Fitch Ratings has affirmed Mozart Holdings, LP's and Medline Borrower, LP's Long-Term Issuer Default Ratings (IDRs) at 'B+'.

In addition, Fitch has affirmed the following Medline Borrower, LP and Medline Co-Issuer, Inc. instrument ratings: senior secured at 'BB-'/'RR3' and senior unsecured at

'B-'/'RR6'.

The Rating Outlook remains Negative.

The affirmation of Medline's 'B+' IDR primarily reflects the company's steady performance in the face of challenging macroeconomic conditions that have produced margin pressure and slower cash conversion. Medline has been able to grow sales volumes and increase prices for certain of its products during the past year resulting in some expansion of gross margin.

As noted in Fitch's April 2022 Outlook revision, financial leverage is expected to remain higher for longer because of the slower than anticipated EBITDA growth and the use of FCF to meet payments under Medline's Managing Partner Program. Fitch is encouraged by Medline's solid execution of its strategy, which has produced continued growth in prime vendor relationships and can be reasonably expected to contribute to meaningful growth as inflation headwinds abate.

Key Rating Drivers

Leading Market Position for Medical/Surgical Products: Medline is a market leader in the manufacturing and distribution of medical/surgical products in the U.S. The company's vertical integration of manufacturing and distribution capabilities and global sourcing relationships helps to differentiate it from leading competitors, such as Cardinal Health, Inc. and Owens & Minor, Inc. Medline's profitability is enhanced by its ability to maintain and grow relationships across a significant number of the largest integrated delivery networks across the U.S. with Medline branded products.

Consistently Solid Cash Flow: A combination of strong persistency of existing customers and the ability to effectively penetrate both the acute care and post-acute care health care market with private label products continues to produce a high level of profitability and cash flow, albeit somewhat constrained by inflationary pressures. Investments in new and existing capacity are expected to remain relatively stable over the forecast horizon.

Leverage Profile is High: A year after the acquisition of Medline by Blackstone, Carlyle and Hellman & Friedman (the Sponsors), Fitch estimates that gross leverage (gross debt/EBITDA) remains above 7.0x and FCF/Debt is below 5%, which is the key driver of Fitch's Negative Outlook. However, Fitch believes gross debt will be reduced over the medium to long term with both the application of FCF to meet debt obligations and ultimately though future sales of equity, either through an IPO or sale to other 3rd parties. In addition, gross leverage will depend heavily on revenue and EBITDA growth. Inflationary headwinds are expected to persist over the medium term; however, Fitch believes Medline has broad pricing power to offset those headwinds. Fitch expects that the implementation of price increases will generally lag rising costs.

Fitch's calculation of gross leverage includes an amount of mortgage debt secured principally by Medline's manufacturing and distribution facilities. Such debt is treated as a having a higher priority of claim than all other senior secured and senior unsecured debt.

Governance and Financial Policy: In its inaugural coverage of Medline, Fitch identified two critical assumptions underpinning its forecast for Medline: 1) the ability of the Mills family and the Sponsors to work together effectively and 2) to reduce debt over the near to medium term. Fitch continues to believe these assumptions are valid because it will lead to the highest value proposition for all parties. However, the decision to prioritize the use of FCF for management compensation instead of debt reduction heightens the weight of this assumption to Fitch's medium-term forecast. Any signs that Medline no longer has the ability or intent to reduce debt towards its negative sensitivities will heighten downgrade pressure.

Derivation Summary

Medline's 'B+'/Negative Long-Term IDR reflects its strong position in the large and stable market for medical/surgical products. The company has established a wide array of branded products for sale to acute care, post-acute care, physician office and surgery center markets. The company's vertical integration of manufacturing capabilities, distribution network and global sourcing relationships differentiates Medline from its principal competition: Cardinal Health, Inc. (CAH; BBB/Stable), Owens & Minor, Inc. (OMI; BB-/Stable) and McKesson Corporation (MCK; BBB+/Stable). Medline's strategy of leading with manufactured products helps to subsidize and win prime-vendor relationships with large integrated delivery networks.

Private label products comprise a majority of Medline's revenue and gross profits compared to significantly lower amounts for CAH and OMI. While OMI, CAH and MCK focus on parts of the acute care, post-acute care, physician office and surgery center markets, only CAH has a comparable segment focus and level of price competitiveness. The company's EBITDA margins are significantly higher than other distributors (including AmerisourceBergen) because of the amount of branded products that it sells. Fitch believes that private label products offer higher margins, albeit at lower price points.

The IDRs of Mozart Holdings, LP and Medline Borrower, LP are rated on a consolidated basis as discussed in Fitch's Parent-Subsidiary Linkage Criteria using the weak parent/strong subsidiary approach, open access and control factors based on the entities operating as a single enterprise with strong legal and operational ties.

Key Assumptions

Revenue increases at a CAGR of approximately 4-5% over the period 2022-2025 (the forecast period);

Adjusted EBITDA margins are maintained between 11%-12% over the forecast period;

Working capital changes represent a use of cash of approximately $200-300 million each year over the forecast period;

Capex of approximately $350 million per year;

FCF is used principally to fund MPU payments in 2022 and 2023 and thereafter to reduce debt; discretionary debt reduction is used while maintaining cash balances of at least $200 million;

Secured mortgage debt of $2.230 billion is assumed to be senior to all other senior secured and senior unsecured debt.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Expectation of sustaining gross debt/EBITDA (including secured mortgage debt) at or below 5.0x by the end of fiscal 2023;

FCF of approximately $750 million-$1.0 billion/year is applied to the reduction of debt over the next three years;

Operational strength demonstrated by customer retention and market share growth leading to increasing CFO;

Expectation of EBITDA margins remaining above 13% and FCF/debt remains consistently above 10%.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Expectation of sustaining gross debt/EBITDA (including secured mortgage debt) at or above 6.0x by the end of fiscal 2023;

FCF is not used principally for debt reduction;

Total revenue growth rate declines to low-to-mid-single digits as a result of customer turnover and price concessions;

Expectation of EBITDA margins falling below 10% and FCF/debt remaining consistently below 5%.

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

Ample Liquidity: Fitch expects Medline's cash flow from operations together with its revolving credit facilities will be sufficient to fund its long-term and short-term capital expenditures, working capital and debt service requirements. The company's revolving credit facility has a financial covenant that provides ample room to borrow in the event of liquidity stress (7.5x, excluding the company's CMBS debt).

Cash and cash equivalents needs are expected to range between $200 million-$300 million and excess cash is expected to be used to pay down debt after servicing MPU payments. Interest coverage (operating EBITDA/interest paid) is expected to remain between 2.5x-3.0x.

Debt Maturities: The amortization of the term loan B is expected to be approximately $70 million/year through maturity in 2028 and all debt maturities are at least five years or longer, except the CMBS debt due 2023. Fitch expects Medline to exercise its option to extend the loan for one year and has two more one-year options to extend thereafter; hence, refinancing risk remains low over the forecast period. Fitch expects that Medline will apply substantially all of its FCF to debt reduction over the forecast period after it has paid the remaining estimated $500 million in MPU payments in 2023.

Rating Recovery Assumptions

Fitch estimates an enterprise value (EV) on a going-concern basis of approximately $10.125 billion for Medline, after deduction of 10% for administrative claims. The EV assumption is based on a post-reorganization EBITDA of $1.5 billion and a 7.5x multiple; neither assumption has changed since Fitch's initial rating assignment.

The post-reorganization EBITDA estimate is approximately 35% lower than Fitch's 2022 adjusted EBITDA estimate. Fitch's estimate of the post-reorganization EBITDA is premised on an EBITDA approximating pre-pandemic levels, which assumes a significantly lower base of revenues and, therefore, EBITDA generation. A bankruptcy scenario could arise as a result of disruption to 3rd party manufacturing services and key supplier relationships along with decreasing prices for Medline's goods and services and an inability to timely reduce its expenses sufficiently to offset a material adverse effect on its business. In this scenario, Fitch expects Medline would need to reduce the size of its operations to offset the loss of revenue.

The 7.5x multiple employed for Medline reflects acquisition multiples of healthcare distributors and trading ranges of Mozart's peer group (CAH, OMI, MCK), which have fluctuated between 6x-12x in the recent past.

Instrument ratings and RRs for Medline's debt instruments are based on Fitch's Corporates Recovery Ratings and Instruments Ratings Criteria. Fitch includes Medline's CMBS debt in its waterfall (approximately $2.2 billion) that occupies a super-senior position. The secured mortgage debt is assumed to be fully recovered before the other senior secured and senior unsecured debt in the capital structure.

The waterfall analysis also includes secured credit facilities and notes as follows: a cash flow revolving credit facility (assumed to be fully drawn on $1.0 billion capacity); secured term loans (approximately $7.7 billion USD equivalent after concession allocation of 2%); and other secured debt (approximately $4.5 billion). The secured debt is expected to recover in a range of 51%-70% and, therefore, is rated 'RR3'.

Medline's senior unsecured debt of $2.5 billion ranks below other secured debt and is estimated to have a recovery in a range of 0%-10%; therefore, it is rated 'RR6'. Fitch has assumed 2% of the recovery value available to senior creditors is allocated to the senior unsecured debt.

Issuer Profile

Medline is the largest U.S.-based privately held manufacturer and distributor of health care supplies to hospitals, post-acute settings, physician offices and surgery centers.

Summary of Financial Adjustments

Fitch adjusted reported EBITDA to remove non-recurring costs, inventory normalization adjustments and non-operating income/expense. In addition, for the forecast periods, Fitch's leverage metrics include CMBS debt.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Medline has an ESG Relevance Score of '4' for Governance Structure, because of the challenge of managing financial policy and capital allocation objectives among the Mills family and the new major shareholders. This has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors.

Medline has an ESG Relevance Score of '4' for Group Structure, because of its complex capital structure and use of secured mortgage debt to fund a material portion of the acquisition of the company. This has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors.

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.

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