March 9, 2012 / 5:51 PM / 8 years ago

TEXT-S&P affirms Boston Scientific Corp 'BBB-' rating

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 	
www.standardandpoors.com. Use the Ratings search box located in the left 	
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