Fitch Places McKesson's L-T Ratings on Rating Watch Negative on Proposed
CHICAGO -- October 24, 2013
Fitch Ratings has placed the long-term ratings of McKesson Corp. (NYSE: 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
-- 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
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 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
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'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Subsidiary Linkage' (Aug. 5, 2013);
--'Trekking the Path to Biosimilars - The Destination' (Oct. 4, 2013);
--'U.S. Healthcare Stats Quarterly - Second-Quarter 2013' (Sept. 26, 2013);
--'Vital Signs - Currents in the Drug Channel' (Podcast) (April 25, 2013);
--'Navigating the Drug Channel - Drug Distributors: A Deeper Dive' (April 24,
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Trekking the Path to Biosimilars -- The Destination
U.S. Healthcare Stats Quarterly - Second-Quarter 2013
Vital Signs -- Currents in the Drug Channel
Navigating the Drug Channel -- Drug Distributors: A Deeper Dive
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Jacob Bostwick, CPA, +1 312-369-3169
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
Bob Kirby, CFA, +1 312-368-3147
John Culver, CFA, +1 312-368-3216
Brian Bertsch, +1 212-908-0549
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