TEXT-S&P cuts Baxter International rating to 'A' from 'A+'

Thu Dec 6, 2012 11:32am EST

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                



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by this rating action can be found on Standard & Poor's public Web site at 
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