TEXT-S&P rates Cerba prelim 'B+', outlook stable

Mon Jan 14, 2013 1:59pm EST

Jan 14 (Reuters) - Standard & Poor's Ratings Services assigned its preliminary 'B+' long-term corporate credit rating (CCR) to France-based clinical laboratory operator Cerba European Lab SAS (Cerba). The outlook is stable.

At the same time, we assigned our preliminary 'B+' issue rating to Cerba's EUR355 million senior secured notes due 2020. The preliminary recovery rating on the notes is '4', indicating our expectation of average (30%-50%) recovery in the event of a payment default.

The final ratings will be subject to the successful closing of the proposed issuance and will depend on our receipt and satisfactory review of all final transaction documentation. Accordingly, the preliminary ratings should not be construed as evidence of the final ratings. If the final debt amounts and the terms of the final documentation depart from the materials we have already reviewed, or if we do not receive the final documentation within what we consider to be a reasonable time frame, we reserve the right to withdraw or revise our ratings.

Rationale

The ratings on Cerba reflect our view of the company's relatively aggressive capital structure through its ownership by private equity group PAI Partners.

We assess Cerba's financial risk profile as "highly leveraged" under our criteria. Cerba is raising EUR355 million of notes to refinance its bank debt. Based on the proposed capital structure after the refinancing, we estimate that Cerba's Standard & Poor's-adjusted net debt-to-EBITDA ratio will be about 10x by Dec. 31, 2013. Our estimate includes financial debt of EUR404 million and about EUR398 million in the form of preference shares, convertible bonds, and other debt-like instruments such as shareholder loans.

Although we view these latter instruments as debt-like, we recognize their cash-preserving function. Excluding these debt-like instruments, Cerba's financial risk profile would be more in line with an "agressive" assessment as our criteria define the term, with debt to EBITDA of between 4.5x and 4.7x by Dec. 31, 2013. Due to Cerba's long-dated debt maturity profile and acquisitive strategy, any future improvement in leverage is likely to result from higher profitability rather than from any reduction in debt, thereby leading to a relatively high cost of funding. This could, in our view, potentially compromise Cerba's operating flexibility.

We estimate that Cerba will achieve adjusted EBITDA of about EUR84 million in 2013. This will cover by 2.6x annual cash interest payments of about EUR32 million, supported by positive free operating cash flow (FOCF), which is in line with what we consider commensurate with the current rating.

We assess Cerba's business risk profile as "fair" under our criteria. We base our view on Cerba's position as a leading operator of clinical laboratory testing services in France, Belgium, and Luxembourg.

We view Cerba's revenue diversification and its growing size as an advantage in the fragmented, highly regulated, and price-competitive environment. This enables the company to exploit cost advantages through common procurement and overhead optimization. These benefits are reflected in comparatively high operating margins. We estimate that EBITDA margins will remain in the low- to mid-twenties, which compares favorably with the margins of the company's larger international peers.

Cerba's business risk profile is further supported by what we view as favorable underlying trends and the characteristics of the clinical laboratory services industry. Chief among these characteristics is the atomistic supply-and-demand structure, involving a multitude of individual orders and transactions with no dependence on one large customer or contracts. As customers are mainly individual patients undergoing diagnostic tests, payment risk is virtually nonexistent since most bills are settled by public and private health insurance or hospitals. In addition, factors such as aging populations, increasingly unhealthy lifestyles that are accompanied by prevalent diseases such as diabetes and cancer, and the increasing demand for precise diagnostics and early detection will in our view continue to drive volumes.

These strengths are partially offset, in our opinion, by Cerba's still-relatively-modest size, with annual revenues on a pro forma basis of about EUR322 million in 2011. This compares with the value of the French clinical laboratories diagnostic services market of about EUR7.3 billion. Cerba's market share is still somewhat low in the routine segment of the French clinical laboratories diagnostic services market. Furthermore, it will take time to expand this share significantly, given the small size of the company's acquisitions. A

t the same time, we consider Cerba's acquisitive business model as the main weakness of its business risk profile. In addition, the clinical laboratories diagnostic services industry lacks barriers to entry, and Cerba's business model is susceptible to market entry by much larger players. This creates risks of margin erosion or escalating purchase prices of takeover targets, and could lead to greater competition.

Furthermore, as European governments seek to meet budgetary constraints, the clinical laboratory segment is becoming subject to stricter regulation and increasing pricing pressure. As such, Cerba is likely to be confronted with the challenge of adapting its cost structures to the more regulated and subsequently more expensive operating environment, and to lower selling prices. While a consolidator such as Cerba is, in our view, in a better position to absorb pricing pressure than smaller laboratories, increasing exposure to regulatory actions is highly likely.

Apart from price regulation, we believe a further challenge could come from limits on reimbursement for diagnostic tests. This could mean greater out-of-pocket contributions from patients and consequently a lower demand for standard tests.

We anticipate continued strong double-digit sales growth in 2012 and 2013, owing to management's planned pace of acquisitions. Without external growth, we believe that underlying revenue growth will be in the low single digits. We believe that operating margins will continue to improve slightly on a pro forma basis, assuming a swift integration of acquired units.

Liquidity

We assess Cerba's liquidity as "adequate" under our criteria. (See "Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers," published Sept. 28, 2011.)

We estimate that liquidity sources (including cash, funds from operations, and the available credit facilities) should exceed uses over the next 12 months by more than 1.2x. Even if EBITDA were to decline by 15%-20%, we believe that net sources would remain positive.

Our assessment takes into account the following factors:

-- The debt is in the form of senior secured notes of EUR355 million due 2020.

-- We believe Cerba should be able to generate free operating cash flow of at least EUR20 million per year, after covering estimated capital spending of about GBP10 million-GBP13 million per year.

-- We understand that an additional source of liquidity under the proposed capital structure will be a super senior revolving credit facility (RCF, not rated) of EUR50 million.

-- We believe Cerba will be able to maintain adequate covenant headroom under the RCF's financial covenants (with leverage in the tightest period of 5x maximum).

-- We do not anticipate any cash dividends or returns to shareholders as stipulated under the conditions of the credit facilities.

Recovery analysis

The preliminary issue rating on the EUR355 million senior secured notes to be issued by Cerba is 'B+', in line with the CCR. The recovery rating on the notes due 2020 is '4', indicating our expectation of average (30%-50%) recovery in the event of a payment default.

The issue and recovery ratings on the senior secured notes are constrained by the relative weak security package consisting of share pledges, bank accounts, and intercompany receivables; and Cerba's incorporation in France, a jurisdiction that we view as relatively unfavorable for senior secured lenders. The recovery rating on the notes is also limited by their subordination to the RCF, which would rank ahead of the notes on enforcement of the collateral according to the intercreditor agreement. Supporting the ratings are our going-concern analysis in an event of default, based on Cerba's good market positions in France and Benelux, its specialized business, and resilient underlying market environment. The relatively simple debt structure and the good guarantor's package further support the ratings.

To calculate recoveries, we simulate a default scenario. We believe that a default would most likely be triggered by an unfavorable regulatory regime and a fragmented and competitive environment. In addition, we consider that lower-than-expected EBITDA growth from acquisitions as a result of a weakening trading environment could also contribute to a decline in the company's profitability. Under our hypothetical default scenario, we forecast a default in 2016, at which point EBITDA would have declined to about EUR50 million. We value the business using a fixed-charge approach, with a 5.5x stressed EBITDA multiple.

From the gross enterprise value of about EUR275 million, we deduct priority obligations comprising enforcement costs, leases, the factoring facility, and other debt remaining at subsidiaries. On this basis, we arrive at a residual amount of about EUR218 million available for the super senior RCF and a residual amount of about EUR165 million for the EUR370 million of senior secured notes outstanding (including six months of prepetition interest). This results in recovery prospects at the high end of the 30%-50% range for the senior secured bondholders.

Outlook

The stable outlook reflects our view that despite the potentially negative effects of European public spending cuts on health care, Cerba will sustain positive underlying revenue growth of at least low single digits while successfully integrating new acquisitions and at least maintaining its operating performance momentum.

We would view adjusted EBITDA cash interest coverage of 2.5x at all times and positive FOCF generation as commensurate with the 'B+' rating. We could take a negative rating action if adjusted EBITDA interest coverage drops below 2.5x, or if Cerba is not able to generate positive FOCF. This would most likely occur if operating margins deteriorate due to an inability to profitably integrate newly acquired operations.

A positive rating movement is unlikely over the next two years, in our view, due to Cerba's already high adjusted leverage. However, we would likely take a positive rating action if the company sustains adjusted debt to EBITDA of less than 5x.

Related Criteria And Research

All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.

-- Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012

-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012

-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011

-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009

-- Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008

-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008

-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

New Rating

New Rating; CreditWatch/Outlook Action

Cerba European Lab SAS

Corporate Credit Rating B+ (prelim)/Stable/--

Senior Secured Debt B+ (prelim)

Recovery Rating 4 (prelim)

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