November 20, 2017 / 12:49 PM / a year ago

Fitch Rates IWH UK Finco 'B(EXP)'; Senior Secured Debt 'B+(EXP)'

(The following statement was released by the rating agency) LONDON, November 20 (Fitch) Fitch Ratings has assigned IWH UK Finco Ltd. an expected Issuer Default Rating (IDR) of 'B(EXP)'. The Outlook is Stable. Fitch has also assigned an expected senior secured rating of 'B+(EXP)'/RR3 to the term loan issued by IWH UK Midco Ltd, a subsidiary of IWH UK Finco Ltd. IWH UK Finco Ltd. will indirectly control the assets comprising a portfolio of women's health products (referred to as Theramex) following the assets' carve-out from Teva Pharmaceutical Industries (Teva). The expected IDR of 'B(EXP)' reflects a mid-cap nature of Theramex with a relatively narrow product portfolio and concentration in a few European markets, albeit with a fairly diversified product portfolio on the individual country level. We view Theramex as a stable performer with mature cash generative brands; two proprietary products are projected to contribute incremental growth supporting the assigned IDR of 'B'(EXP). Leverage of around 6.0x on an FFO adjusted basis is comfortably placed for the IDR level relative to Fitch-rated peers. Lack of meaningful scale, exposure to underlying competition and limited diversification by product or geography will likely constrain the IDR to the 'B' rating category in the long term. This is mitigated by solid cash conversion given the asset-light business model. The assignment of the final ratings is contingent on completion of the carve-out on the terms as presented to Fitch, including the supply and transitional service agreements signed between Theramex (or any of its related entities) and Teva to support the carve-out, as well as receipt of final financing documents being materially in line with the draft indicative terms presented to Fitch in October 2017. KEY RATING DRIVERS Mature Profitable Product Portfolio Theramex benefits from a portfolio of mature and profitable brands generated by an established prescriber and customer base, and facilitated by a dedicated sales force. We estimate the mature product portfolio with osteoporosis, menopause and contraception solutions will contribute 80%-90% to Theramex's business. The stability of core products' earnings is evident in overall steady gross margins and EBITDA, despite volume and price volatility of individual brands. Growth Products Key for the Rating Proprietary new generation drugs complement the product base, with patent-protected income streams projected to contribute the remaining 10%-20% to Theramex's sales. We consider the contribution from growth products to be material to substantiate the assigned IDR of 'B(EXP)'. Delays in rolling out the new products in target markets or price/volume erosion arising from competing products, or as a result of Theramex's inefficient sales and marketing initiatives will materially impact the company's earnings and cash flows, and may put the ratings under pressure. Focus on Women's Health We regard Theramex's focus on women's health as credit supportive, although we do not view it as an overriding business strength, as the company is not immune from generic competition. In a highly dispersed women's health competitive landscape, from big global pharma players to mid- and small-cap market constituents, Theramex will remain exposed to volume and price challenges. However, we project the company will be able to compensate for any weaknesses in individual products through active brand portfolio management, leading to overall stable levels of EBITDA margins of at least 30%. Scale Constrains Rating The mid-cap nature of Theramex's operations will keep the IDR in the 'B' rating category in the medium to long term. We anticipate the sponsor to develop the asset organically, yet complementary product or licence acquisitions of below EUR10 million pa are conceivable. However, we do not project any material change in the business scale or breadth of Theramex's product portfolio. Manageable Carve-Out Risks We view the separation risks as manageable and overall rating neutral against a defensive asset development strategy, despite a comprehensive scope of issues that must be addressed for Theramex to swiftly transition towards an efficiently functioning stand-alone business. The appointment of critical senior executive positions and expected immediate post-carve-out availability of a dedicated international sales force will materially contribute to our expectations of Theramex's stable operating profile. We regard Teva's contractual commitments on supply and transitional business support functions as a considerable credit stabilising factor, as it permits Theramex to avoid operational disruptions and allows a reasonable timeframe to transition towards an independent business entity. Impact of Teva's Negative Performance On 6 November 2017, Fitch downgraded Teva from 'BBB-' to 'BB' with a Negative Outlook, due to operational stress from price pressure in the US, while the company is disposing assets to reduce debt. According to Fitch's estimates, Teva accounts for around 15% of Theramex's supply value and delivers API and FDD for various products, including the proprietary growth-driving drugs Ovaleap and Seasonique. At present, we do not see material risks that would undermine Teva's ability to fulfil its supply obligations towards Theramex. As part of the due diligence of the supply process, the sponsor has identified alternative providers of drug substances and products, including for Ovaleap despite its high manufacturing complexity as a biosimilar drug. High Cash Flow Conversion Theramex is a cash generative business supported by high and stable operating margins in combination with manageable working capital and low capital intensity. We project FFO margins will on average reach 22% over the rating horizon, which is solid for the rating. Based on our expectations of a largely unchanged supplier and distributor networks, which would not adversely affect Theramex's stand-alone cash conversion cycle, working capital outflows will remain contained at EUR2 million a year. This, in combination with low capex required for maintenance of business infrastructure and intellectual property (IP), will result in pre-exceptional FCF margins averaging 20%, leading to a strong implied pre-exceptional FCF/EBITDA conversion rate in excess of 60%. Leverage Aligned with IDR Leverage projected at around 6.0x on an FFO adjusted basis is commensurate with the assigned IDR of 'B' and in line with Fitch-rated mid-cap European generic pharmaceutical companies. In the absence of committed contractual repayments, we forecast no material de-leveraging on a gross basis. However, we note a mild deleveraging path net of accumulated cash, with FFO adjusted net leverage trending to 4.6x by FY20. Above Average Recovery Expectations for Senior Secured Lenders We expect senior secured debt holders to receive above-average recoveries expressed in an instrument rating of 'B+(EXP)'/RR3/57%. In Fitch's recovery analysis, we follow a going concern approach instead of balance sheet liquidation. This reflects Theramex's asset light business model supporting higher realisable values in a hypothetical distress situation. For the going concern analysis enterprise value (EV) calculation, we have applied a 25% discount to Fitch estimated 2017F EBITDA of EUR66 million, leading to a post-distress EBITDA of EUR50 million, as a post-distress cash flow proxy. We have then applied a 5.5x distressed EV/EBITDA multiple, considering Theramex's estimated multiple in the LBO transaction, as well as broader sector trading benchmarks. After a deduction of 10% for administrative claims, the senior secured debt holders would be able to recover 57% of the debt face value, leading to a one-notch uplift from the IDR to 'B+(EXP)'. DERIVATION SUMMARY Fitch considers Theramex in the framework of the Ratings Navigator for pharmaceutical companies, despite some consumer angle of its branded products, where the demand is generated through a pull-marketing strategy at the level of drug prescribers. Compared with Nidda Bondco GmbH (Stada, B+(EXP)), the IDR will remain constrained in the 'B' rating category in the long run, given its considerably smaller operations size with a fairly concentrated product and country exposure. The company's profitability and cash flow margins are high in the sector context, although in line with other mid-cap asset light pharma peers. We therefore attribute such strong margins to the selected in-house competences, avoiding costly product innovations and commoditised, or economically less attractive, manufacturing processes. The financial risk profile with FFO adjusted leverage of 6.0x is well placed for a 'B'(EXP) IDR and in the context of the Ratings Navigator as a mid-point for the 'B' rating category KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Theramex include: - revenue growth of around 2.0% pa from FY18 (ending December 2018); - EBITDA margin of around 30%; - annual capex of 1% of sales; - increase in working capital at 40% of revenue increase; - non-recurring cash outflows in FY18-19 totalling EUR80 million, relating to the carve out and initial working capital required for a standalone entity; - no acquisitions factored over the rating horizon. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -successful completion of the separation from Teva evidenced in efficiently functioning new senior management team, appropriately sized international sales force, fully internalised business support functions and intact supply and distribution networks; - increase in scale with a concurrent sustained expansion of EBITDA and margins; - Free Cash Flows (FCF) trending towards EUR100 million p.a., with FCF margins sustainable at mid to high single-digit levels; and -FFO adjusted gross leverage below 5.0x on a sustained basis. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -significant delays or material challenges incurred with the separation process evidenced in incomplete key senior management team, inadequately staffed sales force, or disruptions in any outsourced or in-house business processes; -declining sales and EBITDA with margins falling below 30%; - declining FCF and FCF margins trending to zero; -FFO adjusted gross leverage above 7.0x. LIQUIDITY Comfortable liquidity The liquidity profile is considered comfortable. This is supported by the company's strong cash generation, availability of EUR55 million RCF, which will remain undrawn at closing, the absence of short-term financial obligation or significant working capital seasonality, as well as the cash overfunding of USD40 million to partly cover the costs of separation and the follow-up restructuring. Contact: Primary Principal Analyst Louise Liu Analyst +44 20 3530 1660 Supervisory Analyst Elena Stock Director +9 69 76 80 76 135 Fitch Deutschland GmbH Neue Mainzer Strasse 46-50 D-60311 Frankfurt am Main Germany Committee Chairperson Pablo Mazzini Senior Director +44 20 3 530 1021 Date of relevant rating committee 8 November 2017 Summary of Financial Statement Adjustments - operating leases capitalised at a multiple of 8.0x, as the company is based in the UK; - shareholder loan is treated as equity; - EUR 1.4million set aside as restricted cash for intra-year working capital movements. Additional information is available on For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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