September 5, 2012 / 9:50 PM / 5 years ago

TEXT-S&P affirms Valeant Pharmaceuticals ratings

Overview
     -- Montreal-based pharmaceutical company Valeant is acquiring
Medicis Pharmaceutical Corp. for about $2.6 billion and funding the purchase
with debt.
     -- We are affirming our 'BB' corporate credit rating on Valeant.
     -- At the same time, we are affirming the 'BBB-' issue-level rating on 
its existing senior secured debt and affirming the 'BB-' issue-level rating on 
the existing senior unsecured notes.
     -- The stable rating outlook primarily reflects our expectations that 
over the next 12 months, Valeant will use its higher cash flows to reduce 
leverage to less than 4x.

Rating Action
On Sept. 5, 2012, Standard & Poor's Ratings Services affirmed all of its 
ratings, including its 'BB' corporate credit rating, on Montreal-based 
pharmaceutical company Valeant Pharmaceuticals International Inc. The outlook 
is stable.

The affirmation follows the company's announcement that it will acquire 
Scottsdale, Ariz.-based Medicis Pharmaceutical Corp. (unrated) for $2.6 
billion. Valeant is funding the purchase with all debt. 

Rationale
The rating affirmation is based on a modest incremental increase in adjusted 
pro forma leverage, which we calculate at approximately 4.5x. It also 
incorporates our expectation that EBITDA growth and continued free cash flow 
generation will result in leverage declining to less than 4x within one year. 
At this time, we view the acquisition as neutral to our view that Valeant has 
a "fair" business risk profile. While the acquisition of Medicis makes Valeant 
the largest U.S. dermatology company (pro forma on the basis of reported gross 
sales), it is also the second-largest acquisition in Valeant's history. 
Despite the product diversity and expanded pipeline through multiple 
acquisitions, the high level of acquisition activity increases the possibility 
that integration issues could jeopardize our base-case scenario.

The rating reflects our belief that Valeant remains committed to a 
"significant" financial risk profile. We believe the company will use its 
strong cash flows to reduce leverage to less than 4x over the next year, in 
line with their stated financial policy of keeping leverage at 4x or less (per 
the credit agreement calculation). Our consideration of Valeant's business 
risk profile as fair reflects the benefits of a broader product portfolio, 
geographic diversification, and expanded pipeline it has achieved through 
multiple acquisitions over the past two years. This is offset by the potential 
for integration issues with Medicis and the potential challenges of managing a 
very large portfolio of small products given the high acquisition activity.

Excluding the impact of foreign currency fluctuations and excluding 
contributions from newly acquired businesses, we believe Valeant will generate 
7%-10% organic growth from higher volumes of prescribed products (given an 
increasingly diverse geographic area) and the U.S. launch of Potiga in the 
second quarter of 2012. The balance of revenue growth will come from increased 
scale following the almost $3 billion of acquisitions completed in 2011 and 
$3.6 billion completed in 2012. We do not include any price increases because 
of an established presence in Europe and the ongoing pricing cuts from 
governments there. We expect higher volumes of products, with economies of 
scale from acquisitions, will also enable Valeant to improve margins by at 
least 100 basis points in 2012.

We expect that, as a pharmaceutical sales and marketing company, Valeant will 
continue relying on small-tomidsized acquisitions for growth, because of its 
weak internal research and development (R&D) program. In 2011, Valeant 
announced or completed 11 acquisitions totaling about $2.9 billion and to date 
in 2012, excluding Medicis, Valeant completed approximately $1 billion of 
acquisitions. Adjusting for acquired EBITDA, leverage was 3.9x at June 30, 
2012. Pro forma leverage, including Medicis, increases to about 4.5x. The 
increase is consistent with our expectations that Valeant could temporarily 
increase leverage to more than 4x for an acquisition. Our adjustments include 
the capitalization of operating leases; we add stock compensation expense to 
EBITDA.

Valeant's fair business risk profile reflects the portfolio diversity and 
expanded pipeline it has achieved through multiple acquisitions. Although the 
company has a good track record of integration, the high level of acquisition 
activity does increase the possibility that integration issues could arise. In 
our view, though, Valeant's diversified portfolio of mostly smaller revenue 
products results in good product diversity: No product accounts for more than 
9% of revenues. Its product diversity also results in minimal patent 
expiration exposure over the medium term. Although about 55% of sales are 
concentrated in the U.S., recent international acquisitions have reduced this 
exposure from 65%, and further geographic expansion is likely to reduce that 
to about 50% over the next year. Valeant's growing geographic diversity also 
results in a low dependence on U.S. and foreign government reimbursement. 
Notwithstanding the potential for integration risk, Valeant's strategy of 
growth through many small-to-midsized acquisitions could also challenge the 
company to effectively manage a very large portfolio of small products, absent 
a large blockbuster drug. Moreover, this large portfolio of relatively small 
products, purchased largely by consumers who self-pay, also exposes the 
company to a potential decline in revenues in periods of sustained economic 
weakness.

Valeant is now composed of four segments: U.S. Neurology, U.S. Dermatology, 
Canada & Australia, and Emerging Markets. Post-Medicis, Valeant will be the 
largest U.S. dermatology company (pro forma on the basis of reported gross 
sales). The company's product portfolio includes dermatology products Zovirax, 
Benzaclin, and Retin-A Micro and neurology products Wellbutrin XL and Xenazine.

Liquidity
We believe Valeant's liquidity is "adequate." Pro forma for the acquisition of 
Medicis, sources of cash likely will exceed mandatory uses of cash over the 
next 12 to 24 months. Relevant aspects of Valeant Pharmaceutical's liquidity 
profile are:
     -- With sources exceeding uses by about $3 billion, we expect coverage of 
uses to be more than 1.2x over the next 12 to 24 months.
     -- Sources of liquidity likely will include funds from operations of more 
than $1.7 billion, balance-sheet cash of at least $1 billion, and nearly full 
availability under its $450 revolving credit facility.
     -- We expect uses of cash to include more than $2.6 billion of 
acquisitions, some investment in working capital, and capital spending of 
roughly $60 million to $70 million.
     -- Over the next two years, Valeant has about $656 million in maturities 
which will easily be met and we expect covenant cushions under the senior 
secured credit facility to be ample.
     -- With pro forma debt of almost $11 billion and a high level of 
acquisition activity, we do not believe Valeant can absorb, without 
refinancing, a high-impact, low-probability event.

Recovery analysis
For the complete recovery analysis, please see the recovery report on Valeant, 
to be published following this report on RatingsDirect.

Outlook
Our stable rating outlook on Valeant primarily reflects our expectation that, 
over the next 12 months, it will reduce leverage to less than 4x following its 
leveraged acquisition of Medicis. It also reflects our expectation of mid- to 
high-single-digit organic growth, continued tuck-in acquisition activity, and 
free cash flow growth that it will use for debt reduction.

Although we could revise our assessment of business risk to "satisfactory" on 
the successful integration of Medicis, in the absence of the adoption of a 
more conservative financial policy where leverage is sustained below 3x, an 
upgrade is unlikely. 

We could lower our rating if Valeant sustains leverage at more than 4x over 
the next 12 months. Most likely, this would occur if revenue and EBITDA growth 
from acquired companies, particularly Medicis, is less than we expected. It 
could also occur is the company did not allocate free cash flow to debt, as we 
currently expect.

Related Criteria And Research
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

Ratings Affirmed

Valeant Pharmaceuticals International Inc.
 Corporate Credit Rating                BB/Stable/--       
 Senior Secured                         BBB-               
   Recovery Rating                      1                  
 Senior Unsecured                       BB-                
   Recovery Rating                      5

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