-- Alere Inc. is issuing $450 million of unsecured notes, which will, in part, be used to repay the $250 million 7.875% senior notes and $97.5 million outstanding revolver balance.
-- As a result of roughly $100 million of incremental debt and operating performance below expectations, we are lowering our corporate credit rating on Alere to ‘B’ from ‘B+'. We are also lowering our ratings on the company’s secured, unsecured, and subordinated debt.
-- We are assigning a ‘B-’ debt rating and ‘5’ recovery rating to the company’s $450 million senior unsecured notes issue.
-- The stable outlook reflects our expectations for mid-single-digit organic revenue growth and debt-to-EBITDA to be about 5.7x in one year. Rating Action On Nov. 27, 2012, Standard & Poor’s Ratings Services lowered the corporate credit rating on Alere Inc. to ‘B’ from ‘B+', and lowered the ratings on the company’s senior secured debt to ‘B+’ from ‘BB-’ (the recovery rating on this debt remains ‘2’, indicating our expectation of substantial (70%-90%) recovery in the event of a default). We also lowered the ratings on the company’s senior subordinated notes to ‘CCC+’ from ‘B-’ (the recovery rating on this debt remains ‘6’, indicating our expectation of negligible recovery (0%-10%) in the event of a default), and lowered the rating on the company’s perpetual preferred stock to ‘CCC’ from ‘CCC+'. The outlook is stable.
At the same time, we assigned a ‘B-’ issue-level rating to the company’s proposed $450 million senior unsecured noted due 2018, with a ‘5’ recovery rating, indicating our expectation for modest recovery (10%-30%) in the event of default. The company plans on using the proceeds of the notes to refinance its $250 million senior secured note due 2016, repay its $97.5 million revolver borrowings, add $73 million of cash to the balance sheet, and pay fees and expenses.
We will withdraw the existing ratings on the $250 million notes due 2016 upon the close of the transaction. Rationale We downgraded Alere because operating weakness over the past year drove its adjusted debt-to-EBITDA ratio as of Sept. 30, 2012, to 6.7x, and we believe this leverage will not approach 5x until 2014. We expect it to decline to about 5.7x by year-end 2013, consistent with a “highly leveraged” financial risk profile (which, under our criteria, refers to leverage over 5x). Our base-case scenario assumes mid-single-digit organic revenue growth and 50% of free cash flow applied to debt reduction. The ratings on the Waltham, Mass.-based health care diagnostics provider also reflect the company’s “weak” business risk profile, given its active acquisition strategy and its position as a niche player in the life sciences industry. Alere’s professional diagnostics segment (about 80% of overall revenues) positions the company well in a health care environment that stresses greater cost control via increased monitoring, especially in the home.
The segment provides a variety of rapid diagnostic tests and equipment for medical professionals for use in hospitals, doctors’ offices, and the point-of-care market. While this segment experienced 5% organic currency-adjusted revenue growth, excluding flu-related sales and the triage product recall, year-to-date Sept. 30, 2012, the most recent quarter showed sluggish growth of 1%. Still, the company is a niche player within the broader life science industry, underpinning our view of its weak business risk profile. We expect organic revenues for this segment to grow in the mid-single digits over the next year, although growth will be hurt in the short term as a result of the triage recall.
The recall lowered revenue by $26 million this year, and impacted gross margins, which declined 100 basis points in the year-to-date period ended Sept. 30, 2012. Margins in the segment will also trend down slightly in the short term because of the addition of the eScreen business, which has lower margins. Although Alere gains some diversity from its health management segment (20% of revenues), the segment’s lackluster performance (sales declined 11% in 2011 and 1% year-to-date Sept. 30, 2012) has hurt the company. While sales appear to have stabilized, with revenue growing 4% in the last quarter, this follows declines in the business because of economic headwinds resulting in pricing pressure, in addition to in-sourcing by managed health care customers in its disease management business. Our base case assumes sales for this segment will grow only slightly, as continued competition for nondifferentiated services pressure prices and increasing in-sourcing activity by managed health care providers offsets growth through acquisitions and improvement in the U.S. economy.
Alere’s adjusted EBITDA margin of about 22% is similar to the margins of most of its peers in the sector. However, margins contracted steadily from 27% over the past two years as new products failed to ramp up sales, manufacturing challenges hampered profitability, and the company experienced pricing pressure in Europe. Our base case assumes that margins improve gradually as the health management segment stabilizes and the company gains some operating leverage; although the triage recall will pressure margins through the second half of 2012. Historically, the company has been very acquisitive. However, it has slowed down. In the first three quarters of 2012 Alere used $385 million on acquisitions.
In 2011 the company made acquisitions of $630 million, up from about $500 million in each of 2009 and 2010 but well below the $2 billion it spent in 2007. Although we expect the company to continue to conduct acquisitions, we expect they will be smaller, as the company increases its efforts to stabilize debt leverage and gradually shifts its focus toward internal growth. Alere’s adjusted debt leverage has steadily increased over the past two years because of debt-financed acquisitions and was 6.7x for the 12 months ended Sept. 30, 2012.
It increases only slightly to 6.9x pro forma for the proposed debt issuance. We consider Alere’s financial risk profile to be highly leveraged because we expect the company’s ratio of funds from operations to debt to be in the low-teens percent and adjusted debt leverage to remain above 5x over the next year. Liquidity We characterize Alere’s liquidity as “adequate.” As of Sept. 30, 2012, Alere’s cash balance was $302 million, and it had $97.5 million outstanding on its $250 million revolving credit facility expiring in 2016. The $450 million note issuance will help pay down the outstanding revolver balance.
Our assessment of Alere’s liquidity profile includes the following assumptions and expectations:
-- We believe sources of cash should exceed mandatory uses of cash over the next 12 to 24 months by greater than a 1.2x ratio.
-- We anticipate sources greater than uses even with a 30% decline in EBITDA.
-- Funds from operations in excess of $400 million annually over the next two years.
-- A modest increase in working capital.
-- Annual capital expenditures of approximately $150 million.
-- The likely event of the acquisition of Epocal.
-- In our opinion, the company has no ability to absorb a high-impact, low-probability event without the need for refinancing.
-- The covenant cushion of its senior secured facility was greater than 25% at Sept. 30, 2012. Recovery analysis Alere’s senior secured credit facility with maturities in 2016 and 2017 is rated ‘B+’ with a recovery rating of ‘2’, indicating the expectation for substantial (70% to 90%) recovery of principal and interest in the event of payment default. The company’s proposed 2018 senior notes are rated ‘B-’ with a recovery rating of ‘5’, indicating modest (10% to 30%) recovery of principal and interest in the event of payment default.
The senior subordinated notes with maturities in 2016 and 2018 are rated ‘CCC+’ with a recovery rating of ‘6’, indicating negligible recovery (0% to 10%) in the event of payment default. The company’s perpetual preferred convertible stock is rated ‘CCC’. For the complete recovery analysis, see Standard & Poor’s recovery report on Alere, to be published following this report, on RatingsDirect. Outlook Our rating outlook on Alere is stable. Our base case assumes that pro forma debt leverage of near 7x will decline to about 5.7x by year-end 2013 as a result of mid-single-digit revenue growth.
While solid growth prospects in the diagnostics markets, combined with a stable health management segment, could generate modest improvements in operating measures, we do not believe it would be sufficient to warrant an upgrade within a year. We calculate that it would require a revenue increase of 10% combined with a 300 basis point EBITDA margin expansion to reduce adjusted debt leverage to around 5x.
Although more unlikely, a downgrade could be precipitated by liquidity concerns.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Corporate Criteria: Analytical Methodology, April 15, 2008
Downgraded To From
Corporate Credit Rating B/Stable/-- B+/Negative/--
$250 mil. incremental term B-1 bank B+ BB-
Recovery Rating 2 2
$625 mil term A bank ln due B+ BB-
Recovery Rating 2 2
$250 mil revolver due 2016 B+ BB-
Recovery Rating 2 2
$925 mil. term B bank ln due 2017 B+ BB-
Recovery Rating 2 2
$300 mil. delayed draw term A bank B+ BB-
ln due 2016 Recovery Rating 2 2
$200 mil. Incremental term B-2 B+ BB-
bank ln due 2017
Recovery Rating 2 2
$400 mil. 9.00% sr sub nts due 2016 CCC+ B-
Recovery Rating 6 6
$400 mil. 8.625% sr unsecured nts CCC+ B-
Recovery Rating 6 6
Preferred stock CCC CCC+
$450 mil. notes due 2018 B-
Recovery Rating 5