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.