CHICAGO - (Business Wire) As a result of the completed merger between Merck & Co., Inc. (Merck) and Schering-Plough Corp. (Schering-Plough) yesterday, Fitch Ratings has downgraded Merck's Issuer Default Rating (IDR) to 'A+' from 'AA-' and upgraded Schering-Plough's IDR to 'A+' from 'BBB+'. Simultaneously, Fitch downgraded Merck's senior unsecured debt and bank loan ratings to 'A+' from 'AA-' and downgraded the short-term IDR and commercial paper rating to 'F1' from 'F1+'. The ratings were also removed from Rating Watch Negative where they were originally placed on March 9, 2009 and assigned a Stable Rating Outlook. The ratings apply to approximately $9.1 billion of debt. (A full list of rating actions follows at the end of this release.) In addition to the upgrade of Schering-Plough's IDR to 'A+' from 'BBB+', Fitch also upgraded the company's senior unsecured debt and bank loan ratings to 'A+' from 'BBB+' and upgraded the trust preferred stock 'A-' from 'BBB-'. Simultaneously, Fitch upgraded the short-term IDR and commercial paper rating to 'F1' from 'F2'. The ratings were also removed from Rating Watch Positive where they were originally placed on March 9, 2009 and assigned a Stable Outlook. Additionally, Fitch has withdrawn the short-term IDR and commercial paper rating. The ratings apply to approximately $8.2 billion of debt.
Yesterday, the merger of Merck and Schering-Plough was completed for approximately $41.1 billion. In line with expectations, incremental debt of $8.5 billion, comprising $4.25 billion of long-term issuances and $4.25 billion short-term borrowings, were used for the cash portion. Including Schering Plough's debt load, pro forma total debt leverage rose to 1.4 times (x) at the end of the third quarter. Fitch expects actual leverage to decrease to 1.3x by the end of 2011. Fitch believes that another leveraging transaction during this time frame would pressure the current rating.
The transaction effectively addresses the anticipated decline of revenues over the long-term horizon due to patent expirations of several of key Merck medicines. With the exception of an estimated revenue decrease in 2010 due to the patent loss of Cozaar, the new combined entity is anticipated to see top-line growth every year thereafter including the patent lapse of the top-selling pharmaceutical, Singulair, in 2012. Overall sales growth is supported by the addition of Schering Plough's diversified and solidly protected product portfolio.
Merck is striving for annual synergies totaling around $3.5 billion beyond 2011, of which 50% will be realized in the first full year, and 75% in the second year after the close of the transaction. The additional synergies are in addition to ongoing programs at each company, specifically a $1.5 billion cost reduction at Schering-Plough ($600 million already achieved in 2008) and around one billion from Merck's 2008 program.
Opposite trajectories were seen for the latest 12-month (LTM) period ending Sept. 30, 2009 pertaining to EBITDA margins. Over the past two years or so, Merck's EBITDA margins have steadily contracted from 36.4% in 2007 to 33% for the LTM period at the end of the third quarter as the company has not yet recovered from the patent losses of Fosamax and Trusopt/Cosopt in 2008. At Schering-Plough, EBITDA margins jumped to 28% for the LTM period at the end of the third quarter from 23.7% in 2007, given a solid intellectual property position. Fitch expects the costs of the integration and restructuring programs to pressure margins over the next two years.
Merck may have an opportunity to reduce leverage quickly, given expected strengthening operating cash flow generation. Fitch anticipates operating cash flow to improve over the intermediate term as a leaner cost structure is leveraged by annual revenue growth. Pro forma operating cash flow was $5.44 billion for the LTM period ending Sept. 30, 2009 as operating cash flow of $2.13 billion at Merck, driven lower by $1.39 billion of payments into the Vioxx settlement and a $660 million tax settlement during 2009, was not fully offset by a record level of cash flow of $3.31 billion at Schering-Plough, mainly from earnings expansion. Fitch will monitor capital deployment as the company may favor shareholder-friendly actions given a history of aggressive share repurchase activity and a commitment to its dividend.
Liquidity is provided by a $1.5 billion 5-year revolving credit facility (due April 2013) that was amended this April due to the merger. The revolver is used as back up to the company's commercial paper program. Additional liquidity comes from full capacity under a new $1 billion facility obtained in conjunction with the merger and Schering Plough's $2 billion revolver expiring August 2012 which remains active. Two other facilities executed in connection with the merger agreement, a $3 billion one-year bridge facility and a $3 billion one year asset sale revolver, were terminated, concomitant with the $4.25 billion of debt issuances in June and the sale of Merck's stake in Merial Ltd. in the third quarter.
Merck had negative free cash flow of $2.37 billion for the LTM period ending Sept. 30, 2009, while Schering Plough generated free cash flow of $2.11 billion during the same period. At the end of the third quarter of 2009, Merck and Schering Plough had cash and short-term investments totaling $22.26 billion and $4.8 billion, respectively. Upcoming long-term debt maturities include around $700 million due next year, a total of $1.5 billion due in 2011, and approximately $700 million due in 2012.
Fitch takes the following actions on Merck's ratings:
--Long-term Issuer Default Rating (IDR) downgraded to 'A+' from 'AA-';
--Senior unsecured debt rating downgraded to 'A+' from 'AA-';
--Bank loan rating downgraded to 'A+' from 'AA-';
--Preferred stock rating (formerly Schering-Plough) upgraded to 'A-' from 'BBB-';
--Short-term IDR downgraded to 'F1' from 'F1+';
--Commercial paper rating downgraded to 'F1' from 'F1+'.
The Rating Outlook is Stable.
Fitch takes the following actions on Schering-Plough's ratings:
--Long-term Issuer Default Rating (IDR) upgraded to 'A+' from 'BBB+' ;
--Senior unsecured debt rating upgraded to 'A+' from 'BBB+';
--Bank loan rating upgraded to 'A+' from 'BBB+';
--Short-term IDR and commercial paper ratings withdrawn.
The Rating Outlook is Stable.
Additional information is available at www.fitchratings.com.
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Fitch Ratings, Chicago
Michael Zbinovec, +1-312-368-3164
Bob Kirby, +1-312-368-3147
or
Cindy Stoller, +1-212-908-0526
(Media Relations, New York)
cindy.stoller@fitchratings.com
