Fitch Ratings has placed the ratings for Covidien plc and Covidien International Finance S.A. (CIFSA) on Rating Watch Negative. A full list of ratings is shown below. The ratings apply to approximately $4.2 billion in debt outstanding as of Sept. 30, 2011.
Earlier today, Covidien announced that it plans to spin-off its pharmaceutical business into a stand-alone, publicly traded company. Completion of the transaction is expected to take about 18 months and is pending regulatory and board of director approvals. The separation is expected to occur through a tax-free spin-off of the pharmaceutical segment. The remaining Covidien will be comprised of the medical devices and medical supplies businesses.
Upon completion of the separation, Fitch thinks that ratings for the existing debt could be the same or lower than the current 'A' rating. Fitch estimates that any potential downgrade will be limited to one-notch. The timing of the resolution of the Rating Watch and determination of the final ratings will depend upon Covidien providing further clarity, particularly with respect to the effect on the separated companies' capital structure and debt levels, as its moves forward with the separation.
Fitch thinks that the spin-off will be beneficial to Covidien's operating profile. Although it generates solid EBITDA and free cash flow (FCF), the growth profile of the pharma segment is less favorable that the devices and supplies segments and is a drag on both top-line growth and profitability. Post the spin-off, Covidien's sales will be heavily weighted (80%) to the more profitable and faster growing medical devices segment.
Covidien has worked to reline and restructure its business since its 2007 split from Tyco International. The spin-off of the pharma segment is consistent with the recent strategy of divesting lower margin business lines. Since fiscal year 2008 (FY08), the first full year post the Tyco spin-off, gross margins have improved by 320 basis points (bps) to 58.6% in FY11 from 53.6%. Sales mix shift toward the higher margin medical devices segment has contributed the majority of the expansion. Operating margins have expanded to a lesser degree over the past few years. The company has recently ramped up SG&A and R&D expenses to support organic sales growth through new product launches in the pharma segment, internal development efforts, and expansion of sales forces in emerging markets.
Rating concerns related to the pending separation include execution risk and possible management distraction caused by the separation process, as well as the potential cost of the transaction - which the company has not provided any estimate of - and uncertainty regarding the eventual financial strategy of the separated companies. Liabilities dating to the 2007 Tyco separation have largely been resolved, with the exception of income tax settlements which are expected to impact Covidien's FCF for several years to come. Fitch thinks that any liability sharing agreements under the pharma segment separation will be less complicated than the Tyco International spin-off.
Covidien's ratings incorporate the company's solid financial flexibility and liquidity, recently improved profitability and decent operating outlook despite the economic headwinds to organic growth. Debt-to-EBITDA was 1.3 times (x) at Sept 30, 2011, and maintenance of the 'A' rating will require the company to manage its balance sheet to debt leverage of 1.5x or below over the longer term.
Debt reduction post any leveraging transaction is supported by the company's very strong FCF generation. At Sept. 30, 2011, latest 12 months (LTM) FCF totaled $1.3 billion. Prior to the separation announcement, Fitch projected ongoing strong FCF generation for Covidien of at least $1.3 billion annually. FCF could be slightly lumpy due to the uncertain timing of cash payments for the settlement of legacy Tyco tax liabilities. As of Sept. 30, 2011, the company had recorded a liability of $1.7 billion for future tax settlement payments, net of payments due from Tyco International and TE Connectivity for their portion of Covidien's payments.
Debt at Sept. 30, 2011 included $4 billion in unsecured notes with maturities ranging from 2012 to 2037. Covidien also has a $1.5 billion commercial paper program ($115 million outstanding at Sept. 30, 2011) that is backed by the company's $1.5 billion unsecured revolving credit facility maturing in 2016. At Sept. 30, 2011 available liquidity was provided by:
--The revolving credit facility ($1.5 billion available);
--Cash on hand ($1.5 billion);
--FCF ($1.3 billion in FY11; defined as cash from operations less dividends and capital expenditures).
DEBT ISSUE RATINGS
Fitch currently rates Covidien as follows:
Covidien plc
--Issuer Default Rating (IDR) at 'A';
--Short-term IDR at 'F1'.
Covidien International Finance S.A. (CIFSA)
--IDR at 'A';
--Short-term IDR at 'F1'.
--Commercial paper program at 'F1';
--Credit facility at 'A';
--Senior unsecured notes at 'A'.
CIFSA, which is the obligor of Covidien's debt, is a wholly owned subsidiary of Covidien plc. CIFSA directly or indirectly owns all of the operating subsidiaries of Covidien, issues debt, and performs treasury operations for Covidien, otherwise it conducts no independent business operations of its own. In addition, all outstanding debt is fully and unconditionally guaranteed by Covidien plc.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' Aug. 12, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.
Contacts:
Fitch Ratings
Primary Analyst:
Megan Neuburger, +1-212-908-0501
Senior
Director
Fitch, Inc.
One State Street Plaza
New York, NY
10004
or
Secondary Analyst:
Michael Zbinovec,
+1-312-368-3164
Senior Director
or
Committee Chairperson:
Michael
Weaver, +1-312-368-3156
Managing Director
or
Media
Relations:
Brian Bertsch, New York, +1-212-908-0549,
brian.bertsch@fitchratings.com