Fitch Ratings has affirmed Inovie Group's (Inovie) enlarged senior secured term loan B's (TLB) rating at 'B+' with a Recovery Rating of 'RR3', in line with our expectations when the EUR775 million fungible TLB add-on was launched in November 2021.

Fitch also affirmed Inovie's Long-Term Issuer Default Rating (IDR) at 'B' with a Stable Outlook.

The affirmation follows the pricing of the add-on TLB and the receipt of final documentation that was substantively in line with the draft documentation provided by the company.

The 'B' IDR of Inovie reflects its smaller scale than rated peers' and its high financial leverage, pro-forma for its announced M&A and contemplated changes in its capital structure. This is compensated by its strong position in the highly regulated and non-cyclical French lab-testing market and strong profitability. Our expectation of robust free cash flow (FCF) generation implies sound deleveraging capabilities, albeit subject to the group's future financial policy, including the profile and funding of future acquisitions.

The Stable Outlook reflects Fitch's expectation that Inovie will maintain some deleveraging capacity, with manageable execution and adequate financial flexibility to implement its future growth strategy.

Key Rating Drivers

Sustainable Business Model: The rating continues to reflect our view of Inovie's sustainable business model in a defensive sector. The group is the third-largest network of private medical-testing laboratories in France, with a historical focus on south and central France. We expect Inovie to benefit from stable non-Covid-19 revenue, high and resilient operating margins and superior cash generation, due to a supportive regulation-and-reimbursement regime, combined with strong barriers to entry.

M&A to Drive Growth: In 2021 Inovie announced bolt-on acquisitions worth close to EUR600 million. We expect Inovie to continue to build its market share in France and to capitalise on a sound and focused M&A strategy, targeting smaller laboratories in its existing and adjacent regions, where it can extract cost savings from an enlarged business scale.

Subdued French Market Growth: We assume the non-cyclical and highly regulated French private lab-testing market to show muted growth (0%-2%) over the next three years, with volume increases offset by lower prices. The market is rapidly consolidating but still has multiple independent laboratories and small laboratory chains.

Positive Near-Term Covid-19 Impact: While the initial lockdown temporarily reduced the sales and profit margins of Inovie's routine-testing business, this was more than offset in 2020 by Covid-19 tests of around EUR200 million. We estimate Covid-19 test sales to have increased above EUR400 million in 2021, due to the French government's supportive policy, which targeted a high number of tests and fully reimbursed Covid-19 PCR test without the need of a prescription or symptoms to get tested, unlike the approach taken by other countries. France had also one of the most generous reimbursement prices for the test, at around EUR73 including sampling cost, but in 3Q21 reimbursement price was cut to EUR35-EUR45 and tests are now reimbursed only to the vaccinated.

Covid-19 Contribution to Decline Post-2021: Fitch forecasts a drastic reduction in Covid-19 testing activity and profitability by 2023, driven by lower reimbursement prices and an expected decrease in volumes, due to the successful rollout of a vaccination programme across a large share of the population. Nonetheless we assume that Covid-19 testing will remain an additional revenue stream in the medium term, with margins broadly in line with the group's EBITDA margin.

Some Diversification Benefits: We view Inovie's diversification in the specialty test (around 15% of non-Covid-19 revenue) as beneficial, as these tests are less regulated (not included in the budgetary scope governed by the triennial act) and offer long-term growth opportunities. We view Inovie as firmly placed to withstand potential tariff pressure relative to smaller peers, given its critical size and operational efficiencies.

Strong Cash Flow: We expect Inovie's non-Covid-19 EBITDA margin to have expanded towards 30% in 2021 and to rise to 32% by 2023. The higher margin will mostly be driven by the agreed re-alignment of the salary of partner biologists to market standards, optimisation of the ratio of biologists per lab and a reduction of reagent costs. We expect this to increase FCF margin to the low teens, higher than the levels achieved by Synlab and broadly similar to other French peers'.

Financial Policy Drives Rating Trajectory: We expect Inovie's buy-and-build M&A strategy to allow for satisfactory deleveraging, subject to multiples paid for lab targets, and the financing mix (including equity reinvested by biologists of acquired labs). We deem its EUR332 million special dividend used to repay quasi equity as exceptional and justified by its very strong performance since 3Q20, due to Covid-19 tests.

Exceptionally high Covid-19 test activity in 2021 will result in moderate leverage. We expect funds from operations (FFO) adjusted gross leverage to stabilise at 6.5x-7.0x, and total adjusted debt/ operating EBITDAR below 5.5x over 2023-2025 once Covid-19 activity normalises, which is adequate for the rating. We expect Inovie to finance bolt-on acquisitions with FCF.

Derivation Summary

Inovie's 'B' IDR is in line with that of Laboratoire Eimer Selas (Biogroup; B/Stable) and below that of Synlab AG (BB/Stable), which are direct routine medical lab-testing peers. Inovie's profitability, cash generation and leverage, as well as those of direct peers, benefited from Covid-19 related activity in 2020 and 2021, which we expect to decrease in 2022 and to normalise at much lower levels from 2023.

Inovie is smaller in scale and less diversified geographically than its rated peers, making it highly exposed to the French market and to potential reimbursement changes in the medium term. Synlab is well-diversified across Europe, while Biogroup has expanded to Belgium. Inovie's lack of geographical diversification is somewhat compensated by a more diversified product offering, with around 15% of its non-Covid-19 revenue derived from specialty testing.

Inovie's leverage is lower than Biogroup's but much higher than Synlab's. Synlab materially decreased its FFO adjusted gross leverage to 3.5x, following its recent IPO. We expect Inovie's FFO adjusted gross leverage to be in line with a 'B' IDR, at slightly below 7x in the medium term once Covid-19 activity normalises. This compares with our expectation of Biogroup's 8x FFO adjusted gross leverage in the medium term. In addition, Inovie has witnessed less aggressive external growth over recent years, which is characterised by more prudent financing, equity partnerships with biologists and smaller targeted acquisitions.

Compared with investment-grade global medical diagnostic peers such as Eurofins Scientific S.E. (BBB-/Stable) and Quest Diagnostics Inc (BBB/Stable), Inovie is smaller and geographically concentrated, more exposed to the routine lab-testing market and has much higher leverage.

Inovie's rating is supported by our expectation of strong profitability and cash flow generation. Inovie's expected profitability is higher than Synlab's and similar to that of French peers.

Key Assumptions

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

Organic sales growth of non-Covid-19 business at 2.2% in 2021, 1% in 2022 and 0.5% p.a. over 2023-2025

Covid-19 revenue above EUR400 million in 2021, before normalising gradually in the following years (25% of 2021 revenue in 2022, 15% in 2023 and 7% in 2024-2025)

Group EBITDA margin around 38% in 2021 and around 32% over 2022-2025, with EBITDA margin of non-Covid-19 business at 30% in 2021, 31% in 2022 and 32% in 2023-2025. EBITDA margin of Covid-19 business at 50% in 2021, 40% in 2022 and 35% in 2023-2025

Acquisitions for a total amount of EUR830 million over 2022-2025

Annual bolt-on acquisitions assumed at a 10x EBITDA and 20%-financed with equity related to biologists reinvesting in the business

Capex at 1.9% of revenue in 2021, followed by 2.5% to 2025

Operating leases at 4% of revenue, excluding Covid-19 tests from 2021 onwards

Taxes paid at 23% of EBITDA from 2022 to 2025

EUR20 million working-capital outflow in 2021; no major swings in working capital in 2022-2025

Dividend of EUR332 million in 2021 to repay convertible bond. No further dividend over the following four years

EUR50 million earn-out paid to shareholders in 2022, purchase of put/call options of EUR10 million in 2021 and EUR20 million in 2023

RECOVERY ANALYSIS ASSUMPTIONS

In Fitch's recovery analysis, we follow a going-concern (GC) approach as this leads to higher recoveries than a liquidation approach in the event of bankruptcy.

GC EBITDA (post-announced acquisitions) estimated at EUR208 million. Our GC EBITDA includes the annualised contribution of acquisitions secured as of November 2021 and only includes a small long-term contribution from Covid-19 tests. This level of EBITDA, which could be caused by lower reimbursement, would lead to materially lower FCF corresponding to a minimum level of earnings required to cover its cash debt service, tax, maintenance capex and trade working capital.

Distressed enterprise value (EV)/EBITDA multiple of 5.5x, which implies a discount of 0.5x against the 6.0x multiple used for more geographically diversified and larger peers Synlab and Biogroup.

Committed revolving credit facility (RCF) of EUR175 million assumed to be fully drawn upon default, in line with Fitch's Corporates Notching and Recovery Ratings Criteria.

EUR126 million of structurally higher-ranking senior debt at subsidiary level, ranking ahead of the RCF and TLB.

After deducting 10% for administrative claims from the estimated post-distress EV, our waterfall analysis generates a ranked recovery for the senior secured debt (including RCF and TLB) in the 'RR3' band, indicating a 'B+' instrument rating for the enlarged TLB, with a waterfall-generated recovery computation of 52%.

RATING SENSITIVITIES

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

A larger scale and/or increased product/geographical diversification, while maintaining EBITDA margin

Total adjusted debt/operating EBITDAR below 5.0x, or FFO adjusted gross leverage trending towards 6.0x on a sustained basis (pro-forma for acquisitions)

FFO fixed charge coverage above 3.0x on a sustained basis (pro-forma for acquisitions)

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

Loss of M&A target selection discipline leading to weak operating performance, continued dividend payment policy leading to increased leverage and/or adverse regulatory changes eroding profitability

Total adjusted debt/operating EBITDAR above 6.5x, or FFO adjusted gross leverage above 8.0x on a sustained basis (pro-forma for acquisitions)

FFO fixed charge coverage below 2.0x on a sustained basis (pro-forma for acquisitions)

FCF margin in low single digits on a sustained basis

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

Comfortable Liquidity: We estimate Inovie to have had around EUR500 million in readily available cash at end-2021 following the successful issuance of its EUR775 million add-on TLB and the payment of EUR332 million in dividends to repay quasi equity instruments. In addition, Inovie has EUR175 million in undrawn committed bank facilities maturing in 2027 and no other debt maturities until 2027.

Our expectation of consistently positive FCF generation also enhances Inovie's liquidity profile and financial flexibility.

Issuer Profile

Inovie operates the third-largest network of private medical-testing laboratories in France. Established in 2009, Inovie is a market leader in the French private medical laboratory testing industry with a strong footprint in the south/centre of France. Its activities include routine (85% of estimated 2021 revenues excl. Covid-19) and specialty testing (15% of 2021 revenues excl. Covid-19).

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

Inovie has an ESG Relevance Score of '4' for Social Impacts, due to its exposure to the French regulated French medical lab-testing market, which has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors. The French medical lab-testing market is subject to pricing and reimbursement pressures as governments seek to control national healthcare spending. Adverse regulatory changes in the lab-testing services sector may, therefore, have a negative impact on Inovie's ratings. This is, however, mitigated by the 2020-2022 triennial plan agreement, providing some market growth and earnings visibility until December 2022.

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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