Overview
-- Boston Scientific Corp. will exercise its option to acquire Cameron
Health Inc., the developer of a subcutaneous implantable cardioverter
defibrillator (S-ICD), an alternative to the conventional ICD.
-- We are affirming our 'BBB-' rating and stable outlook on Boston
Scientific.
-- The stable rating outlook reflects our expectation that it has
sufficient global and product diversity, and financial cushion, to absorb a
modest revenue decline in 2012 and fund the Cameron Health acquisition with
internally funded cash.
Rating Action
On March 9, 2012, Standard & Poor's Rating Services affirmed its 'BBB-'
corporate credit and senior unsecured debt ratings on Natick, Mass.-based
Boston Scientific Corp. The outlook is stable.
This action reflects Boston Scientific's intention to purchase the outstanding
equity in Cameron Health Inc. for an upfront payment of $150 million at
closing (expected in the second or third quarter of 2012), a payment of $150
million on U.S. Food and Drug Administration (FDA) approval (expected in the
first half of 2013), and up to an additional $1.05 billion of revenue-based
milestone payments over six years after FDA approval. We view this as credit
neutral in the short term, given the company's ability to fund the initial
investments with internally generated cash. Despite a window subsequent to FDA
approval where cash outflows could exceed earnings, this scenario would arise
from the product's success.
Rationale
The ratings on Boston Scientific reflect the company's "satisfactory" business
risk profile (according to our criteria), attributable to its broad portfolio
of market-leading medical devices, an expansive geographic footprint, and high
barriers to entry. We view the company's financial risk profile as
"significant" (as defined in our criteria), given funds from operations to
adjusted debt of 26% at year-end 2011; ongoing litigation risk; material cash
outflows for investments, acquisition earn-outs, and shareholder returns.
While adjusted debt leverage, at 2.7x, is modestly stronger than the
significant financial risk category range of 3x-4x, financial metrics have
deteriorated in past two quarters. Despite a cash balance below historical
levels, the company's liquidity profile is "adequate" (as defined in our
criteria).
We expect volume and pricing pressures in the cardiac rhythm management (CRM)
and drug-eluting stents (DES) markets to continue in the near term,
particularly in the U.S. Boston Scientific's revenue decline of 2% (in
constant currency, and excluding the sale of the neurovascular business) in
2011 was slightly below our expectations. We now expect flat to a
low-single-digit total revenue decline for 2012, with CRM and DES revenue
losses offsetting mid- to high-single-digit revenue gains in other business
segments, such as endoscopy and peripheral interventions. We believe the
company can reverse the six-year trend of profitability erosion; its adjusted
EBITDA margin was 24% at Dec. 31, 2011, having fallen from 39% at year-end
2005. This erosion was largely caused by steep volume declines and attendant
loss of manufacturing leverage, combined with average selling price erosion.
Our projections incorporate a 100-basis-point (bp) EBITDA margin improvement
in 2012, largely reflecting the recent introduction of PROMUS Element DES in
the U.S. and Japan. We expect sales of this self-manufactured stent system to
boost gross margins by an annualized $200 million, since the company will no
longer make a profit sharing payment to Abbott on those sales. We believe that
financial metrics in 2012 will remain relatively consistent with 2011. We
adjust debt for off-balance-sheet debt-like obligations, which at Dec. 31,
2011, included $213 million of operating leases, $578 million of receivables
financing, and $87 million of pension and postretirement benefit obligations.
Satisfactory business risk reflects Boston Scientific's position as a large,
worldwide manufacturer of medical devices used in diverse interventional
medicine specialties, offset by a third-tier market position in the key CRM
market and industry challenges in both CRM and DES. The company is
geographically diverse, with international sales representing 47% of 2011
total revenues. Strong product diversity is evidenced by the following segment
contributions: within the cardiovascular group, CRM, interventional
cardiology, and peripheral intervention groups were 28%, 33%, and 10% of total
2011 sales, respectively. The endoscopy business segment, women's
health/urology, and neuromodulation contributed 16%, 7%, and 5% of 2011 sales,
respectively; the company divested its neurovascular business in early 2011.
Despite good diversity, Boston Scientific has struggled with declining
revenues and EBITDA over the past several years because of pressures in two of
its key product lines, CRM and DES. Furthermore, with an estimated 18% global
CRM market share, it trails St. Jude Medical Inc. and Medtronic Corp. in the
CRM market. CRM difficulties were caused by competition, price erosion, and
safety issues (both company and industrywide); the company's one-month ship
hold in 2010 on sales of U.S. ICDs and cardiac resynchronization therapy
defibrillators (CRT-Ds) has had a lingering impact on market share. U.S. CRM
device volume contracted further as a result of a medical journal study and
subsequent U.S. Department of Justice investigations into hospitals'
implantable cardioverter defibrillators (ICD) implant practices. We believe
these challenging conditions are likely to be a feature of the company's
business risk profile for the foreseeable future. Upside net cash flow
potential from an S-ICD product, via the Cameron acquisition, is several years
off. Although U.S. procedure volume remains soft, Boston Scientific's DES
share exceeds that of main competitors Abbott Laboratories and Medtronic.
We believe 2012 is a transitional year for Boston Scientific, and it will need
to successfully execute on its growth strategy to turn the overall declining
business trend around. It has made significant investments in new product
areas and disease states, and accelerated its expansion into emerging markets.
It spent $370 million and $199 million on acquisitions in 2011 and 2010,
respectively, in such areas as structural heart therapy, deep brain
stimulation, peripheral vascular disease, and atrial fibrillation. While
several new products are expected to be launched internationally in 2012, FDA
approval and U.S. commercialization is not likely until 2013. Boston
Scientific will invest an incremental $150 million in China (in addition to
total emerging-market spending) to build a manufacturing and training
facility. In contrast to lackluster revenue performance in the U.S. and much
of developed Europe, emerging markets are experiencing double-digit (even
exceeding 20%) growth. We believe this strategy could be successful, but it
likely will take several years to provide meaningful EBITDA and cash flow
contribution given the high, upfront investment in infrastructure. The company
should achieve further EBITDA margin improvement beyond 2012 via its targeted
$650 million to $750 million of operating profit improvement, to be garnered
from gross margin improvement, a plant network optimization program, and
sales, general, and administrative restructuring efforts; the 2.3% U.S.
medical device tax (to be implemented on Jan. 1, 2013) will create modest
headwinds. As volumes increase, the company will benefit from operating
leverage given high fixed costs.
In addition to recent lackluster revenue performance, ongoing risks include
the rapid pace of technology changes, regulatory challenges and both patent
and product liability litigation. Over the past few years, the company has
opted to settle certain lawsuits to remove overhang, and has had a few recent
favorable court decisions. Ongoing litigation risk includes Johnson &
Johnson's claim related to the Guidant Corp. acquisition.
Liquidity
We believe Boston Scientific currently has adequate liquidity to meet its
needs over the next two to three years, including milestone payments for
Cameron Health over the next seven years. Required capital expenditures are
manageable; the company generated $1 billion of operating cash flow in 2011
relative to $304 million of capital expenditure needs. Boston Scientific must
invest in technology to remain competitive, and it spent 12% of revenues ($895
million) on R&D in 2011. In July 2011, the company announced a $1 billion
share repurchase program, in addition to the remaining (roughly) $300 million
outstanding from its prior program. While discretionary, we view the $1.3
billion share repurchase program as a relatively firm use of cash. Boston
Scientific spent $492 million on share repurchases in the second half of 2011.
Our view of the company's liquidity profile incorporates the following
expectations:
-- We expect liquidity sources (consisting primarily of cash and
discretionary cash flow) to exceed uses by 1.2x over the next 12 months. In
January 2011, Boston Scientific sold its neurovascular business to Stryker
Corp. for $1.5 billion. We expect liquidity sources to continue exceeding
uses, even if EBITDA declines by 15%.
-- We believe the company would struggle to absorb a high-impact,
low-probability litigation-related event.
-- We believe Boston Scientific would not breach its covenants in the
event of a 15% EBITDA decline, because it had a 54% EBITDA debt leverage
covenant cushion on Dec. 31, 2011.
-- In our assessment, Boston Scientific has well-established bank
relationships and has demonstrated its ability to tap the public bond markets.
However, the company's stock price has been on a steep downward trajectory
since 2004 (currently about $6), and has not visibly improved as a result of
the share repurchase program. As a result, we believe the company would be
unlikely to issue common equity.
As of Dec. 31, 2011, Boston Scientific had $267 million of cash, which remains
below historical levels. At that time, the company had virtually full
availability of its $2 billion revolving credit facility. The revolver matures
in June 2013, but has up to two one-year extension options subject to certain
conditions. Moreover, the company maintains a $350 million facility secured by
U.S. receivables and receivables factoring programs in certain European
countries and Japan that total about EUR330 million ($430 million) and JPY18.5
billion ($240 million), respectively. The company has no debt maturities until
2014, when $600 million of senior notes come due.
Outlook
Our stable rating outlook on Boston Scientific reflects our expectation that
it has sufficient global and product diversity, and financial cushion, to
absorb a modest revenue decline in 2012, and fund the Cameron acquisition with
internally funded cash; we expect cash from operations to remain relatively
flat due to EBITDA margin improvement. Although the company believes that CRM
and DES decline rates have slowed and may have stabilized, we believe these
markets may not have bottomed out.
Still, it would take substantial adversity to cause financial weakening
sufficient for a downgrade. For example, a 10% sales decline and 300-bp
compression in operating margin would increase 2012 adjusted debt to EBITDA to
about 3.2x from our projected 2.2x (our base case calls for a 2% revenue
decline and 100-bp margin improvement). Thus, the potential for a downward
rating action would more likely be tied to an unexpected event, such as a
material product recall, a significant adverse legal event, or a large,
debt-financed acquisition. We could lower the ratings if we believed that debt
to EBITDA would exceed 3x on a sustained basis.
We could raise the ratings within two years if debt to EBITDA improved
significantly, to under 2.5x on a sustainable basis, and we believe liquidity
would be sufficient to meet unexpected events. This could result if the
company substantially recaptures CRM market share, launches additional
products with better-than-market growth potential, or accelerates its
emerging-market presence.
Related Criteria And Research
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Ratings List
Ratings Affirmed
Boston Scientific Corp.
Corporate Credit Rating BBB-/Stable/--
Senior Unsecured BBB-
Complete ratings information is available to subscribers of RatingsDirect on
the Global Credit Portal at www.globalcreditportal.com. All ratings affected
by this rating action can be found on Standard & Poor's public Web site at
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