TEXT-S&P affirms Hill-Rom rating after Aspen Surgical deal

Fri Jul 27, 2012 11:43pm IST

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Overview
     -- We believe U.S.-based patient bed maker Hill-Rom Holdings' prospects 
for sustained mid-single-digit sales growth and modest expansion in EBITDA now 
will rely on the contribution of acquisitions, given weak organic demand for 
its hospital beds.
     -- The acquisition of Aspen Surgical Products does not meaningfully 
diversify Hill-Rom's exposure to variable capital equipment sales. 
     -- We are affirming our ratings on the company, including our 'BBB' 
corporate credit rating. The outlook is stable.
     -- Our stable rating outlook reflects our expectation that credit metrics 
will remain consistent with a "modest" financial risk profile.

Rating Action
On July 27, 2012, Standard & Poor's Rating Services affirmed its corporate 
credit and issue-level ratings on Batesville, Ind.-based Hill-Rom Holdings 
Inc. at 'BBB.' The rating outlook is stable.

These actions follow earnings weakness that we already considered in our 
base-case expectations, given the company's exposure to variable hospital 
customer demand for its high-ticket equipment. The acquisition of Aspen 
Surgical Products, a maker of consumable surgical products, will not 
meaningfully diversify operations, but neither does it require more financial 
leverage than is factored into the ratings. 

Rationale
The ratings on Hill-Rom incorporate Standard & Poor's assessment that the 
patient bed maker has a "fair" business risk profile that features a 
well-established, but narrow, market position. Its "modest" financial risk 
profile reflects cash generation ample to sustain debt leverage of under 2x on 
an ongoing basis, even with a moderate pace of share repurchases and 
acquisitions.

The company's reliance on its beds and surfaces operations and, consequently, 
its exposure to variable U.S. hospital capital spending, is a key element in 
our assessment of its fair business risk. Revenue rebounds of both 8% and 6%, 
in fiscal 2011 and fiscal 2010, respectively, as recessionary fears subsided, 
demonstrated this variation. Fiscal 2009 revenues had declined 8%. However, 
the 5% year-over-year decline in North American revenues in the June quarter 
shows the readiness of hospitals to postpone capital purchases amid sluggish 
in-patient activity in the U.S. Total constant-currency revenues for Hill-Rom 
through the nine months of fiscal 2012 were up 4.9%, year over year, aided by 
international operations (which account for about one-quarter of revenues). We 
believe that the relatively high margins of the North America Acute Care 
segment (62% of total revenues) will continue to benefit from manufacturing 
and distribution economies of scale tied to its market-leading positions. 
Hill-Rom's long history in the design and manufacture of patient beds and 
surfaces, and its well-established customer relationships provide competitive 
advantages. 

We anticipate that acquisitions, such as the just-completed purchase of Aspen 
(some $120 million in revenues), and the early 2012 purchase of Germany-based 
Volker group (some $100 million in annual revenues), will leverage its 
marketing presence with hospitals. While these respective acquisitions enhance 
the company's distribution capability and increase participation in consumable 
surgical products, they will not soon provide significant customer diversity 
suggestive of a business risk profile better than "fair." 

We believe prospects for sustained mid-single-digit sales growth through 2013 
and modest expansion in EBITDA now will rely on the contribution of 
acquisitions, given weak organic demand for its hospital beds. Variations in 
discretionary capital spending by customers could lead to an uneven organic 
revenue performance, but one that exceeds the 2% rise in 2012 and 2013 GDP 
expected by our economists in their base case. Acquisitions, such as the 
February 2012 purchase of Volker group, and the just-completed acquisition of 
Aspen, will supplement the company's product offering to health care 
institutions. 

We continue to assess Hill-Rom's financial risk profile as "modest." We 
believe soft North America customer demand could contribute to a decline in 
consolidated average adjusted EBITDA margins through 2013 of some 200 basis 
points (bps), from the 21.3% fiscal 2011 level. Dimmed prospects for 2012 
EBITDA, reflecting a downshift in momentum for the second half of the fiscal 
year, we believe, will be followed by EBITDA improvement in 2013, supported by 
the inclusion of Aspen. Accordingly, we expect that, even with incremental 
debt used for the transaction, debt leverage will continue to remain low 
relative to our modest financial risk profile guidelines, which includes 
leverage of 1.5x to 2.0x.

Hill-Rom's distribution agreement (part of the spin-off) limits certain 
discretionary expenditures once debt to EBITDA hits 1.8x. This distribution 
agreement will remain in place until Hillenbrand Inc. settles legal issues 
regarding alleged restraint of trade in the casket business. When the 
distribution agreement expires, Hill-Rom will be held to a 3.5x debt to EBITDA 
covenant and 3.5x EBITDA to interest coverage ratio covenant in its credit 
agreement. While we expect Hill-Rom could then become more acquisitive, its 
generation of substantial discretionary cash flow should give it room to make 
niche-filling acquisitions and share repurchases without compromising its 
record of operating with relatively low leverage.

Liquidity
We view Hill-Rom's liquidity as "strong," with sources of cash well exceeding 
mandatory uses of cash over the next 12 to 24 months. Relevant aspects of the 
company's liquidity are:
     -- Sources of liquidity will exceed uses by at least 2x;
     -- Annual funds from operations (FFO) of some $250 million; 
     -- Cash and cash equivalents, totaled $220 million at June 30, 2012, a 
portion of which funded the Aspen acquisition; 
     -- A substantial portion of the revolver, of which $449 million was 
available at June 30, 2012, was also used in the transaction. The planned 
renewal of the revolver within the next couple of months is an important 
liquidity consideration, since it expires in March 2013;
     -- We expect annual capital expenditures to be manageable, at roughly $75 
million;
     -- We believe that any debt-financed share repurchases will supplement 
acquisition spending within a 2x leverage figure. Share repurchases, which 
totaled $115 million in fiscal 2011, have been minimal in fiscal 2012 with the 
increase in acquisition activity; and
     -- Dividends should be manageable ($27 million in fiscal 2011).

The company is exposed to potential settlements or adverse rulings related to 
the outstanding legal issues of Hillenbrand. However, Hill-Rom is responsible 
for payments for legal settlements or rulings only after Hillenbrand has 
exhausted its financial resources.

Outlook
Our stable rating outlook on Hill-Rom reflects our expectation that credit 
metrics will remain consistent with a modest financial risk profile. This view 
incorporates the possibility of approximately 200-bp margin decline over the 
next two years, reflecting customer cost-containment efforts and the 
imposition of a U.S. medical device tax in 2013. We expect debt-financed 
acquisition activity to occur at a measured pace, supplemented with share 
repurchases. We also believe, however, that FF0 to debt will remain above 45% 
and debt to EBITDA will stay below 2x.

A lower rating is possible in the next few years if there is a combination of 
sustained organic revenue declines tied to slackened demand and pricing 
pressure from customers under third-party payor reimbursement reductions. Such 
a scenario could involve margin declines in excess of 300 bps. Surprisingly 
large borrowing that takes leverage above 2x, without an early prospect that 
it would subside to more historically conservative levels, also could lead to 
a downgrade. A higher rating is unlikely, given clouded business prospects and 
the increased use of the company's debt capacity for acquisitions.

Related Criteria And Research
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011 
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 
     -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

Ratings Affirmed

Hill-Rom Holdings Inc.
 Corporate Credit Rating                BBB/Stable/--      
 Senior Unsecured                       BBB                

Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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