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May 8 (The following statement was released by the rating agency)
Fitch Ratings has revised Germany-based healthcare company Bayer AG's Outlook to Negative from Stable. The agency has also affirmed its Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'A', its Short-term IDR at 'F1', and its hybrid instrument rating at 'BBB+'.
The rating action follows Bayer's offer to acquire the consumer healthcare division from Merck & Co Inc (Merck) for USD14.2bn. In addition to this announcement, Bayer has entered into collaboration with Merck in cardiovascular therapeutic developments (sGC modulators), which will result in an USD1bn upfront payment to Bayer and additional sales milestones payments depending on R&D success. Based on Fitch's projections the company post acquisition would have exhausted its financial flexibility and we would expect a period of deleveraging for the rating to remain at its 'A' level, to which management have reiterated their commitment.
The announced transaction is expected to be fully debt-funded by way of senior and hybrid debt issues (split to be determined) and is subject to regulatory approvals with expected completion in 2H14.
KEY RATING DRIVERS
Acquisition to Increase Leverage
The Negative Outlook reflects an expected increase in leverage due to the debt-financed acquisition of Merck's consumer health care division. Fitch projects around a 1.2x increase in funds from operations (FFO) adjusted net leverage to an annualised peak of around 2.5x post acquisition, incorporating also the earlier acquisition of Norway-based pharma company, Algeta ASA, for around USD2.6bn and announced plans to acquire Dihon Pharmaceutical Group Co., Ltd., based in China. Such a financial profile is not compatible with the current 'A' rating given Bayer's underlying business risk profile.
Strategic Fit and Improving Business Profile
Fitch considers the proposed 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 will regain the No 2 global market position in the consumer health segment (behind the recently announced Novartis/GSK combination and ahead of Johnson & Johnson).
Accordingly, Fitch believes the business risk profile will improve as a result of the transaction as it will strengthen the competitive position of its consumer healthcare division in a rapidly consolidating market, and improve the overall diversification of the group.
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 an 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.
Fitch, however, highlights significant uncertainties associated with this transaction that could affect the rating level of Bayer post completion. These include delays in achieving the estimated margin improvement; long-term debt structure post completion and associated financing costs; benefits arising from the strategic cardio-vascular collaboration agreement; and details around tax benefits (which the company has not yet finalised).
A change of the Outlook back 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 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 rating downgrade. At present, a potential downgrade would be limited to one notch.