-level rating and '6' recovery rating. -- The stable outlook reflects our expectation that despite the generation of cash flow, debt leverage will remain above 5x over the next couple of years. Rating Action On Nov. 8, 2012, Standard & Poor's Ratings Services assigned Raritan, N.J.-based health care research company Therakos Inc. its 'B' corporate credit rating. At the same time, we assigned the $245 million first-lien debt (which includes an undrawn $35 million revolving credit facility) our 'B' issue-level rating with a recovery rating of '3', indicating meaningful (50% to 70%) recovery in the event of a payment default. We also assigned the $80 million second-lien debt our 'CCC+' issue-level rating with a recovery rating of '6' (0% to 10% recovery expectation). Rationale The ratings on Therakos Inc. overwhelmingly reflect a "weak" business risk profile, exhibited by the company's limited scale and heavy reliance on one therapy--extracorporeal electrophoresis (ECP)--for all of its revenues. The ratings also reflect our expectation that Therakos will operate with a "highly leveraged" financial risk profile for at least the next couple of years. Therakos manufactures and distributes the only integrated systems (2nd generation XTS and 3rd generation CellEx) for providing ECP, a second-line therapy used to treat several orphan disease states arising from immune system imbalances. Therakos, founded in 1986, is being carved out of Johnson & Johnson as an independent operation. The weak business profile considers the company's small revenue base, with only about $130 million in annual revenues. The company will remain relatively small and susceptible to currently unforeseen changes in disease treatment protocols, and their level of reimbursement provided to their customers by third-party payors. The company will heavily rely on the sale of its kits that provide for proprietary equipment to process the blood of patients outside their bodies by photoactivating a drug (UVADEX) with ultraviolet light. Offsets to the company's small scale and limited growth prospects include the company's entrenched niche position, with its proprietary instruments installed in more than 325 centers, which are about evenly divided in the U.S. (60% of revenues) and other countries (40%). The company provides for recurring revenues over periods that could approximate six months, largely from the sale of its highly profitable kits. Still, we believe that the company's margins, which now exceed 40%, will be pressured by unanticipated costs as an independent operation, and industry price pressure beyond 2013. We compare Therakos' business profile to that of Ikaria, reflecting a similar niche medical business that, though it generates high margins, is vulnerable to unexpected adverse changes in its narrow therapeutic focus. While emerging uses provide some additional potential for expansion over the long term, most of the mid-single-digit annual growth we expect over the next few years relate largely to price increases supported by higher reimbursement by Medicare and other third-parties. We anticipate only modest increases in the treated population; symptoms of Graft vs. Host Disease (GvHD), which accounts for about two-thirds of treatment, and cutaneous T-cell lymphoma (CTCL), which contributes about one-quarter of treatment primarily, are addressed with well-established first-line steroid therapy. We assume that margins over the next couple of years will average in the high-30% range, enabling Therakos to generate at least $20 million of annual free cash flow over the near term, some of which will be used for debt reduction. While we believe that there is potential for leverage to decline to about 5x by the end of 2013, we also believe that any decrease in leverage is likely to be temporary. In our opinion, the sponsors will likely use Therakos' growing debt capacity and free cash flow to fund an acquisition or dividend, keeping leverage within 5x to 6x--the parameters for a highly leveraged financial risk profile. Liquidity Therakos has adequate liquidity. Sources of cash will exceed mandatory uses of cash by at least 1.2x over the next 12 to 24 months. Relevant aspects of Therakos' liquidity profile are: -- Sources will exceed uses by more than $50 million, allowing for a 15% decline in EBITDA. -- Sources of cash will include some balance sheet cash, full availability of the $35 million revolving credit facility, and some $25 million of free cash flow. -- We assume only relatively small requirements for working and fixed capital investment. Annual loan amortization payments approximate $2 million. -- There are no covenants on the term loans. -- However, as a single-therapy company, we believe that the company does not likely have the ability to absorb, with limited need for refinancing, a high-impact, low-probability event. Recovery analysis We assigned the proposed $210 million first-lien term loan due 2019 and $35 million revolving facility (undrawn)due 2017 our 'B' issue-level rating with a recovery rating of '3', indicating our expectation for meaningful (50% to 70%) recovery in the event of a default. We assigned the second-lien term loan due 2020 our 'CCC+' issue-level rating with a recovery rating of '6', indicating our expectation for negligible (0% to 10%) recovery in the event of payment default. Outlook Our stable rating outlook on Therakos reflects our expectation that demand for the company's ECP therapy, coupled with modest price increases, will result in at least mid-single-digit annual revenue growth through 2013 and free cash flow generation. We expect the company to use this free cash flow for modest debt reduction that will reduce leverage to about 5x by the end of 2013. However, we also expect the sponsors to use the growing debt capacity for acquisitions or shareholder friendly actions that will keep leverage above 5x. We could raise our corporate credit rating if Therakos, as an independent company, extends a record of double-digit revenue growth and EBITDA margins of at least 38% that contributes to our belief that leverage will be sustained below 5x. Our perception that the financial sponsor is committed to such a financial policy likely would be a prerequisite for a rating upgrade. A downgrade most likely would accompany a sponsor dividend or a richly valued acquisition--probably exceeding $50 million--that would take leverage over 7x. Related Criteria And Research -- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012 -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 Ratings List New Rating Therakos, Inc. Corporate Credit Rating B/Stable/-- Senior Secured $210M first-lien term loan due 2019 B Recovery Rating 3 $35M revolver loan due 2017 B Recovery Rating 3 $80M second-lien term loan due 2018 CCC+ Recovery Rating 6 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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