TEXT-Fitch assigns Teva initial idr of 'A-', rates new debt 'A-'
Dec 13 - Fitch Ratings has assigned Teva Pharmaceutical Industries Ltd. (Teva) an Issuer Default Rating (IDR) of 'A-'. The Rating Outlook is Stable. In addition, Fitch rates Teva's proposed senior unsecured debt issuance 'A-'. See the full list of ratings assigned below. The ratings apply to approximately $13.8 billion of debt at Sept. 30, 2012, and reflect the following key credit considerations: Acquisitions Stretch Leverage; Financial Discipline Demonstrated Teva has grown to be the world's largest generic drug firm and a top-20 global pharmaceutical company through a series of acquisitions. Business development activities accelerated over the past five years as the business increased to one generating over $20 billion in annual sales from $8.4 billion in 2006. During this time, the company spent nearly $20 billion on new assets. The most recent acquisitions in 2011, notably Cephalon, Inc. (Cephalon) and Taiyo Pharmaceutical Industry Ltd. (Taiyo), totaled $7.6 billion and pushed gross debt leverage to 2.8x in 2011 and 2.3x for the latest 12 months (LTM) as of the third quarter of 2012 (3Q'12). Leverage spikes are not an uncommon occurrence for Teva given its acquisition history. The company typically winds down debt leverage steadily following debt-funded asset purchases as last seen following the acquisitions of Barr Pharmaceutical in December 2008, and Merkle ratiopharm Group (ratiopharm) in August 2010. Teva significantly decreased leverage to below 1.5x within 12 months in both situations. Currently, leverage has remained at levels more indicative of a 'BBB+' rating category as a result of Teva's refinancing of most of the acquisition debt given an attractive credit environment, and seeking to push out average maturity of the debt load. The rating reflects some comfort in Teva's commitment to near-term debt reduction gained from the company's intention to repay up to $1 billion in debt annually. In Fitch's estimation, the pay down of approximately $2 billion during the next two years would yield gross debt leverage of 2.3x in 2013 and 1.8x in 2014, a level indicative of the current rating category. New Strategic Plan Recently Unveiled Clearly, Teva has built its organizational structure over the past years to facilitate balanced growth in the face of looming pressure from the patent expiration of Copaxone as well as a general industry slowdown post patent cliff in 2015. The mechanisms that a new management team will put into place over the intermediate term to mitigate the impacts once the situations arise were detailed at an investor conference on Dec. 11, 2012. At the meeting, the company announced plans to 'reshape' its operating structure that will involve facility consolidation and capital and expense rationalization, including a strategic assessment of the current R&D portfolio. Management said cost savings from the program are in the range of $1.5 billion to $2 billion over five years. Double-Digit Sales Growth Bolstered by Acquisitions Teva's previous acquisition strategy sought product (both complex generic and brand name drugs) and geographic diversification. The series of acquisitions completed since 2006 cost $19.9 billion, and yielded an increase in revenues to $18.3 billion in 2011 from $5.3 billion in 2005 for compound annual growth of 23.1%. Notable acquisitions were IVAX Corporation and Barr Pharmaceuticals (global generic drug firms), ratiopharm (an international branded generic maker), and Cephalon (a specialty medicine developer). In the first nine months of 2012, total revenues jumped 19.3% bolstered by the addition of Cephalon's brand-name drugs and new revenue sources in Japan from Taiyo, both purchased in 2011. Patent Cliff in 2015-2016 Teva faces a key drug patent expiration period in 2015 and 2016, mainly due to the potential loss of market exclusivity for Copaxone in September 2015. The medicine for the treatment of multiple sclerosis (MS) generated $3.86 billion in sales for the LTM 3Q'12, which represented 19.5% of total revenues. While Teva contends with the negative effect of the Copaxone patent loss, Mylan Laboratories (Mylan) may launch its generic version of Nuvigil in June 2016 per a legal settlement agreement. Together, Fitch expects the two intellectual property losses to drag growth down by almost 5% in 2016. The generic drug business that generates a little more than half of Teva's revenues provides a minimal buffer to the expected sales drop, in Fitch's opinion, and the company will need to find new branded-drug revenue drivers in the next few years. The R&D program has been refocused on two therapeutic classes - central nervous system (including pain) and respiratory. As such, potential therapies in non-core areas have been recently cancelled including late-stage projects in stem cell therapies, a potential lung cancer medicine, and a new anti-TNF for sciatica treatment. However, Teva has added two new molecular entities - XEN042 and pridopidine - since September, bringing total Phase III programs to 15 (including line extensions). The new focus, beyond CNS (including pain) and respiratory, includes the development of new therapeutic entities (NTEs) or existing pharmaceuticals in new formulations or delivery formats. Teva plans to start development of 10-15 NTEs in 2013 with an expectation of first launching in 2016. Fitch expects that commercialization of the current branded pipeline will only partially offset Teva's patent cliff. Strong Cash Flow Cash generation is consistent and robust, driven by an extensive product portfolio and good geographic diversification. LTM free cash flow (FCF) for the period ended Sept. 30, 2012 was approximately $2.5 billion, rising from nearly $2.3 billion generated in 2011. FCF has remained above $2 billion annually since 2008. Fitch expects Teva to maintain FCF above $2.8 billion per year (excluding a potential material legal settlement pertaining to an 'at-risk' launch of Protonix in December 2007) and FCF margins in excess of 14% over the ratings horizon. Cash balances of $1.4 billion and full availability under its $2.5 billion revolver due January 2014 on Sept. 30, 2012 further support an exceptional liquidity profile. Capital Deployment Evenly Split Teva publicly outlined uses for estimated cash flows between $4.5 billion to $5.5 billion annually through 2016 with approximately $2 billion to be dedicated to business development and $1 billion to $2 billion to shareholder returns. The new strategic plan looks to repay up to $1 billion in debt annually as well. Teva's Board of Directors authorized a $1 billion share buyback program in December 2010, and throughout 2011, a total of $899 million in shares were repurchased. Along with the announcement of a new $3 billion program in December 2011, the company stated an expectation to exhaust the authorization over three years. Fitch expects equity repurchases to resume in the near term after a temporary suspension in the third quarter in line with the expectation for shareholder returns detailed at the recent analyst conference. Teva's Board also makes dividend decisions, and Fitch anticipates future increases more modest in comparison to the 25% jump in 2011. Cost Initiatives Implemented as Revenue Growth Slows Teva has held EBITDA margins above 28% since 2009, which is commendable given the volatility in revenues and earnings inherent in the generic drug industry and continuous disruptions from acquisitions. EBITDA and EBITDAR margins were relatively steady at 29.4% and 30.0%, respectively, for the LTM Q3'12, compared to 28.2% and 28.9%, respectively, in 2011. Fitch sees revenue growth easing from the torrid pace over the past years due to brand name competition to Copaxone, a slowing patent cliff, and moderating asset purchasing. As such, profitability may stagnate if not for cost cutting. The company had already planned for $500 million of integration synergies from the Cephalon acquisition before seeking incremental cost savings of $1.5 billion to $2 billion over five years under the new strategic initiative. Fitch builds in cost savings of $2 billion in 2014-2016 that would serve to bolster margins. What Could Trigger A Rating Action An upgrade will not be considered until the company significantly reduces higher leverage that remains after the purchase of Cephalon in October 2011. A positive rating action would be favorably influenced by gross debt leverage to the low end of Teva's debt leverage range (i.e. 1.5x to 2.0x EBITDA). The reduction could come from debt repayment following the long-term maturity schedule as well as shoring up margins from expense saving resulting from operational reorganization ahead of the coming Copaxone patent expiration in 2015 and general generic industry slowdown in 2016. Negative rating pressure would result from total debt leverage persisting above 2.0x at the end of 2014. Failure to achieve this leverage level could arise from failure to pay down 2013 debt maturities, leveraging transactions, and/or inability to extract operating expenses ahead of the looming patent loss of Copaxone and generic drug industry pressures. Fitch has assigned the following ratings: --Long Term IDR of 'A-'; --Senior unsecured debt of 'A-'; --Bank loan of 'A-'. Additional information is available at www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable Criteria and Related Research: --'Corporate Rating Methodology' Aug. 8, 2012; --'Rating Pharmaceutical Companies - Sector Credit Factors', Aug. 9, 2012. Applicable Criteria and Related Research: Corporate Rating Methodology Rating Pharmaceutical Companies