Fitch Ratings has affirmed Medline Borrower, LP's (Medline) Long-Term Issuer Default Rating (IDR) at 'B+'.

The Rating Outlook is revised to Negative from Stable.

The Outlook revision is primarily based on Fitch's expectation that Medline's EBITDA growth will be slower than anticipated, and, therefore, the company's leverage may remain significantly above our prior expectations, which were set at gross leverage (gross debt/EBITDA) of 6x or lower by YE 2023. In addition, leverage may remain higher for a longer period of time if the company elects to use FCF to make payments in 2022 and 2023 under a Management Performance Unit (MPU) Plan in lieu of reducing debt. Fitch could stabilize the Outlook and affirm the ratings if inflationary pressures subside or if Medline is able to mitigate such pressures.

The ratings applied to approximately $17 billion of debt as of Dec. 31, 2021.

Fitch has also assigned a 'B+' IDR to Mozart Holdings, LP with a Negative Outlook. Mozart Holdings, LP is the parent of Medline Borrower, LP and the reporting entity of the consolidated financial statements. The IDRs 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 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 produces a high level of profitability and cash flow. Investments in new and existing capacity are expected to remain relatively stable over the forecast horizon.

Leverage Profile is High: Pro forma for the acquisition of Medline by Blackstone, Carlyle and Hellman & Friedman (the Sponsors), gross leverage (gross debt/EBITDA) is above 7.0x and FCF/Debt is below 5%. Gross debt is expected to be reduced over the medium to long term, however, the amount and timing of debt reduction will depend largely on whether Medline uses FCF to reduce debt or to make payments under an MPU Plan or to make acquisitions. Also, gross leverage will depend heavily on revenue and EBITDA growth. Inflationary headwinds are expected to persist over the medium term, however, Medline is believed to have broad pricing power to offset those headwinds. Implementation of price increases is expected to 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: Following the acquisition of Medline, the Mills family remains the single largest shareholder in the company. However, the Mills family no longer controls the company and will need to work with the Sponsors to undertaking significant actions, such as entering into material M&A transactions, issuance of debt or equity, or paying of material dividends. Fitch believes two critical assumptions underpinning its forecast for Medline are the ability of the Mills family and the Sponsors to work together effectively and to reduce debt over the near to medium term.

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.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer

Revenue increases at a CAGR of approximately 5% over the period 2021-2025 (the forecast period);

EBITDA margins are maintained at approximately 10.0%-10.5% over the forecast period;

Working capital changes represent a use of cash of approximately $150 million-$200 million each year over the forecast period;

Capex of approximately $400 million per year;

Cash distributions made for equity investors' tax liabilities of approximately $300 million-$350 million over the forecast period;

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 facility (RCF), will be sufficient to fund its long-term and short-term capex, working capital and debt service requirements. The company's RCF has a financial covenant that provides ample room to borrow in the event of liquidity stress. Fitch expects modest use of the RCF to fund working capital needs.

Cash and cash equivalents are expected to remain above $200 million over the forecast period and interest coverage (operating EBITDA/interest paid) is expected to remain above 2.5x.

Debt Maturities: The amortization of the term-loan B is expected to be approximately $73 million/year through maturity in 2028 and all debt maturities are at least five years or longer; hence, refinancing risk remains low over the forecast period (through 2025). It remains to be determined whether Medline will apply most of its FCF in 2022 and 2023 for MPU payments; thereafter, Fitch assumes substantially all of the FCF is used to pay debt, except for the application for 'tuck-in' acquisitions.

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 not changed since Fitch's initial rating assignment.

The post-reorganization EBITDA estimate is approximately 29% lower than Fitch's 2021 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.

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 and therefore is rated 'RR1'.

The waterfall analysis also includes secured credit facilities and notes as follows: 1) a cash flow revolving credit facility (assumed to be fully drawn on $1.0 billion capacity; Fitch's initial rating recovery analysis assumed an 80% draw or $800 million), 2) secured term loans (approximately $7.8 billion USD equivalent); and 3) 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.

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.

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.

RATING ACTIONS

Entity / Debt

Rating

Recovery

Prior

Medline Co-Issuer, Inc.

senior unsecured

LT

B-

Affirmed

RR6

B-

senior secured

LT

BB-

Affirmed

RR3

BB-

Mozart Holdings, LP

LT IDR

B+

New Rating

Medline Borrower, LP

LT IDR

B+

Affirmed

B+

senior unsecured

LT

B-

Affirmed

RR6

B-

senior secured

LT

BB-

Affirmed

RR3

BB-

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VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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