July 16, 2012 / 2:53 PM / 5 years ago

TEXT-S&P cuts Thermo Fisher Scientific rating to 'A-'

July 16 - Overview
     -- U.S. life science tools manufacturer Thermo Fisher Scientific will 
acquire One Lambda, a privately held transplant diagnostic and research 
provider for $925 million; we expect the acquisition to be financed with 
intermediate or long term debt. 
     -- Thermo Fisher has increased its share repurchase program by $500 
million.
     -- We are lowering our corporate credit rating to 'A-' from 'A', 
reflecting the change in financial policy. We are lowering our commercial 
paper rating to 'A-2' from 'A-1' and senior unsecured issue-level ratings to 
'A-' from 'A'. 
     -- Our stable rating outlook reflects our expectation that Thermo Fisher 
will operate with credit metrics consistent with an intermediate financial 
risk profile over the long term.

Rating Action
On July 16, 2012, Standard & Poor's Ratings Services lowered its corporate 
credit rating on Waltham, Mass.-based Thermo Fisher Scientific Inc. to 'A-' 
from 'A'. We lowered our senior unsecured debt ratings to 'A-' from 'A' and 
commercial paper rating to 'A-2' from 'A-1'.

The downgrade reflects Thermo Fisher's lack of commitment to retire debt, 
which we view as a shift in financial policy. Prior to the announced deal for 
One Lambda, we expected the company to reduce existing debt levels. Although 
incremental debt will rise only moderately (given expected repayment of 
commercial paper and a $350 million notes maturity in 2012), funding of the 
$925 million acquisition and the $500 million share repurchase program will 
add to debt and divert internally generated funds from debt repayment. We are 
modifying our financial risk descriptor to "intermediate" from "modest," given 
expectations of weaker credit metrics relative to our prior base-case 
assumptions and increasing acquisition activity. We now expect debt leverage 
to be about 3x at the end of 2012 and 2.8x at the end of 2013; we previously 
expected debt leverage to be closer to 2.0x in 2013.   

Rationale
The ratings on Thermo Fisher reflect a "strong" business risk profile 
characterized by its diverse presence across geographies and customers, its 
ability to retain market leadership through organic growth, and successful 
execution of moderate bolt-on acquisitions that support core business 
strengths. The company's intermediate financial risk profile reflects our 
belief that Thermo Fisher will operate with debt leverage of between 2x and 
3x. We believe the company will pursue a more shareholder-friendly policy, 
evidenced by its decisions to increase its share repurchase program, and to 
borrow for an acquisition purchased at approximately 9x expected EBITDA.

We characterize Thermo Fisher's financial risk profile as intermediate, debt 
to EBITDA was about 2.8x and funds from operations (FFO) to debt was about 
30%, as of March 30, 2012. Pro forma for the One Lambda acquisition, debt 
leverage will increase to about 3.2x. We expect debt leverage, to be 3x at the 
end of 2012, when its $350 million note come due. 

Standard & Poor's 2012 base case scenario is as follows:
     -- We expect that, as in 2011, the company will generate low- to 
mid-single-digit organic revenue growth, including low-single-digit growth in 
laboratory products and services segment.
     -- We project 21% adjusted EBITDA margins, supported in part by recent 
restructuring activities.
     -- We expect $1.5 billion in free operating cash flow to cover dividends 
of $200 million and share repurchases of $1,150 million, with the balance 
applied to debt repayment. 
     -- We assume the One Lambda acquisition is financed with debt and that 
there are no other acquisitions in 2012.
     -- In 2013 we assume $500 million of share repurchases, a $200 million 
dividend, and $500 million of acquisitions. The balance of free cash flow is 
used to repay debt.  

Thermo Fisher's strong business risk profile is highlighted by its position as 
the largest provider of analytical instruments, equipment, and reagents for 
the research market. In the first quarter of 2012, Thermo Fisher reported 4% 
pro forma revenue growth and adjusted EBITDA margins of 21.2%, tracking to our 
expectations. It operates a somewhat decentralized operation, with 13 
divisions across three main business segments:  Analytical technologies (31% 
of revenues, and operating margin approximating 20%), laboratory products and 
services (50%, low margin), specialty diagnostics (via the August 2011 Phadia 
acquisition). In addition to product diversity, which supports its strong 
business risk profile, it has a varied product mix, consisting of consumables, 
instrumentation, and software and services, that contribute about 53%, 33%, 
and 14%, respectively, to total revenues. Cash-flow visibility is supported by 
the fact that about two-thirds of revenues are recurring, significantly higher 
than lower rated Agilent Technologies (where recurring revenue is only about 
30% of the total), but lagging several peers (e.g., lower rated Bio-Rad 
Laboratories and Life Technologies generate 70% and 80% from recurring 
revenue, respectively). 
It is geographically diverse, with about 44% of revenues coming from outside 
of the U.S. and has more diverse end markets than most of its life science 
competitors, with only about 25% of revenue generated from academic and 
government end markets, compared with 50% for Life Technologies. 

The life sciences industry is experiencing a period of consolidation, with 
economies of scale and breadth of product portfolio increasingly important to 
customers. Thermo Fisher continues to be active on the acquisition front and 
we expect it to continue undertaking acquisitions to diversify its portfolio 
and geographic reach; in 2011 the company acquired Dionex Corp. for $2 billion 
and Phadia for roughly $3.5 billion, financed mostly with debt. While these 
acquisitions further strengthen its product portfolio, they increased debt 
leverage to over 3x. Thermo Fisher used over $1.3 billion to repurchase shares 
in 2011 and $300 million in the most recent quarter; as of March 30, 2012, 
$350 million remained outstanding on its authorization. With its new dividend 
policy in place (which we view as a more permanent use of cash) and an 
additional $500 million share repurchase program, our view of Thermo Fisher 
financial policy has shifted negatively. 

Liquidity
Thermo Fisher's liquidity is "strong" (as defined in our criteria). Sources of 
cash are likely to exceed mandatory uses of cash over the next one to two 
years. Relevant aspects of Thermo Fisher's liquidity profile include:
     -- We expect liquidity sources to exceed uses by at least 5x over the 
next two years.
     -- Even if EBITDA declines by 50%, we expect liquidity sources to 
continue exceeding uses.
     -- The company has well-established, solid relationships with banks, in 
our assessment, and generally high standing in credit markets.
     -- The company has very modest debt repayment requirements over the 
intermediate term.

Sources of liquidity include $790 million of cash and short-term investments 
as of March 31, 2012, which are largely held  outside of the U.S.;  we believe 
that cash would be repatriated if needed for U.S. operations or debt 
repayment. Thermo Fisher also has an (unrated) $1 billion revolving credit 
facility due 2017. We expect the company to generate about $2 billion in FFO 
in 2012, which will generously cover capital spending of about $325 million, 
modest working capital needs, $350 million of notes due at the end of 2012, 
and bolt-on acquisitions. We expect it to make a quarterly dividend payment 
($150 million in 2012) and continue share repurchases. 
Outlook
Our stable rating outlook reflects our expectation that Thermo Fisher will 
operate with credit metrics consistent with an intermediate financial risk 
profile over the long term. Our view is underpinned by Thermos's intention to 
finance the One Lambda acquisition with debt, while at the same time, 
authorizing a $500 million share repurchase program.  

We could lower the rating if management's financial policy becomes more 
aggressive and accelerates debt-financed acquisitions or share repurchase such 
debt leverage would exceed 3.0x and FFO to debt would remain below 30%. Also, 
in the more unlikely scenario that Thermo's strong business risk profile 
weakens, possibly because of market-share losses, or the long-term decline of 
a particular end market or geography, we could lower ratings.

While not currently expected, we could raise the ratings if management 
demonstrates and commits to a financial policy indicative of a modest 
financial risk profile (i.e., debt leverage between 1.5x and 2.0x). 

Related Criteria And Research
     -- Methodology: Short-Term/Long-Term Ratings Linkage Criteria For 
Corporate And Sovereign Issuers, May 15, 2012
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List
Thermo Fisher Scientific Inc.
Downgraded; Outlook Action
                                        To                 From
Corporate Credit Rating                 A-/Stable/A-2      A/Negative/A-1
Senior Unsecured                        A-                 A
 Commercial Paper                       A-2                A-1

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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