November 1, 2017 / 6:08 PM / a year ago

Fitch Rates Express Scripts Bank Facility 'BBB'; CP Program 'F2'

(The following statement was released by the rating agency) CHICAGO, November 01 (Fitch) Fitch Ratings has assigned a 'BBB' rating to Express Scripts Holding Company's $6.125 billion senior unsecured bank facility. Fitch has also assigned an 'F2' CP rating and an 'F2' Short-Term Issuer Default Rating (IDR) to Express Scripts. In addition, Fitch has affirmed the existing ratings, including the 'BBB' IDR. A full list of rating actions follows at the end of this release. The ratings apply to approximately $17.8 billion of debt pro forma as of Sept. 30, 2017. The Rating Outlook is Stable. KEY RATING DRIVERS Market-Leading Scale: The ratings reflect the company's market-leading scale and strong cash flows on stable margins and efficient working capital. ESRX is the largest stand-alone pharmacy benefit manager (PBM) and one of the largest pharmacy operators in the U.S. Fitch expects such scale to continue enabling ESRX to negotiate favorable purchasing discounts and pricing rebates and to leverage its fixed costs associated with mail-order pharmacy. These positives are offset by Express Script's leveraged acquisition strategy, increased competition and the expected loss of earnings as well as pending litigation with Anthem, Inc. Strong Cash Flows: Despite relatively low margins (as reported), ESRX exhibits consistent and robust cash flows, which are driven by excellent working capital management and very efficient operations. Consistent cash flows and a solid liquidity profile afford good ratings flexibility at current ratings in the event of acquisitions, such as the proposed acquisition of eviCore, a medical benefits manager, for $3.6 billion in cash. FCF to adjusted debt for the TTM ended June 30, 2017 was approximately 35%. Historically an Active Acquirer: ESRX has been an active acquirer over the past decade, often employing large debt balances to fund deals. The possibility of large-scale M&A and a significant increase in leverage pressure the ratings somewhat. Notably, the firm has routinely executed on its de-leveraging plans, reducing leverage appropriately within 12-18 months of each deal. Total debt to operating EBITDA was approximately 2x for the TTM ended June 30, 2017. Increasing Competition, Consolidation: ESRX is expected to continue to experience pricing pressure from new contracts, consolidating clients and competitors, including the potential for competition from non-traditional players. Current trends supporting consolidation and alignment in many areas of healthcare are expected to continue for the foreseeable future. Growth Opportunities: Fitch believes ESRX will continue to grow, albeit at low-single-digit levels because of its scale, specialty-market growth, the emergence of biosimilar drugs, and ongoing cost containment efforts by payors. These forces are expected to produce increased PBM volumes and utilization of more value-added services. In addition, ESRX is uniquely positioned to leverage data about patient outcomes in order to help improve the effectiveness of treatments and to lower costs. Loss of Anthem Business: Fitch's ratings case forecast for ESRX assumes the company loses about $20 billion of revenue associated with its contract with health insurer Anthem in 2019-2020. While the loss of the Anthem contract is absorbable at the current rating level, if customer retention ultimately requires increased pricing concessions, it could eat further into ESRX's margins over the longer term as contracts roll. If this constrains ESRX's ability to maintain leverage at or below 2.3x, it may result in a negative rating action. While Anthem's dispute with ESRX comes down to a pricing dispute with one customer, it is occurring at the same time that other PBM customers are expressing concerns about the industry's pricing model. DERIVATION SUMMARY Express Scripts' BBB IDR reflects the company's strong position as the largest stand-alone PBM company in the U.S., moderate leverage and consistent FCF generation. Express Scripts stand-alone profile differs from its two leading peers: CVSCaremark (owned by CVS Health - not rated) and OptumRx (owned by UnitedHealthGroup - A/Stable), and as a result, raises the potential for greater concentration risk of its revenue stream. ESRX's scale and size of its operations (measured by claims processed) provides strong negotiating leverage with manufacturers and pharmacies, which supports steady cash flows compared with smaller peers such as MedImpact (BB-/Positive), and other PBMs owned by managed care organizations such as Aetna and Humana. Express Scripts is rated at or below some other healthcare and life science entities, such as Agilent Technologies, Inc. (BBB+/Stable) and PerkinElmer (BBB/Stable) even though its FCF as a percentage of debt is substantially higher because of its growth strategy based on acquisitions and record of significant share repurchases. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Annual revenue growth of 3% in 2018-2020 for the core business ex-Anthem. Assume the Anthem contract terminates leading to a loss of approximately $20 billion of revenue over 2019-2020; --Total debt of approximately $17 billion at the end of 2017, pro forma for the acquisition of eviCore; --Gross debt/EBITDA between 2.0x-2.3x through 2020, this assumption incorporates repayment of all maturing debt during the forecast period; --Strong FCF between $4.5 billion-$5 billion in 2017-2019, directed toward acquisitions, shareholder payouts and mandatory debt repayment; upon loss of the Anthem business in 2020 FCF is maintained near $3 billion. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -ESRX's current 'BBB' ratings contemplates gross debt/EBITDA of around 2.3x over the forecast period. With the amendment to the bank credit facility and addition of a CP program, ESRX will have more flexibility to manage working capital needs and small acquisitions. Positive rating actions are unlikely over the near to medium term without a shift in ESRX's financial policy that results in debt to EBITDA durably below 1.5x. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -A downgrade could result if Fitch expects debt/EBITDA will remain above 2.3x over the rating horizon and that FCF deteriorates beyond the levels caused by the loss of the Anthem contract. This development might result from any or a combination of the following factors: a significant, leveraged acquisition, prolonged negative underlying script growth, customer losses, or heightened competition. LIQUIDITY Solid Liquidity: The rating action follows Express Script's recent announcement of an amended and restated $6.125 billion bank credit agreement and the creation of a $3.5 billion CP program, both of which are expected to be partially used to finance ESRX's proposed $3.6 billion acquisition of eviCore. Fitch believes ESRX has a solid liquidity profile, supported by approximately $2 billion of cash and equivalents over the forecast period, the $3.5 billion CP program, and availability of a revolving credit facility under the amended and restated credit facility of $3.5 billion (due October 2022). Fitch understands that Express Scripts will maintain 100% revolver coverage for CP balance outstanding. Strong Cash Flows: Fitch estimates ESRX will have annualized FCF over the forecast period of approximately $4.5 billion. Strong cash flows are driven by good customer retention, excellent working capital management and steady and efficient operations. Well-Laddered, Manageable Maturities: The firm's debt maturity schedule is well-laddered and manageable, especially given its strong cash flow profile. No more than approximately $2.5 billion is due for mandatory repayments through 2019, compared to annual forecasted FCF of $4.5 billion. Nevertheless, Fitch expects ESRX to pay down most debt maturities through 2019 and to direct the remainder of FCF toward M&A and share purchases. FULL LIST OF RATING ACTIONS Fitch has taken the following rating actions: Express Scripts Holding Company --Assign long-term senior unsecured bank facility rating of 'BBB'; --Assign Short-Term IDR of 'F2'; --Assign commercial paper rating of 'F2'. --Long-Term IDR affirmed at 'BBB'; --Senior unsecured notes affirmed at 'BBB'. Express Scripts, Inc. --Assign IDR of 'BBB' --Senior unsecured notes affirmed at 'BBB'. Medco Health Solutions, Inc. --Assign IDR of 'BBB'. --Senior unsecured notes affirmed at 'BBB'. The Rating Outlook is Stable. Contact: Primary Analyst Patrick Finnegan, CFA Senior Director +1 646-582-4620 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Bob Kirby, CFA Director +1-312-368-3147 Committee Chairperson Megan Neuburger, CFA Managing Director +1-212-908-0501 Summary of Financial Statement Adjustments Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation; Historical revenue amounts have been adjusted to eliminate amortization expense related to the Anthem contract and to reclassify such amounts as amortization expense; Historical provision for income taxes adjusted for the deemed one-time tax benefits related to the PolyMedica Corporation tax and various state tax audit settlements. 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