Kinetic Concepts Inc. Corporate Credit Rating Affirmed And Outlook Revised To Positive On LifeCell Sale

Stocks and Financial Services Press Releases Friday January 20, 2017 09:13
BOSTON--20 Jan--S&P Global Ratings
BOSTON (S&P Global Ratings) Jan. 19, 2017--S&P Global Ratings affirmed its 'B' corporate credit rating on Kinetic Concepts Inc. and revised the outlook to positive from stable.

At the same time, we lowered the rating on the first-lien debt due 2021 to 'B' from 'BB-' and revised the recovery rating to '3' from '1'. The '3' recovery indicates expectations for meaningful (50%-70%, upper end of the range) recovery in a default. We also assigned a 'B' rating to the new first-lien debt with a '3' recovery rating. The debt consists of a $1.125 million first-lien term loan due 2024, a Euro equivalent $250 million first-lien term loan due 2024, and a $300 million revolver due 2022. The borrowers are Kinetic concepts Inc. and KCI USA Inc. The '3' recovery rating indicates our expectations for meaningful (50%-70%; upper end of the range) recovery in a default.

In addition, we raised the rating on the third-lien debt to 'B-' from 'CCC+' and revised the recovery rating to '5' from '6'. The '5' recovery rating indicates expectations of modest recovery (10%-30%, lower half of the range) in a default.

"The rating actions follow the sale of LifeCell to Allergan for $2.9 billion and Kinetic Concepts' refinancing of its first-lien debt," said S&P Global Ratings credit analyst Lucas Taylor. The company plans to use proceeds from the sale to pay down debt, and the lower overall EBITDA will be offset by a reduced overall debt structure, resulting in leverage that is lower by about two turns. While the company is smaller post-sale, we believe Kinetic will maintain an adequate position within wound care, which supports our view of its fair business risk.

Previously, we considered Kinetic to be highly reliant on its vacuum assisted closure (VAC) therapy (negative-pressure wound therapy) sector, because it made up a dominant share of the company's revenue. LifeCell, focused on regenerative and reconstructive acellular tissue matrices and autologous fat grafting solutions, provided some diversification and brand awareness with its ALLODERM product. While we think the sale affects overall diversification and further concentrates Kinetic's efforts into VAC, it does not put the company in a materially worse position than before, given that VAC remains a highly respected product, Prevena Incision Management System continues to make strides in developed markets, and the company is one of the strongest contributors in the wound care space.

The divestiture of LifeCell has material implications on the company's overall profitability. The LifeCell division had margins that were significantly higher than overall company margins, which provided ballast while the company struggled to grow. However, the sale allows Kinetic to lower its leverage by repaying some of its debt, although EBITDA margins will likely be about 300 basis points lower. We now expect leverage in 2017 to be about 5.3x compared with previous estimates of 7.4x.

The positive rating outlook on Kinetic Concepts Inc. incorporates our expectation that while adjusted debt leverage will remain above 5.0x, the company will progressively deleverage and substantially improve free cash flow. As a result, there is at least a one in three chance of an upgrade over the next 12 months.

We could revise the outlook to stable if the sale of the LifeCell business results in a market position that is materially worse for Kinetic Concepts and its annualized cash flow remains under $75 million. We would revise our assessment of business risk if the company experiences market share losses within the Advanced Woundcare Therapeutics segment or if an influx of new competition indicates lowered barriers to entry and an reduced ability to effectively compete.

We would consider an upgrade if Kinetic Concepts managed to increase its free cash flow profile such that it exceeded that of similarly rated peers. This would require margins maintained at 33% and continued market share stability, which would help cash flow rise above $75 million. An upgrade, though, would be predicated on a reduction in working capital swings, which would impart a sense of stability in the overall sources and uses of capital.

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