Overview
-- Wilmington, N.C.-based contract research organization (CRO)Pharmaceutical Product Development LLC (PPD) is issuing $500 million in notesthat, together with $115 million in cash, the company will use to fund asponsor dividend.
-- Pro forma the transaction, we expect leverage (including our standardanalytical adjustments) to increase to above 7x, a departure from our priorexpectation that leverage would decline below 6x this year.
-- We are lowering the corporate credit rating to 'B' from 'B+', therating on the senior secured credit facilities to 'B+', and the rating on theexisting senior notes to 'B-'. The '2' recovery rating on the senior securedcredit facilities and the '5' recovery rating on the senior notes areunchanged.
-- At the same time, we are assigning PPD's proposed $500 million PIKoption notes a 'CCC+' rating with a recovery rating of '6'.
-- The stable outlook reflects our expectation that PPD will continue tobenefit from growing demand, but that sponsor ownership will result infinancial policy that directs free cash flow to growth opportunities andshareholders, rather than to debt repayment.
Rating ActionOn Oct. 10, 2012, Standard & Poor's Ratings Services lowered its corporatecredit rating on contract research organization Pharmaceutical ProductDevelopment LLC to 'B' from 'B+'. The outlook is stable.
In addition, we lowered our issue-level ratings on the company's existing debtby one notch in conjunction with the downgrade. We lowered our rating on thesenior secured credit facility to 'B+'. The recovery rating on this debt isunchanged at '2', reflecting our expectation for substantial (70% to 90%)recovery in the event of payment default. We also lowered our rating on thesenior notes to 'B-'. The recovery rating on this debt is unchanged at '5',reflecting our expectation for modest (10% to 30%) recovery in the event of apayment default.
At the same time, we assigned the company's proposed $500 million holdingcompany PIK option notes a 'CCC+' issue-level rating with a recovery rating of'6' (0% to 10% recovery expectation).
Rationale
The rating downgrade follows the company's announcement that it will issueadditional debt to fund a sponsor dividend less than one year following the2011 leveraged buyout. Pro forma leverage will increase from the low 6x rangeto more than 7x, versus our prior expectation that leverage would decrease tobelow 6x by year end from EBITDA growth.
The ratings on PPD reflect the company's "highly leveraged" financial riskprofile and "fair" business risk profile, according to Standard & Poor'sRatings Services' criteria. Our assessment of a highly leveraged financialrisk profile incorporates our belief that leverage, which increases to over 7xpro forma the new debt issuance, will remain above 6x over the next two years.It also reflects our expectation that funds from operations to total debt willbe sustained in the high single digits, consistent with a highly leveragedfinancial risk profile.
On a year-to-date basis, PPD's low-double-digit revenue growth has exceededour mid- to high-single-digit estimates, and EBITDA margins have been in linewith our expectations. Based on year-to-date trends and strong first-half netauthorizations, we believe PPD will generate low-double-digit revenue growththis year, which incorporates our expectation of mid- to high-single-digitgrowth for the late-stage segment of the CRO industry and modest market shareexpansion by the largest CROs (including PPD). Based on high-single-digitincreases in net authorizations in the first half of 2012, we expect that 2013revenue growth will be at least in the mid to high single digits. While webelieve the company will realize some scale efficiencies as the businessgrows, we expect that these savings will be mostly offset by higher laborcosts, resulting in flat EBITDA margins and funds from operations to totaldebt in the mid single digits over the next two years.
Our assessment of PPD's business risk profile as fair considers the cyclicalnature of the CRO business and exposure to contract cancellation risk, whichis only partly offset by PPD's position as one of the biggest players in aconsolidating industry and its focus on more stable and predictable late-stagedevelopment work. PPD is the solid No. 2 player in late-stage clinicaldevelopment services and is one of a relatively small number of CROs with aglobal footprint. We believe its scale and global presence will allow it tobenefit disproportionally from industry growth as bigger pharmaceuticalcompanies continue consolidating their development work with a small number oflarger, global CRO partners. Based on our belief that outsourcing penetrationwill continue to grow, we expect demand for late-stage clinical testing tocontinue to grow at least at a low- to mid-single-digit pace over the nextfive years.
Liquidity
Our assessment of PPD's liquidity profile as adequate incorporates thefollowing expectations and assumptions:
-- Sources of liquidity should exceed uses by at least 1.2x over the next12 to 24 months.
-- Sources of liquidity include access to an undrawn $175 millionrevolving credit facility, cash of over $200 million, and annual FFO of around$175 million.
-- Uses of cash include annual capital expenditures of about $75 million,working capital usage, commitments to joint ventures, and an annual debtamortization payment of $14.5 million.
-- We expect ample covenant cushions under a generous covenant test willallow for access to the company's revolver.
-- Even if EBITDA declines by 20%, liquidity will continue exceedingneeds.
Recovery analysisFor the complete recovery analysis, please see our recovery report on PPD tobe published on RatingsDirect following this release.
Outlook
Our stable rating outlook on PPD reflects our expectation that mid- tohigh-single-digit revenue and EBITDA growth over the near term will result insome positive free cash flow, but that adjusted leverage will remain above 7xfor the next several quarters following the new debt issuance. We could lowerthe rating if an event jeopardized operating company liquidity and promptedthe holding company to elect their PIK option. Given the company's cashbalances and revolver availability, we think such a liquidity scenario wouldinvolve an unforeseen problem with quality or contract execution, resulting incontract losses and a diminished ability to compete for new work.
Our leverage expectations reflect our belief that sponsor ownership willcontinue to shape an aggressive financial policy, where cash flow isprioritized toward shareholder return, as opposed to permanent debt repayment.In addition, we do not expect to see a rapid near-term improvement in creditmetrics, and we believe that any improvement over the longer term would betemporary. As a result, upgrade consideration is unlikely.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18,2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- Standard & Poor's Revises Its Approach To Rating Speculative-GradeCredits, May 13, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ratings ListDowngradedTo From
Pharmaceutical Product Development LLC
Corporate Credit Rating B/Stable/-- B+/Stable/--Senior Secured B+ BB-Recovery Rating 2Senior Unsecured B- BRecovery Rating 5New RatingJaguar Holding Company I
$500M sr PIK toggle nts due 2017 CCC+
Recovery Rating 6
Complete ratings information is available to subscribers of RatingsDirect onthe Global Credit Portal at
. All ratings affectedby this rating action can be found on Standard & Poor's public Web site at. Use the Ratings search box located in the leftcolumn.(New York Ratings Team)
((e-mail: pam.niimi@thomsonreuters.com; Reuters Messaging:pam.niimi.reuters.com@reuters.net; Tel:1-646-223-6330;))