Grifols S.A. #BB# Ratings Affirmed On Announced Acquisition Of Hologic Inc#s NAT Outlook Stable

Stocks and Financial Services Press Releases Monday December 19, 2016 17:33
PARIS--19 Dec--S&P Global Ratings

PARIS (S&P Global Ratings) Dec. 19, 2016--S&P Global Ratings today affirmed its 'BB' long-term corporate credit rating on Spain-based global specialty biopharmaceutical company Grifols S.A. following the company's announcement that it will acquire Hologic Inc.'s specialty diagnostic assets for $1.85 billion. The outlook remains stable.

At the same time, we affirmed our 'BB' issue rating on Grifols' senior secured bank debt. The recovery rating on this instrument remains '3', indicating our expectation of meaningful recovery in the higher half of the 50%-70% range in the event of a payment default. We also affirmed our 'B+' issue rating on the unsecured notes issued by fully owned U.S. subsidiary Grifols Inc. The recovery rating on this instrument remains '6', indicating our expectation of negligible (0%-10%) recovery in the event of a payment default.

Following Grifols' announcement that it will acquire Hologic's assets for $1.85 billion (partly funded by an additional $1.7 billion in debt), we forecast that the company's adjusted leverage will increase to about 4.5x at the end of 2017 from 3.8x at the end of 2016. Because of the weakening credit protection metrics that we anticipate following this transaction, we have revised our assessment of Grifols' financial risk profile to aggressive.

We expect that the company's financial metrics will improve gradually through at least 2018 because of an increase in absolute EBITDA and a progressive uptake in cash generation in the current investment cycle. Grifols' free cash flow generation should be constrained by inventory build-up and substantial investment in new capacity in the next three years. This year, for example, Grifols launched a major infrastructure project dedicated to meet demand and secure its growth expectations from 2022-2023. In a nutshell, Grifols will add 6 million liters of primary fractionation capacity, taking the total to 18.5 million liters, and add sufficient downstream purification capacity. The total cost of this investment is expected to be $360 million, which is on top of investments required to open new donor centers and procure plasma.

Our adjustments to 2016 debt include about €240 million of obligations under operating leases, about €250 million of factoring remaining due end-2015, and €325 million of unamortized financial expenses. In addition, we net the adjusted debt with approximately €1 billion of surplus cash, excluding our estimates of trapped cash.

We expect Grifols adjusted leverage willbe in the 4x-4.5x range by the end of 2018 as well as adjusted EBITDA interest coverage remaining comfortably above 4x, in the absence of any significant debt-funded acquisition in the next two years.

Following the consolidation of its diagnostic business, we still view Grifols' business risk as satisfactory, reflecting primarily the group's No. 3 position in the growing blood plasma-derived biopharmaceutical market and its well-diversified geographic spread, with established positions in both mature and emerging markets.

The company's bioscience division remains the key profit driver, contributing about 80% of its sales and EBITDA. However, the group is further increasing its presence in the diagnostic market; it substantially strengthened its capacity in this area with the acquisition of Novartis' blood transfusion diagnostic unit in January 2014. The contemplated acquisition of Hologic's specialty diagnostic (NAT) assets should enhance Grifols' diagnostic competitive position and profitability, with the EBITDA margin expected to improve to about 40% (pro forma the Hologic acquisition) from 18%. The diagnostics business will account for about 18% of the group's sales in 2016, and its share is expected to remain about the same in 2017 because Grifols was already consolidating all revenues from the business.

The plasma derivatives industry is concentrated, with two-thirds of the global market dominated by the top three players (CSL, Shire, and Grifols). These three companies control about 90% of the key U.S. market and account for about 70% of all collection centers worldwide. Large pharmaceutical companies have left this market and are unlikely to return, given the industry's relatively small size and unique requirements.

As a key constituent of life-saving drugs, the plasma industry (collection and fractionation) is highly regulated and benefits from high barriers to entry.

This is because it requires sizable capex, and there is significant lead time before capacity is built, certified, and operational. The risk of substitution or generic competition is limited, given the importance of production expertise in the industry. The only alternatives to some plasma-derived products are recombinants (genetically engineered clotting factors), which are more expensive and more difficult to create than plasma products; we understand that other products have no substitutes.

In addition to its strong growth prospects because of new disease indications and increased uses in emerging markets, this market is characterized by strong profitability because end-product price increases can offset rising prices for raw materials.

Grifols' leading brand-name drugs have prominent market positions globally. These include Intravenous Immoglobulin, the leading product of the plasma derivatives market; Alpha-1 for specific pulmonary indications; and plasma-derived factor VIII, which is used mainly for treating hemophilia.

Grifols also enjoys a solid No. 2 position in Albumin, with strong market shares in the largest markets--the U.S. and China. In addition, Grifols reports good diversity of revenues by geography and, in part, products. Grifols' revenues come from the U.S. and Canada (about 65%), Europe (20%), and the rest of the world including Asia and Latin America (15%). The company has established market positions in both mature countries and fast-growing emerging markets such as China and Brazil.

Negatively, the plasma industry is exposed to inherent risk of product contamination or product withdrawal, which could lead to significant revenue loss and liabilities. However, Grifols has a strong track record in terms of


We are also monitoring the potentially disruptive technologies that could affect Grifols' market share despite its high barriers to entry. For instance, new entrants in the specific FVIII market--such as Roche or Shire--can offer a compelling alternative to plasma-derived FVIII. However, we consider the threat to be limited to less than 10% of Grifols's Bioscience sales.

Lastly, we expect that Grifols' capacity roll-out program will affect its margins in the next two years. The costs of expanding its plasma collection centers--to about 225 in 2020 from 160 currently--should partially be offset by excess capacity reductions at the Clayton facility. We also view favorably Grifols' vertical integration model, which gives it direct control over its blood plasma supply and inventory. The subsequent lower reliance on third-party suppliers for its principal material could also have positive gross margin implications.

The stable outlook reflects our opinion that Grifols will acquire Hologic's assets and successfully integrate its high-margin blood screening expertise, enhancing the competitive position of Grifols' diagnostic division. We also expect the adjusted debt-to-EBITDA ratio to spike at close to 4.5x in 2017, reflecting the Hologic transaction being almost entirely debt-funded. However, we consider that leverage will progressively decrease thereafter because of solid performance in the plasma derivatives business. We anticipate Grifols will demonstrate lower cash generation capacity in the next two years as it embarks on a new industrial investment phase, resulting in higher ramp-up working capital outflows and sustained capital expenditure (capex) needs. Finally, we are factoring in limited bolt-on acquisitions of €100 million in our base case and limited returns to shareholders. We are excluding from our base case any significant debt-funded acquisitions in the next 24 months.

We could lower our rating if Grifols failed to deleverage below 4.5x within the 12 months following the proposed acquisition of Hologic assets. We believe this would most likely occur due to strong operational setbacks, such as higher-than-expected plasma costs, higher-than-expected costs of collection capacity expansion, or an unexpected slowdown of the more competitive diagnostic business. This could translate into deteriorating cash generation capability and impair the company's ability to reduce its leverage. Also, we could lower the rating if Grifols were to pursue an unexpected sizable debt-financed acquisition.

An upgrade could occur if Grifols continues to deleverage while committing to a tight financial policy, though we consider Grifols' track record of external growth to be a constraining factor. An upgrade would also be conditional on the company improving its cash generation capacity following the substantial investment plan it is committed to in the four coming years. Therefore, we view an upgrade as unlikely in the next 12 months.

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