Fitch Rates Merck & Co.'s Proposed Debt 'A+'
CHICAGO -- May 16, 2013
Fitch Ratings has assigned an 'A+' rating to Merck & Co.'s (Merck) public
issuance of $6.5 billion of senior unsecured notes comprising six tranches.
Proceeds from the senior unsecured debt are expected to be used for general
corporate purposes, including share repurchases. A complete list of Merck's
ratings is provided at the end of this release.
On May 1, Merck expanded its share repurchase program by $15 billion to $16.3
billion. The company intends to use debt issuances, in part, to repurchase
$7.5 billion worth of shares over the next 12 months with the timing of the
remaining buybacks to be open-ended. Merck has ample liquidity via cash on
hand and operating cash flow generation to complete the repurchasing activity
without harm to the credit profile. However, the plan to partially fund the
program through debt financing will halt positive momentum the company gained
through solid operational performance through its long patent cliff period.
The Negative Outlook reflects Fitch's concern that the pacing and financing of
the share repurchase program could drive debt leverage to a level that is no
longer reflective of the 'A+' Issuer Default Rating (IDR). If the company were
to fund two-thirds, or $10 billion, of the planned share repurchases through
debt issuance, Fitch sees an increase in total debt leverage (gross debt to
EBITDA) to greater than 1.5x in 2014. This would likely result in a one-notch
downgrade of the IDR, to 'A'. In addition, Merck faces $6 billion of debt
maturing in 2013-2015, which Fitch expects the company to refinance.
KEY RATING DRIVERS:
Solid EBITDA growth following the 2009 merger with Schering Plough has driven
improvement in gross debt leverage and adjusted debt leverage to 1.2 times (x)
and 1.3x, respectively, at the end of 2012 from 2.1x and 2.2x, respectively,
in 2009. However, further leverage improvement is not expected given potential
for incremental debt to fund accelerated share repurchases over the ratings
Merck is approaching the end of a long-standing patent expiration period
following annualizing the patent lapse of the once top-selling drug Singulair
in August 2013. Company sales fell by 1.6% and 9% in 2012 and the first
quarter of 2013, respectively, due in part to rapidly declining Singulair
revenues. Merck's exposure to drug patents expiring over the next three-year
horizon ending 2015, excluding Singulair, is more manageable at 15.9% of
Fitch anticipates the revenue decrease due to expiring drug patents will peak
in 2013 led by the sales erosion of Singulair. Easing pressure from the
Singulair patent loss in the second half of the year, a return to growth of
the Januvia franchise, and continued demand for the vaccine portfolio and core
drug products may lessen the revenue decline experienced in the first quarter.
Fitch believes Merck can mitigate the present patent risk through demand for
the current diversified product portfolio, and commercialization of a broad
late-stage research program over the long term. Accordingly, Fitch expects
compound annual growth (CAGR) in 2012-2016 for the overall company of 0.1%,
and improved growth during a recovery phase in 2013-2016 of 1.65%.
Merck's sustained strong free cash flow generation and large cash and
short-term investments provides liquidity to address upcoming maturities
totaling nearly $6 billion in 2013-2015. The company generated free cash flow
of $2.8 billion in 2012, down from $5.8 billion in 2011, due to a $960 million
legal settlement and $1.3 billion in pension contributions.
Fitch still expects that free cash flow will remain above $5 billion annually
and free cash flow margin sustained above 10% through 2016 despite an
increasing dividend, higher capital spending, and pressure from declining
Singulair revenues in the first half of 2013.
Merck's strong liquidity is supported by cash and short-term investments of
$16 billion and $8 billion of long-term investments on March 31, 2013. In
addition, Merck had full capacity under a five-year $4 billion revolving
credit facility due May 2017.
Positive rating action is unlikely given the expanded share repurchase
program. An upgrade to 'AA-' would require sustained gross debt leverage in
the range of 1.0x to 1.3x. Leverage in this range is possible if Merck is able
to couple operational improvement with financially-disciplined share
repurchasing. Operational improvement would be demonstrated by sustained
positive sales growth, through demand for core drug products and uptake of new
medicines, subsequent to a trough in 2013.
A downgrade of the ratings would result from a rise in total debt leverage
above 1.5x in the intermediate term. The increase in total debt leverage would
likely result from incremental borrowing for funding the expanded share
repurchase program. Leverage pressure could also result from operational
weakness due to inability in achieving cost containment targets or ongoing
negative sales growth despite the imminent end of the company's patent cliff.
Fitch currently rates Merck as follows:
--Long-term Issuer Default Rating (IDR) at 'A+';
--Senior unsecured debt rating at 'A+';
--Bank loan rating at 'A+';
--Short-term IDR at 'F1';
--Commercial paper rating at 'F1'.
The Rating Outlook is Negative.
Additional information is available at 'www.fitchratings.com'. The issuer did
not participate in the rating process, or provide additional information,
beyond the issuer's available public disclosure.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' dated Aug. 8, 2012;
--'Rating Pharmaceutical Companies - Sector Credit Factors', dated Aug. 9,
Applicable Criteria and Related Research
Rating Pharmaceutical Companies
Corporate Rating Methodology
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Michael Zbinovec, +1-312-368-3164
70 West Madison Street
Chicago, IL 60602
Megan Neuburger, +1-212-908-0501
Mark Oline, +1-312-368-2073
Brian Bertsch, New York, +1-212-908-0549
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