Fitch Assigns Bayer AG's Hybrid Notes 'BBB+', 50% Equity Credit; Affirms IDR at 'A'

Wed Aug 13, 2014 5:59am EDT

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(The following statement was released by the rating agency) LONDON, August 13 (Fitch) Fitch Ratings has assigned Bayer AG's EUR1.75bn and EUR1.5bn subordinated resettable floating-rate notes a rating of 'BBB+', two notches below Bayer's Issuer Default Rating (IDR) of 'A' in line with the existing hybrid notes. Fitch has applied a 50% equity credit to the two bonds, which are identical in ranking and terms with exception of maturity and pricing. Fitch has also affirmed Bayer's IDR at 'A' with Negative Outlook. The senior unsecured rating is affirmed at 'A' and the existing hybrid instrument rating at 'BBB+'. The Short-term IDR has been affirmed at 'F1'. The hybrid notes issuance represents a first step refinancing of the announced USD14.2bn acquisition of Merck & Co Inc's (Merck) consumer health care acquisition, currently awaiting regulatory approval and expected to complete in 2H14. KEY RATING DRIVERS OF THE NOTES Equity Treatment Reflects Equity-like Features Both issues qualify for 50% equity credit as they meet Fitch's criteria with regard to deep subordination, remaining effective maturity of at least five years (including coupon step ups < 1.0% and replacement language) and deferrable interest coupon payments at the option of the issuer. Fitch regards these characteristics as key requirements for assigning equity credits to hybrid issues, as they offer issuers the financial flexibility required to protect its capital structure. Coupon & Maturity Date The notes are long-dated instruments with the EUR1.75bn tranche having a 61-year maturity and 3.0% coupon and the EUR1.5bn tranche a 60-year maturity and 3.75% coupon. The first redemption options are in 2020 and 2024, respectively, well after five years and with coupon step ups below 1.0%, in line with Fitch's methodology for assigning equity credit to hybrid issues. The notes are not subject to financial covenants and rank senior only to common equity. Instrument Rating Reflects Deep Subordination Fitch notches the notes by two levels from Bayer's IDR given their contractual subordination to senior debt and senior ranking only to common equity, reflecting the consequently lower recovery prospects in a bankruptcy or liquidation scenario relative to senior obligations. The notes rank pari passu with the existing hybrid notes issued in 2005, which is also rated 'BBB+'. However, the 2005 notes are subject to a look-back period (i.e. if a dividend has been paid out during the last 12 months, then the payment of the coupon on the hybrid instrument is compulsory) as well as subject to a first call option in 2015. Fitch does not attribute any equity credit to these existing notes, Cumulative Coupon Deferrals Limit Equity Credit Deferrals of coupon payments for the new notes are cumulative and incur interest when overdue; in addition the company will be obliged to settle interest arrears under certain circumstances, including following the resumption of dividend payments as well as on redemption dates. These are debt-like features, which reduce the company's flexibility under the instruments and accordingly limit the equity treatment to 50%, in line with Fitch's methodology. KEY RATING DRIVERS FOR BAYER'S IDR Insufficient Enhancement in Financial Headroom post Hybrid Issuance Originally supported by USD14.2bn bridge funding, the hybrid issues is the first step of refinancing the Merck acquisition and improving the group's long-term capital structure post acquisition. The 50% equity credit assigned to the instruments will restore some flexibility under Fitch's 'A' IDR (reducing financial leverage by around 0.2x relative to prior expectations). However, we do not consider this improved flexibility as sufficient to trigger a revision of the Outlook to Stable. Strategic Fit and Improving Business Profile Fitch considers the acquisition of the Merck consumer health assets a sound strategic fit as it enables Bayer to significantly boost its product range and geographical reach in this segment. The Bayer/Merck combination in the consumer health segment will help it regain the No 2 global market position (behind the recently announced Novartis/GSK combination and ahead of Johnson & Johnson). Accordingly, Fitch believes the transaction, once completed, will improve the business risk profile. Active Management of R&D Risks The strategic collaboration in the cardio-vascular therapeutic area will combine two complementary and promising pipelines in cardio-vascular treatment with a view to lowering the cost and risks of bringing products to market. This combination should result in enhanced R&D success probability for both companies. Synergies and Tax Benefits Fitch believes that the transaction will be margin-enhancing and offer considerable revenue synergies in addition to some cost savings. However, we have not factored a significant upside in our forecasts due to the inherent execution risk in extracting such benefits. In addition, it will lower the group's overall tax rate by structuring the transaction as an 'asset' rather than an 'entity' purchase. However, Fitch highlights significant uncertainties associated with this transaction that could affect Bayer's rating post completion. These include delays in achieving the estimated margin improvement; long-term capital structure post completion and associated financing costs; benefits arising from the strategic cardio-vascular collaboration agreement; and tax benefits. RATING SENSITIVITIES A revision of the Outlook to Stable is contingent on a return to an improved financial leverage profile with FFO adjusted net leverage below 2.0x on a sustained basis, resulting from evidence of a smooth integration of the acquisition supported by other cash preservation measures, and FFO fixed charge cover of above 8.0x within the next 12 to 18 months. Sustained financial ratios worse than above indicated levels -i.e. as a result of lower-than- expected cost savings and/or revenue uplift or a permanently higher debt burden could result in a downgrade. At present, a potential downgrade remains limited to one notch. Contacts: Principal Analyst Roma Patel Analyst +44 20 3530 1465 Supervisory Analyst Frank Orthbandt Director +44 20 3530 1037 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chair Pablo Mazzini Senior Director +44 20 3530 1021 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable criteria, 'Corporate Rating Methodology', dated 28 May 2014, are available at Applicable Criteria and Related Research: Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage here Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis here The Rise in European Corporate Hybrids: Equity Credit Alone Not Indicative of Enhanced Financial Flexibility here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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