TEXT-S&P rates Patheon credit facility 'B+'

Thu Nov 8, 2012 5:17pm EST

Nov 8 - Overview
     -- U.S. pharmaceutical contract manufacturer Patheon Inc. recently
announced a plan to acquire Banner Pharmacaps from VION N.V. for $255 million.
     -- Patheon intends to fund the purchase through a new $565 million term 
loan B and a new $85 million revolver, undrawn at close, which will also 
refinance existing debt.
     -- We are affirming our 'B+' corporate credit rating. We are also 
assigning the company's new senior secured credit facility our 'B+' 
issue-level rating with a recovery rating of '4'.
     -- The rating outlook is negative, reflecting integration risk.
 
Rating Action
On Nov. 8, 2012, Standard & Poor's Ratings Services affirmed its 'B+' 
corporate credit rating on Research Triangle Park, N.C.-based pharmaceutical 
contract manufacturer Patheon Inc. following the company's announcement that 
it will issue new debt to fund an acquisition and to repay existing debt. The 
rating outlook remains negative.

At the same time, we assigned the company's proposed new senior secured credit 
facilities (consisting of a $565 million term loan B and $85 million revolver) 
our 'B+' issue-level rating with a recovery rating of '4', indicating our 
expectation for average (30% to 50%) recovery in the event of a payment 
default.

Rationale
We continue to view the company's financial risk profile as "aggressive," 
despite the increase in debt. While we measure pro forma leverage at 5.4x, pro 
forma for the acquisition debt and inclusion of EBITDA from Banner, but 
excluding pro forma cost savings or acquisition synergies, we expect that 
leverage will decline to the low-4x range by the end of fiscal-year 2013. Free 
cash flow is expected to be positive. We continue to view the business profile 
as "weak," which reflects the company's inconsistent but improving operating 
performance in the competitive and highly fragmented pharmaceutical contract 
manufacturing business, as well as the company's need to integrate Banner's 
operations following the acquisition. While the Banner acquisition adds some 
scale, we do not believe that the improvement in scale alone warrants a 
stronger business risk score.

Patheon's new management has been successful in rationalizing capacity and 
signing new business, and in leveraging revenue growth into gross margin 
improvement. While these improvements have allowed Patheon to generate modest 
positive free cash flow in the second half of 2012, we still expect full-year 
discretionary cash flow to be negative due to heavy consulting spending in the 
first half of the year. Pro forma the acquisition and debt refinancing, 
adjusted leverage is about 5.4x, inconsistent with our assessment of an 
aggressive financial risk profile. However, we expect Patheon to reduce 
leverage to the low-4x level over the next year and to generate funds from 
operations to total debt in the low double digits in fiscal-year 2013 and 
modestly positive free cash flow after about $55 million in expected capital 
spending. This expectation reflects our belief that the company will generate 
mid-single-digit pro forma revenue growth in fiscal-year 2013, and that EBITDA 
margins will expand about 250 basis points next year, resulting in 2013 EBITDA 
of more than $140 million. This largely reflects the full-year impact of the 
operational improvements realized in the second half of fiscal-year 2012.

Our assessment of Patheon's business risk profile as weak reflects our view 
that the CMO industry is capital intensive, highly fragmented, and 
competitive; that the company has a short track record in generating positive 
free cash flow; and that the company needs to quickly integrate the Banner 
acquisition while completing its internal operating improvement plan. In 
addition, while the pro forma entity will be the No. 2 player in softgels 
behind industry leader Catalent Pharma, softgels represent a relatively small 
portion of the broader solid oral dosage market. These factors are only 
partially offset by Patheon's positioning as a market leader in each of its 
two existing major market segments and its well-established customer 
relationships (including relationships with 18 of the 20 largest global 
pharmaceutical companies and nine of the 10 largest global biotechnology 
companies). Our assessment also considers the recent improvement in revenues 
and operating margins, the diversity of the company's service offerings, and 
our expectation that long-term demand for Patheon's services will continue to 
grow at a low- to mid-single-digit rate.

Liquidity
Our assessment of Patheon's liquidity profile as "adequate" incorporates the 
following expectations and assumptions:
     -- Sources of cash should exceed mandatory uses over the next 12 to 24 
months.
     -- Sources of cash include about $85 million in availability under the 
new revolving credit line and about $60 million in expected funds from 
operations.
     -- Ongoing uses of cash include minimal working capital usage and about 
$55 million in annual capital expenditures (about half of which is 
expansionary).
     -- Following the refinancing, Patheon has no near-term debt maturities 
and no financial maintenance covenants.
     -- We expect liquidity to exceed needs, even if EBITDA declines by 20%.
     -- Given the company's cash balances and available revolver capacity, we 
do not believe Patheon can absorb, without refinancing, a high-impact, 
low-probability event.
 
Recovery analysis
We are assigning Patheon's proposed new senior secured credit facilities our 
'B+' issue-level rating with a recovery rating of '4', indicating our 
expectation for average (30% to 50%) recovery in the event of payment default.

Outlook
Prior to the acquisition announcement, our negative outlook reflected our view 
that Patheon was in the early stages of an operating turnaround, and that 2012 
would be a transformative year for the company. While Patheon has now produced 
two quarters of improved operating results, the company has now introduced new 
elements of business risk with the Banner acquisition. While the acquisition 
adds some business diversity, we view this acquisition as transformative, and 
debt levels are increasing at a somewhat fragile period in the company's 
recovery.

While we expect Patheon to generate over 30% pro forma EBITDA growth in 
fiscal-year 2013, this forecast is not without risks, particularly because the 
company must now integrate newly acquired Banner while at the same time 
completing its internal turnaround plan. If Patheon is able to manage the 
integration and to grow revenues in the low to mid-single digits while 
expanding margins around 100 basis points and generating positive free 
operating cash flow, we could consider an outlook revision to stable.

We could consider a lower rating if Patheon is unable to reduce leverage and 
generate positive free operating cash flow over the next four quarters. We 
believe that this could occur if the company experiences any difficulties in 
integrating the Banner acquisition, or if the company is unable to sustain the 
operating improvements realized over the last two quarters, resulting in 
margin deterioration.

Related Criteria And Research
     -- 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
Ratings Affirmed

Patheon Inc.
 Corporate Credit Rating                  B+/Negative/--     
 Senior secured notes                     B+                 
   Recovery Rating                        4
 Senior secured revolving loan            BB                 
   Recovery Rating                        1

New Rating

Patheon Inc.
 Senior Secured
  $565M fltg rate term B loan due 2019    B+                 
   Recovery Rating                        4                  
  $85M fltg rate revolver loan due 2017   B+                 
   Recovery Rating                        4                  


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.
Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.