TEXT-S&P cuts Baxter International rating to 'A' from 'A+'
Overview -- U.S.-based medical products company Baxter International Inc. announced a definitive agreement to acquire privately-held dialysis product company Gambro AB for approximately $4 billion. -- The deal will be financed with roughly $1 billion of overseas cash and the proceeds from $3 billion of new debt. -- We believe that the additional debt will push Baxter's credit metrics outside our guidelines for a "modest" financial risk profile. We now view Baxter's financial risk profile as "intermediate". -- We are lowering our corporate credit and unsecured debt ratings on Baxter to 'A' from 'A+', given the company's weakened financial risk profile. -- Our short-term rating on Baxter remains 'A-1'. -- The stable outlook reflects our view that product diversity should help Baxter absorb setbacks in any one product line, and that its financial risk profile will improve slowly but remain "intermediate" for the next two years. Rating Action On Dec. 6, 2012, Standard & Poor's Ratings Services lowered its corporate credit and unsecured debt ratings on Baxter to 'A' from 'A+'. Our short-term rating on the company remains 'A-1'. The lower ratings reflect our view of the company's weakened financial risk profile, which we now view as intermediate and had previously viewed as modest. The proposed acquisition of Gambro will add roughly $3 billion of new debt, which will push pro forma debt to EBITDA to around 2.5x from 1.9x as of Sept. 30, 2012. This well exceeds our previously published downgrade trigger of more than 2x (without expectations of rapid deleveraging). We believe that deleveraging will be slow given the company's numerous calls on cash such as dividends, share repurchases, and capital to build and expand its plasma fractionation capacity. Rationale The ratings on Baxter continue to reflect its "strong" business risk profile as a leading manufacturer of diversified and relatively noncyclical medical products. The company has extensive worldwide operations, solid distribution channels, a very large and entrenched customer base, and low-cost manufacturing. The acquisition of Gambro does not change our view of the company's business risk. We have revised our financial risk profile to "intermediate" reflecting a less conservative balance sheet, stable recurring revenues from consumables and disposables, and strong liquidity. We expect that, over the near term, revenues (excluding the impact of Gambro) will grow in the low- to mid-single digits, in line with overall health care industry growth. We believe Baxter can sustain an adjusted EBITDA margin (per our calculation) of around 30%, as manufacturing optimization programs, operating leverage, and expanded product offerings offset the impact of health care legislation, global pricing pressures, costs associated with plant expansions, and the lower-margin Gambro business. Debt (adjusted for factored receivables of $154 million, operating leases of $679 million, unfunded pension liabilities of $1.2 billion, and $3 billion of assumed acquisition-related debt) was $11 billion on a pro forma basis as of Sept. 30, 2012. Debt to EBITDA is about 2.5x at Sept. 30, 2012 on a pro forma basis, and we expect pro forma funds from operations (FFO) to debt to be at the lower end of the 30% to 45% range for an intermediate financial risk profile. We expect very modest deleveraging over the next two years. Baxter develops, manufacturers, and markets a broad array of products for the treatment of hemophilia, immune disorders, infectious diseases, kidney disease, trauma, and other chronic and acute medical conditions. Its diversity is evidenced by many product categories that operate under its bioScience and medical products business segments; no product category contributes more than 18% of total sales. We believe some loss in market share of infusion pump systems, because of the U.S. Food and Drug Administration-mandated COLLEAGUE infusion pump replacement, will not be material to results. Baxter has a broad geographic footprint, deriving 59% of 2011 revenues from outside the U.S., including a meaningful presence in emerging markets. It is a leading supplier with strong brand awareness, selling products in more than 100 countries, and manufacturing products in 27 countries; end users are diverse. However, Baxter is exposed to competitive pressures, particularly in markets with commodity-like characteristics, such as plasma, and/or where generic alternatives are available. Thus, in addition to development of new products and product indication expansions, it distinguishes itself with optionality in treatment regiments, innovative packaging, and unique medication delivery systems. Baxter has a robust product pipeline because of its targeted investment in research and development (R&D), which we believe will help it remain competitive in an industry facing relatively fast innovation cycles for certain products. R&D spending was $946 million (7% of revenues) and acquisition spending was $590 million in 2011. Pricing remains under pressure from large purchasing groups in the U.S. and international tenders. Certain of Baxter's markets (e.g., plasma products) have commodity-like characteristics. Baxter plans to upgrade its older plasma-fractionation facility in the coming year to position itself for future growth and is beginning construction of a new facility in Covington, Georgia. It also entered into a manufacturing services agreement with Stichting Sanquin Bloedvoorziening that will provide up to 1.6 million liters of incremental plasma fractionation capacity. Liquidity Our short-term credit rating on Baxter is 'A-1'. We continue to believe Baxter has strong liquidity to meet its needs over the next two to three years, despite the drop in cash balances to fund the acquisition. The use of cash for expansion projects and acquisitions has removed much of the cushion for our assessment of the company's liquidity as strong. Our view of its liquidity profile incorporates the following expectations: -- We expect liquidity sources (primarily cash, discretionary cash flow, and revolving credit facilities) to exceed uses (including dividends and anticipated share repurchases) by at least 1.5x over the next two to three years. -- We expect liquidity sources to continue to exceed uses, even if EBITDA declines by 30%. -- We believe Baxter can absorb a high-impact, low-probability event. -- We believe Baxter has well-established bank relationships. Baxter's strong liquidity is evidenced by $3.2 billion of cash and equivalents on Sept. 30, 2012, and cash flow from operations of $3.3 billion for the 12 months ended Sept. 30, 2012, generously covering capital expenditures of $1.2 billion for that period. Baxter will use roughly $2 billion of cash for its planned acquisition of Gambro and its investments in plasma fractionation facilities. Baxter's low effective income tax rate of about 21% enhances free cash flow. The company manages its tax strategy to generate sufficient cash denominated in U.S. dollars to fund U.S. cash needs. However, cash demands in the U.S. often outstrip U.S. cash flows, resulting in a mismatch of U.S. cash that is often made up for through reimported overseas cash or balance sheet cash. Baxter's commercial paper programs ($1.4 billion), used to support operational requirements, are backed up by a $1.5 billion revolving credit facility that matures in June 2015. The company also maintains a $393 million (at Sept. 30, 2012) euro-denominated credit facility, which matures in January 2013. At Sept. 30, 2012, Baxter had no commercial paper outstanding, and both the revolvers were undrawn. Baxter has a capital allocation guideline to return about 35% to 40% of internally generated cash to shareholders. It recently increased its dividend by 34%, which will translate into a roughly 40% payout ratio. We expect share repurchases will be tempered to roughly $300 million in 2013 and 2014 following the Gambro acquisition, and then increase to about $750 million annually. Outlook Our rating outlook on Baxter is stable. Product diversity should help the company absorb setbacks of any one product line. We could lower our ratings if we believe Baxter is willing to operate on a long-term basis at the weaker end on an intermediate financial risk profile (debt to EBITDA of 2x to 3x, and FFO to debt of 30% to 45%). We currently believe that Baxter is committed to slowly improving its financial risk profile following the Gambro acquisition. However, we would likely lower the rating if revenue declines or operating losses would be material enough to stall or reverse improvement in the company's financial risk profile. It is unlikely that we would raise our ratings on the company over the next two years. However, we could raise our ratings on Baxter over the long term if the company improves credit metrics to be in line with a modest financial risk profile, and we believe that the company will operate at the improved level on an ongoing basis. Related Criteria And Research -- Methodology: Short-Term/Long-Term Ratings Linkage Criteria For Corporate And Sovereign Issuers, May 15, 2012 -- Liquidity Descriptors for Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 Ratings List Downgraded; Rating Affirmed To From Baxter International Inc. Corporate Credit Rating A/Stable/A-1 A+/Stable/A-1 Downgraded To From Baxter International Inc. Senior Unsecured A A+ Ratings Affirmed Baxter International Inc. Baxter Holdings B.V. Commercial Paper A-1 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.