-- In connection with its acquisition of eScreen, U.S. life science tools provider Alere is issuing an incremental $200 million senior secured term loan.
-- We are assigning a ‘BB-’ issue-level rating and ‘2’ recovery rating to the company’s proposed incremental term loan.
-- We are affirming our ‘B+’ corporate credit rating on the company, along with existing issue-level ratings, and revising the outlook to negative.
-- The negative outlook reflects the risk of a downgrade if Alere’s credit metrics do not improve in 2012.
On March 20, 2012, Standard & Poor’s Ratings Services assigned its ‘BB-’ issue-level rating and ‘2’ recovery rating to Waltham, Mass.-based Alere Inc.’s proposed incremental term loan. We also affirmed the ‘B+’ corporate credit rating and existing issue-level ratings. We revised the outlook to negative.
The company intends to use the proceeds from the incremental term loan and $75 million of cash from its balance sheet to acquire eScreen Inc., a toxicology firm. We expect pro forma adjusted debt leverage to increase to 5.9x from 5.8x.
The ratings on Alere reflect the company’s “highly leveraged” financial risk profile (based on our criteria), highlighted by persistent leverage above 5x. We characterize its business risk profile as “weak,” given its active acquisition strategy and its position as a niche player in the life sciences industry. As of Dec. 31, 2011, adjusted debt leverage was 6.5x--somewhat stretched for the rating. Our ratings expectation is that adjusted debt leverage will decline to 5.4x by the end of 2012, consistent with what we consider to be Alere’s “highly leveraged” financial risk profile. We expect recent acquisitions to increase EBITDA by about 13% in 2012.
Alere’s Professional Diagnostics segment (about 70% of overall revenues) positions the company well in a health care environment that stresses greater cost control via increased monitoring, especially in the home. The segment provides a variety of rapid diagnostic tests and equipment for medical professionals for use in hospitals, doctors’ offices, and the point-of-care market, and experienced 6% organic currency-adjusted revenue growth, excluding flu, in 2011. We expect organic revenues for this segment to grow in the upper-single-digit area in the next 12 to 24 months, in line with growth in the point-of-care market.
In contrast, sales of the health management segment--Alere’s other major segment--continue to decline because of economic headwinds resulting in pricing pressure, in addition to in-sourcing by managed health care customers in its disease management business. Sales for this segment declined 11% in 2011, although sales stabilized sequentially in the second half of the year. We expect sales for this segment to be flat, as continued competition for nondifferentiated services pressure prices and an increase in in-sourcing activity by managed health care providers offsets growth through acquisitions and improvement in the U.S. economy.
Alere’s adjusted EBITDA margin of about 25% is similar to the margins of most of its peers in the sector. However, margins contracted steadily from 27% over the past two years as new products failed to ramp up sales, manufacturing challenges hampered profitability, and the company experienced pricing pressure in Europe. We expect the margins to improve again as the health management segment stabilizes and the company gains some operating leverage.
Historically, the company has been very acquisitive. However, it has slowed down acquisition activity: In 2007, Alere made acquisitions of $2 billion, compared with about $500 million in each of 2009 and 2010. In the past year, Alere made acquisitions of $630 million. Although we expect the company to continue to conduct acquisitions, we expect that they will be smaller, as the company increases its efforts to stabilize leverage and gradually shifts its focus toward internal growth.
Alere’s adjusted debt leverage has steadily increased over the past 18 months because of debt-financed acquisitions. We are revising Alere’s financial risk profile to highly leveraged from “aggressive,” because we expect the company’s funds from operations to debt to be in the low teens and adjusted debt leverage to remain above 5x over the next year.
We characterize Alere’s liquidity as “adequate.” Pro forma for this transaction, Alere’s cash balance is $224 million, and it has full availability of its $250 million revolving credit facility expiring in 2016. Other factors supporting liquidity include:
-- Our belief that sources of cash should exceed mandatory uses of cash over the next 12 to 24 months by a greater than 1.2x ratio;
-- Expectations of positive free cash flows over the next two years;
-- Sources greater than uses even with a 30% decline in EBITDA; and
-- Our expectation that the company’s bank loan covenant cushion will be about 26%;
-- In our opinion, the company having no ability to absorb a high-impact, low-probability event without the need for refinancing. Recovery analysis For the complete recovery analysis, see Standard & Poor’s recovery report to be published on RatingsDirect as soon as possible after this release.
Our rating outlook on Alere is negative. Solid growth prospects in the diagnostics markets, combined with a stable health management segment, could generate modest improvements in operating measures. Any setback in operations that causes a decline in credit metrics, such that we expect leverage would not approach 5x in 2013, would lead to a downgrade. Also, an ongoing strategy of acquisitions such that Alere consistently operates with adjusted debt leverage in the high-5x area, while not deploying cash to repay its large debt burden, would lead to a one-notch downgrade.
We could revise the outlook to stable if Alere’s operating performance improves and it slows down its pace of acquisitions such that credit metrics improve and the company builds its financial capacity to execute its acquisition strategy.