Fitch Ratings has downgraded Bausch + Lomb Corporation's (BLCO) Issuer Default Rating (IDR) to 'B-' from 'B+' and senior secured debt to 'BB-'/ RR1' from 'BB+'/'RR1'.
Fitch has also maintained BLCO's ratings remain on Rating Watch Evolving. Prior to these rating actions, Fitch maintained all of the Rating Watch Evolvings related to BLCO while recording the Restricted Default at the Bausch Health and Bausch Health America entities.
The Rating Watch Evolving reflects the potential for BLCO's ratings to move higher should it become an unrestricted subsidiary and Bausch Health Companies' and Bausch Health Americas' (collectively BHC) ownership diminished through the distribution and/or sale of its remaining interests. Conversely, BLCO's ratings could move lower should BHC's ratings be downgraded or in the absence of the aforementioned separation. BLCO's ratings could also be downgraded should Fitch reconsider the strength of the linkage between the entities that results in equalized ratings or a one notch uplift rather than the two notch uplift. BHC has not made any announcements that indicate a change to their intentions for or relationship with BLCO. Resolution of the Rating Watch may occur more than six months in the future.
Key Rating Drivers
BLCO Solid Eye Care Business: BLCO is a leading global eye health company with a portfolio of over 400 products. Fitch expects that it will maintain an investment-grade capitalization upon its separation from BHC and transition from a secured borrowing base to unsecured. Fitch views BLCO as significantly smaller than Boston Scientific Corp. (BBB/Positive), Baxter International (BBB/Negative), Becton, Dickinson & Company (BBB/Stable) and Zimmer Biomet Holdings, Inc. (BBB/Stable). BLCO also operates in consumer health and prescription pharmaceuticals, providing some additional sector diversification compared to Boston Scientific and Zimmer Biomet.
BLCO's Ratings Tied to BHC's: The primary driver of BLCO's ratings is that of BHC's 'CCC' IDR until the complete separation. Fitch views the ringfencing and access and control factors to be porous thereby allowing BHC's credit profile to influence BLCO's. Until separation, any changes in the linkage could lower BLCO's ratings.
Changes to BHC's ratings would influence BLCO's until they are assessed on a stand-alone basis. An investment-grade rating would likely have leverage below 3.5x and an unsecured capital structure. Fitch will assess BLCO's Corporate Governance and its impact on ratings and ESG Relevance Scores as it relates to the separation. Additional detail on BHC's ratings can be found in Fitch's release ' Fitch Downgrades Bausch Health to 'RD' and Subsequently Upgrades to 'CCC' Post Distressed Exchange' dated Oct. 6, 2022, which can be viewed at www.fitchratings.com.
Separation Mechanics Unaffected: The recent distressed debt exchange that occurred at BHC may satisfy some of the steps necessary for a separation of BLCO whereas the mixed court ruling that occurred in August 2022 affecting BHC does not directly influence the timing or likelihood of a complete separation of the entities, as management has heretofore stated is their intention. The net leverage test needed to unrestrict BLCO from BHC's secured debt is on a trailing basis and the timing of potential cashflow losses are prospective.
Assessing Changes to Incentives for Separation: BHC is not legally obligated to complete the separation and BLCO's stronger credit profile could provide support for BHC's credit profile by providing covenant headroom.
Conversely, if BHC could meet the net leverage ratio and effectuate the separation, they may be further incentivized to do so given the increasing uncertainty at BHC. Advancing the separation would ensure BLCO's relatively healthy business and balance sheet are isolated from BHC's creditors and BHC's shareholders ownership in both entities would be unchanged were it to be a distribution in kind.
Coronavirus Impact Moderating: BLCO's business is recovering from the negative impact of COVID-19. Cataract and laser vision correction surgeries faced significant challenges as these procedures are generally considered elective or deferrable. Looking back, the second quarter of 2020 will probably remain the trough in revenues. Fitch believes growth will continue as population immunity increases, more therapeutics and diagnostic tests become available and protocols by providers mitigate the risk and patient concern associated with having these procedures. Nevertheless, the potential emergence of a resistant and more virulent variant could lead to a setback in procedure volumes.
Supply Chain/Inflation: Supply chain constraints and inflationary pressures present challenges to many firms in the healthcare sector. BLCO is generally managing these issues through building stocks of raw materials and API. In addition, the company is adding redundancies in its suppliers.
Reliably Increasing Demand: Aging demographics, improved income demographics in emerging markets, increasing digital screen times and the ongoing increase in the incidence of diabetes will likely drive low- to mid-single-digit growth in the demand for eye health products and services during the intermediate term. A significant number of BLCO's products enjoy leading market positions and strong brand recognition. Consumables and contracted services account for roughly 78% of BLCO's revenues, and the company's product portfolio has only limited exposure to market exclusivity losses.
Pipeline to Support Growth: Innovation is important to remain competitive in the eye health market, Fitch views the company's R&D efforts will help to drive intermediate- and long-term revenue growth while also supporting margins. BLCO makes consistent and significant investments in new product development. Its R&D efforts span all three businesses with intensity geared more towards surgical and ophthalmic pharmaceuticals. Fitch expects the company will also continue to pursue innovation in its Vision Care business with technological advancements being more incremental in nature.
Margin Expansion: Fitch assumes that margins will improve over the forecast period. Improving sales mix and manufacturing efficiency gains should increase gross margins. SG&A as a percent of sales are forecasted to decline owing to strong management of other operating costs. Increasing revenue should provide additional operating leverage. In addition, less than 15% of BLCO's revenues are exposed to branded pharmaceuticals pricing issues in the U.S.
Consistently Positive FCF: Advancing sales, improving margins, solid working capital management and moderate capex requirements should support consistently positive and increasing FCF. Fitch does not expect that BLCO will pay dividends or engage in share repurchases during the near term. Capital deployment will focus on internal investment, external collaborations and targeted acquisitions.
For a leading global eye health company, Fitch believes BLCO has relatively minimal contingent liability risk regarding product liability, intellectual property and other regulatory issues. As such, Fitch forecasts BLCO's leverage (total debt/EBITDA) to decline over the forecast period to below 2.5x, primarily through EBITDA growth. The current level of balance sheet debt is generally viewed as a permanent component of the capital structure and does not include the secured debt issued as part of the BHC exchange offer at the entity above BLCO. Fitch notes the potential for this debt to be serviced by dividends from BLCO.
BLCO's 'B-'/Rating Watch Evolving is based on it being a majority owned subsidiary of Bausch Health until the separation. Fitch views BLCO to be a stronger subsidiary than the weaker parent and notches BLCO's ratings by up by two from the consolidated parent's IDR. The notching is based on Fitch viewing the ringfencing to be porous due to the lack of significant restrictive investment or dividend covenants and access and control to be porous due to some overlapping Board of Directors members. Until separation, BLCO's ratings will be influenced by BHC's whose Rating Derivation is described in Fitch's release 'Fitch Downgrades Bausch Health to 'RD' and Subsequently Upgrades to 'CCC' Post Distressed Exchange' dated Oct. 6, 2022.
BLCO is significantly smaller than Boston Scientific Corp. (BBB/Positive), Baxter International (BBB/Negative), Becton, Dickinson & Company (BBB/Stable) and Zimmer Biomet Holdings, Inc. (BBB/Stable). BLCO also operates in consumer health and prescription pharmaceuticals, providing some additional sector diversification compared to Boston Scientific and Zimmer Biomet. It also presents a moderate degree of regulatory risk regarding drug pricing. BLCO is somewhat less diversified than Becton, Dickinson and Baxter. In addition, BLCO is solely focused on eye health, while all of its peers address a number of disease markets, with Zimmer Biomet also being somewhat less diversified than the others. Zimmer Biomet and Becton, Dickinson have a similar financial profile to BLCO, and Fitch expects the company to maintain gross debt/EBITDA between 2.5x-3.0x.
The approach taken is a weak parent (BHC)/strong subsidiary (BLCO). Using Fitch's PSL criteria, we conclude there is porous ring fencing and porous access & control. As such, we rate the parent and subsidiary at the consolidated level while notching the subsidiary's rating two notches above BHC's IDR.
Mid- to high-single-digit organic revenue growth driven by the uptake of new product commercialization moderately offset by increased competitive pressure for some established products;
Annual FCF generation greater than $400 million during the forecast period with moderately improving operating EBITDA margins;
Dividends are not included in the forecast, but if instituted would decrease FCF by the same amount as Fitch defines as CFFO-capex-dividends;
Cash deployment prioritized for tuck-in acquisitions.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Fitch viewing BLCO on a standalone basis;
An upgrade at BHC.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Evidence of factors related to ring-fencing and access and control that would lead Fitch to rate BLCO on a consolidated basis with BHC or with one notch uplift rather than two notches;
A downgrade at BHC.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
BLCO Liquidity: Fitch expects BLCO will have sufficient liquidity in the near term with an undrawn $500 million, five-year secured revolving credit facility and no near-term debt maturities given a $2.5 billion secured five-year term loan. The company has mandatory annual amortization on its term loan of $25 million. At June 30, 2022, the company had $437 million of cash on hand.
Recovery and Notching Assumptions
The recovery analysis assumes that BLCO would be considered a going concern in bankruptcy and that the company would be reorganized rather than liquidated. Fitch estimates a going concern enterprise value (EV) of $3.5 billion for BLCO and assumes that administrative claims consume 10% of this value in the recovery analysis.
The going concern EV is based upon estimates of post-reorganization EBITDA and the assignment of an EBITDA multiple. Fitch's estimate of BLCO's going concern EBITDA of $500 million is roughly 38% lower than the FYE 2021 EBITDA. The assumed going concern EBITDA reflects a scenario where the pandemic continues to weigh on certain business segments during the intermediate term and the company experiences some shortfalls in commercializing the R&D pipeline, thereby resulting in a restructuring or default.
Fitch assumes a recovery EV/EBITDA multiple of 7.0x for BLCO. This is generally in-line with the 6.0x-7.0x Fitch typically assigns to medical device/specialty pharmaceutical manufacturers.
Fitch applies a waterfall analysis to the going concern EV based on the relative claims of the debt in the capital structure, and assumes that the company would fully draw the revolvers in a bankruptcy scenario. The senior secured credit facility, including the term loans and revolver have outstanding recovery prospects in a reorganization scenario and are rated 'BB-'/'RR1'/Rating Watch Evolving.
Bausch + Lomb Corporation has an ESG Relevance Score of '4' for Exposure to Social Impacts due to pressure to contain health care spending growth; highly sensitive political environment, and social pressure to contain costs or restrict pricing, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors. It is worth noting that pharmaceuticals account for less than 15% of the firm's total sales.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg