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Fitch Affirms Synlab at 'B'; Outlook Stable
May 22, 2017 / 6:11 PM / 4 months ago

Fitch Affirms Synlab at 'B'; Outlook Stable

(The following statement was released by the rating agency) LONDON, May 22 (Fitch) Fitch Ratings has affirmed Synlab Unsecured Bondco PLC's (Synlab) Long-Term Issuer Default Rating (IDR) at 'B' with a Stable Outlook. We have also affirmed Synlab Bondco PLC's senior secured instrument rating at 'B+'/RR3/55% and Synlab Unsecured Bondco PLC's senior instrument rating at 'CCC+'/RR6/0%. A full list of rating actions is below. Synlab's IDR of 'B' is supported by the growing scale of the business as well as the defensive nature of the routine medical testing business model. However, the rating is constrained by the significant financial leverage, which facilitates the underlying growth of the operations as Synlab continues to be an active player in the accelerating consolidation of the fragmented laboratory testing industry. In our view, high financial leverage is counterbalanced by beneficial underlying volume growth, scale benefits support profitability, and low capital intensity support satisfactory FCF generation and deleveraging ability in case of need. The Stable Outlook assumes that Synlab will continue to be an active consolidator in the industry and continue its selective 'buy-and-build' strategy to grow diversification and scale of the business. KEY RATING DRIVERS Stretched Leverage; Supportive Model: We view Synlab's capital structure as highly leveraged, with funds from operations (FFO) adjusted gross leverage around 8.0x and FFO fixed charge cover remaining just below 2.0x (but trending towards 2.0x over a four-year rating horizon). Although such leverage is high for the 'B' rating level, the rating is supported by adequate free cash flow (FCF) generation, projected on average at 5.0% over Fitch's four-year rating horizon, as well by a defensive business model, which increasingly benefits from scale advantages. Volume Growth Supports Profitability: Despite a comparatively stable pricing environment at present, Fitch expects structural pressures on pricing to continue in many of Synlab's core markets as healthcare payers seek to manage rising medical cost inflation. However, we expect this trend to be counterbalanced by volume growth associated with increasing demand from an ageing population in combination with more preventive treatments and improved testing technology. Fitch assesses a sustainable EBITDA margin for this business at around 20%. Active Player in Industry Consolidation: Fitch expects an increasing pace of consolidation in the fragmented market for routine and specialist laboratory testing services, with Synlab remaining an active consolidator following In our rating case, we have modelled EUR450 million of additional acquisition spending over the next two years, aided by the additional liquidity raised by the recent increase of the Novo equity stake, increasing Synlab's liquidity and financial flexibility. We expect upward pressure on EV/EBITDA multiples, to around 8.0-8.5x for smaller bolt-on and medium-sized acquisitions in the sector. Above-Average Senior Secured Notes Recoveries: Fitch assigns a 'B+' instrument rating to the senior secured debt, one notch above the IDR, to reflect our expectation of above-average recovery in our hypothetical default analysis. In our analysis, we expect a going concern restructuring scenario to yield stronger recoveries for creditors than liquidation. Therefore, our recovery analysis assumes a distressed sale of the group as a whole because a liquidation of individual labs could prove challenging given laboratory ownership regulatory constraints in various European jurisdictions, in particular clinical pathologists' pre-emptive rights in France. In our recovery assessment, we conservatively value Synlab on the basis of a 6.0x EV/EBITDA multiple applied to an estimated post-restructuring EBITDA of EUR241 million (2016 EBITDA adjusted for full-year acquisition effects discounted by 20%). Poor Recovery Prospects for Senior Notes: Based on our recovery assumptions, the senior notes issued by Synlab Unsecured Bondco PLC carry poor recovery prospects in a default scenario given their subordination to the super senior RCF and certain other obligations of non-guarantor subsidiaries, as well as the senior secured notes in the debt waterfall. This is reflected in the instrument rating of 'CCC+/RR6/0%'. DERIVATION SUMMARY Following last year's merger of Synlab and Labco, the combined group is the largest lab testing company in Europe, twice the size of nearest competitor, Sonic Healthcare. Its operations consist of a network of 465 laboratories across 28 countries, providing good geographical diversification and less exposure to single healthcare systems. The EBITDA margin at around 19.2% is in line with close peer Unilabs (not rated at 18.8%, although slightly lower than Cerba HealthCare SAS (B/Stable) at 20.7% because the Group has exposure to a lower-margin market (Germany). Like other sector peers, Synlab is highly levered (FFO adjusted gross leverage at above 8.0x in 2016), which is a key rating constraint. However, Synlab has strong free cash flow generation abilities and we forecast it to deleverage via earnings growth towards 7.0x by 2019. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Low to mid-single-digit organic growth in key markets - EBITDA margin gradually improving towards 20% due to cost savings and economies of scale achieved from the enlarged group - Up to EUR450 million of acquisitions, including bolt-on and one mid-sized expected over the next two years - Moderate capital intensity with CapEx/Sales estimated at around 4% -Satisfactory FCF generation of around 5% on average over the four-year rating horizon - No dividends paid RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO adjusted gross leverage above 8.0x or FFO fixed charge cover at less than 1.3x for a sustained period of time (both adjusted for acquisitions) - Reduction in FCF margin to only slightly positive levels or large debt-funded and margin-dilutive acquisition strategy could also prompt a negative rating action Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - FFO adjusted gross leverage below 6.5x and FFO fixed charge cover above 2.0x - Improved FCF margin in the mid- to high- single digits or more conservative financial policy reflected in lower debt-funded M&A spending LIQUIDITY Satisfactory Liquidity: Synlab has access to a super-senior RCF of EUR250 million due in 2021, which remains undrawn at present. Liquidity is aided by the EUR250 million raised by the increase of Novo's equity stake, which is earmarked for investment in the business, in addition to positive FCF generation. Synlab's funding structure is long-dated with no meaningful debt maturities before 2021. FULL LIST OF RATING ACTIONS Synlab Bondco PLC --Senior secured RCF affirmed at 'BB/RR1/100%' --Senior secured notes affirmed at 'B+'/'RR3'/55% Synlab Unsecured Bondco PLC -- Long-Term IDR affirmed at 'B'; Stable Outlook -- Senior notes affirmed at 'CCC+'/'RR6'/0% Contact: Principal Analyst Peter Wormald Analyst +44 203 560 1357 Supervisory Analyst Frank Orthbandt Director +44 20 3530 1037 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Edward Eyerman Managing Director +44 203 530 1359 Summary of Financial Statement Adjustments - Fitch adjusts readily available cash by an amount of EUR30 million, reflective of intra-year working capital swings in the business. We further capitalise leases using a capitalisation factor of 8.0x in line with existing criteria. Finally, we calculate adjusted FFO and EBITDA to reflect full year contribution of the various bolt-on acquisitions in pro-forma debt protection ratio calculation. Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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