Overview -- Endo Health Solutions entered into an agreement with Watson Pharmaceuticals to resolve two patent infringement lawsuits related to Lidoderm.
-- We are affirming all of our ratings, including the ‘BB’ corporate credit rating, on Endo.
-- Our stable outlook reflects our belief that, over the next 12 months, Endo will use its free cash flow to reduce leverage to no more than 3x in anticipation of a potential decline in EBITDA following the generic launch of Lidoderm.
Rating Action On May 30, 2012, Standard & Poor’s Ratings Services affirmed its ‘BB’ corporate credit rating on Chadds Ford, Penn.-based Endo Health Solutions Inc.
The outlook is stable. We also affirmed our ‘BBB-’ issue-level and ‘1’ recovery ratings on Endo’s senior secured debt and our ‘BB-’ and ‘5’ recovery ratings on its senior unsecured debt.
The ratings affirmation reflects our belief that, over the next 12-18 months, the company will use its free cash flow to reduce leverage to 3x or less in anticipation of a potential generic launch of Lidoderm by Watson on Sept. 15, 2013.
Despite the potential for an EBITDA contraction in 2013 and 2014, we have a high degree of confidence that Endo’s debt leverage will not exceed 4x over that period.
Rationale The rating on Endo reflects its “significant” financial risk profile (as our criteria describe the term) and leverage of 3.4x as of March 31, 2012. The leverage results from higher debt incurred for the $4.1 billion of acquisitions completed over the past 18 months.
Standard & Poor’s believes Endo has only a “fair” business risk profile, given franchise and product concentrations. We believe that Endo will generate high single-digit sales growth in 2012.
Our expectation is based on low single-digit growth of Lidoderm, low double-digit growth in generics, and mid-to-high single-digit growth in medical devices and technology. We expect that free cash flow will increase modestly over the next 12 months, and that the company will apply some of that free cash flow to debt reduction. Therefore, leverage should decline to about 3x over the next 12 months, in our opinion.
The concentration in Lidoderm could result in revenues of that product declining by 20% in 2013, if Watson’s generic version of Lidoderm is approved and it successfully launches the product on Sept. 15, 2013.
Nonetheless, we believe that Endo’s revenues will expand in 2013, but that a generic launch could reduce that growth to the low-to-mid single digits. Lidoderm revenues could then decline by about 50% in 2014, based on historical data of branded product sales declines following generic launches.
Although we expect EBITDA contraction at that time, our belief that Endo will reduce debt over the next 18 months gives us a high degree of confidence that leverage will not exceed 4x at the time of Lidoderm’s generic launch.
Endo’s significant financial risk profile reflects leverage of about 3.4x as of March 31, 2012. It also reflects a shift toward a more aggressive financial policy following the higher leverage incurred for the expensive acquisition of American Medical Systems Inc. (AMS), which followed closely after the company’s $1.2 billion purchase of Qualitest Pharmaceuticals in November 2010.
We believe Endo may make other acquisitions to further offset the expected sales decline that could occur as early as Sept. 15, 2013, from Watson’s launch of generic Lidoderm (a patch-based version of lidocaine), particularly if the company has underestimated the sales decline of Lidoderm. In the 12 months ended March 31, 2012, about 51% of Endo’s revenues were from branded pain medications and about 29% of total revenues were from Lidoderm.
Endo’s fair business risk profile reflects product and therapeutic sales concentration that continues to persist, despite acquisitions made over the past 18 months to provide diversity. It also reflects our belief that this concentration will decline as the generics and medical devices businesses grow. Moreover, the addition of a generics and medical devices businesses enhances product and geographic diversity and, over the longer term, reduces Endo’s dependence on patented pharmaceutical products for revenue.
Liquidity Endo has “strong” liquidity, as our criteria describe the term. We expect sources of liquidity to exceed uses by more than 2x, or by at least $700 million, over the next 12 to 24 months.
Other relevant aspects of our assessment of Endo’s liquidity are:
-- Sources of liquidity include funds from operations of more than $600 million, full availability of the $500 million revolving credit facility, and surplus cash of at least $250 million. -- Uses of cash include some working capital uses, capital expenditures of $100 million, and debt maturities.
-- The company has no near-term debt maturities; its earliest debt maturity is the convertible notes due 2015. Recovery analysis The issue-level rating on the company’s $2.7 billion senior secured credit facility is ‘BBB-’ with a recovery rating of ‘1’, indicating our expectation of very high (90%-100%) recovery in the event of payment default. The issue-level rating on the company’s $900 million senior unsecured notes due in 2019 and 2022 is ‘BB-’ with a recovery rating of ‘5’, indicating our expectation of modest (10%-30%) recovery in the event of payment default.
(For the complete recovery analysis, see our recovery report on Endo published on RatingsDirect on Nov. 9, 2011.)
Outlook Our stable rating outlook on Endo reflects our expectation that its leverage will remain consistent with our significant financial risk profile assessment, even though EBITDA will likely decline if Watson Pharmaceuticals’ generic version of Lidoderm is approved and that product is launched on Sept. 15, 2013.
We expect the company to use its free cash flow to reduce debt in advance of this occurrence in order to establish some capacity to absorb lower EBITDA. In the next 18 months, we could lower the rating if, following the commercialization of Lidoderm by Watson, sales and EBITDA decline more than we expect and leverage is sustained at more than 4x, which is indicative of an aggressive financial risk profile. This could occur if the company chooses to use free cash flow for acquisitions instead of debt reduction, or if there isn’t significant growth of the company’s other products.
An upgrade of Endo is unlikely over the next one to two years, given the uncertainty surrounding Watson’s launch of Lidoderm.
Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria, April 15, 2008 Ratings List Ratings Affirmed Endo Health Solutions Inc. Corporate Credit Rating BB/Stable/-- Senior Secured BBB- Recovery Rating 1 Senior Unsecured BB- Recovery Rating 5