Oct 24 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has placed the long-term ratings of McKesson Corp. (MCK), including the 'A-' long-term Issuer Default Rating (IDR), on Rating Watch Negative. The rating action follows the firm's announcement that it intends to acquire Celesio AG, including the voluntary tender for the firm's publicly-held stock, in a deal valued at approximately $8.3 billion. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
-- The proposed Celesio deal is strategically sound, but its funding is likely to significantly increase MCK's debt load. Debt leverage (1.45x at June 30, 2013) is already elevated relative to the 'A-' ratings following the PSS World Medical, Inc. deal earlier in 2013.
-- MCK and its peers maintain stable operating profiles and consistent cash generation, owing to steady pharmaceutical demand and the oligopolistic U.S. drug distribution market. Fitch sees the European drug channel as somewhat less stable and efficient, and generally higher risk, than the U.S. market.
-- MCK's robust cash flows and solid capital market access contribute to a strong liquidity profile. Fitch's expectation for strong cash generation will give MCK the ability to rapidly repay debt associated with the proposed Celesio deal.
-- Both U.S. and European pharmaceutical wholesalers have benefited from the unprecedented wave of branded-to-generic drug conversions. These conversions are expected to slow post-2015, but much of the margin gains they have facilitated will be durable for MCK and its peers.
-- MCK holds leading U.S. market positions in specialty drug distribution, medical-surgical distribution, and healthcare IT, as well as traditional drug distribution in Canada. These businesses will support intermediate-term growth and profitability and, in addition to measured expansion in other non-U.S. markets, are likely to represent areas in which MCK will pursue future growth opportunities over the ratings horizon.
Maintenance of an 'A-' IDR for MCK will require debt-to-EBITDA of 1.4x or below. The ratings could be maintained if acquisition funding results in temporary increases above this range, depending on the company's ability and willingness to de-lever (e.g. the recent PSS World Medical, Inc. acquisition). Based on a preliminary analysis of the potential acquisition of Celesio by MCK, Fitch expects debt-to-EBITDA will be sustained above 1.4x for an extended period. Consequently, a downgrade of MCK's long-term ratings is likely, pending the successful consummation of the deal.
Fitch believes the company is committed to maintaining solid investment grade ratings, but notes that several currently unknown factors will influence the credit profile pending the completion of the proposed deal. Most notably, these factors include the number of publicly-held shares tendered to MCK and the ultimate funding scheme, including the amount of internal and the nature of external sources of liquidity employed. MCK had about $2.96 billion of cash on hand at Sept. 30, 2013. Cash held outside the U.S. approximated $1.5 billion at June 30, 2013.
MCK's significant cash generating ability could afford the company the opportunity to rapidly repay acquisition debt, possibly limiting a downgrade of the ratings to one notch. However, a two-notch downgrade could result from Fitch's expectation for debt-to-EBITDA to be sustained around 2x or above 18-24 months following a potential deal's consummation. Fitch believes that even in the event of a two-notch downgrade of the long-term IDR, MCK's strong liquidity profile will support a short-term IDR maintained at 'F2'.
CELESIO DEAL IS STRATEGICALLY SOUND; LIMITED NEAR-TERM FINANCIAL BENEFITS
Fitch views the proposed acquisition of Celesio by MCK as strategically sound, as it offers the potential for better buy-side drug pricing and additional growth opportunities outside the largely penetrated U.S. market. The realization of these benefits, however, is likely to take several years. Fitch sees relatively few financial synergies in the near term.
MCK's proposed acquisition of Celesio is differentiated from the March 2013 announcement of a strategic, long-term relationship among U.S. drug distributor AmerisourceBergen Corp. (ABC), U.S. drugstore chain Walgreen Co. (Walgreens), and European drug distributor Alliance Boots. ABC will likely share the benefits of buy-side cost savings and non-U.S. growth prospects with Walgreens - now its largest customer and expected to become its largest shareholder - and Alliance Boots. Conversely, MCK will solely benefit from these tailwinds, but will also bear fully the risks associated therewith. The overall relative benefits of these two divergent globalization schemes are not yet able to be ascertained, and each will take quite some time to be fully realized.
STABLE OPERATIONS IN THE U.S. AND EUROPE
MCK and its peers in the drug distribution industry continue to exhibit exceptionally stable operations and financial performance. Despite weak macroeconomic conditions and moderately decreased utilization of healthcare in the U.S., core business growth at MCK has remained largely in-step with or ahead of broader market growth. Organic low-single digit growth is driven by consistent demand for pharmaceuticals and is realized relatively uniformly, since the largest three drug distributors account for approximately 90%-95% of the market.
The U.S. drug distribution industry should maintain good operating stability. The industry's very slim margins make it an unlikely target for extra taxes and fees (like those recently imposed on the pharma and medical device sectors in the U.S.) Furthermore, the industry excels in adding value to the drug channel through the supply chain management and other services it offers to both its upstream and downstream customers.
The proposed Celesio transaction will provide MCK with significant new exposure to the European drug distribution and pharmacy markets. Fitch sees the European drug channel as relatively less stable and efficient than that found in the U.S. Furthermore, Fitch believes risks related to drug pricing and reimbursement are greater for drug wholesalers in Europe than in the U.S.
A COUPLE MORE YEARS OF THE UNPRECEDENTED GENERIC WAVE
MCK and its peers - both in the U.S. and in Europe - continue to benefit from the unprecedented wave of branded drug patent expirations in calendar 2011-2014. Most drug channel participants, including distributors, earn higher margins - though less revenues - on the sale of lower-cost generic drugs. Fitch believes much of the margin expansion MCK and its peers have achieved in recent years is durable, as generic penetration in the U.S. is likely to remain at or above 80%. As the pace of branded-to-generic conversion slows post-2015, Fitch expects top-line and margin growth to benefit from biosimilars, as well as new branded biologic drugs. Pharmaceutical wholesalers generally earn higher margins on more expensive biologics, compared to traditional drugs, and Fitch thinks biosimilars potentially represent an even more compelling margin expansion opportunity for drug distributors in the intermediate-to-longer term.
SOLID PRESENCE IN SPECIALTY, MED-SURG, AND HIT
Traditional drug distribution in the U.S. is a consolidated industry characterized by steady growth in the low-single digits. Traditional drug distribution accounts for roughly 80% of MCK's overall revenues. The remaining 20% comes from the company's leading market positions in the distribution of specialty pharmaceuticals and of med-surg supplies, and in healthcare information technology (HIT). MCK is one of only a handful of companies with a significant share of these relatively fragmented markets.
As a result, Fitch believes MCK is uniquely positioned to benefit from growth opportunities related to its ancillary businesses as those markets grow and consolidate over time. To that end, Fitch expects MCK to continue consummating small, tuck-in acquisitions in especially the med-surg and HIT spaces.
ROBUST CASH FLOWS AND SOLID LIQUIDITY
MCK's stable margins, efficient operations, and good asset management contribute to stable and strong cash generation measures. Funds from operations (FFO) for the latest 12 months (LTM) period ended June 30, 2013 was a robust $3 billion. Annual free cash flow is forecasted to exceed $2 billion over the ratings horizon, though this figure is highly dependent on working capital swings inherent in drug distributors operating profiles.
In addition to cash generation, MCK's solid liquidity position includes a $1.3 billion unsecured revolver due September 2016 and a $1.35 billion accounts receivable facility due November 2013. Cash on hand as of Sept. 30, 2013 was $2.96 billion.
Debt maturities are estimated as follows: $350 million for the remainder of fiscal 2014; $1.1 billion in 2016; $500 million in 2017; $500 million in 2018, and $2.4 billion thereafter.
Fitch has placed the following ratings of MCK on Rating Watch Negative:
-- Long-term IDR 'A-';
-- Unsecured bank facility 'A-';
-- Unsecured senior notes 'A-'.
Fitch has affirmed the following ratings of MCK:
-- Short-term IDR at 'F2';
-- Commercial paper at 'F2'.