-- Wilmington, N.C.-based contract research organization (CRO) Pharmaceutical Product Development LLC (PPD) is issuing $500 million in notes that, together with $115 million in cash, the company will use to fund a sponsor dividend.
-- Pro forma the transaction, we expect leverage (including our standard analytical adjustments) to increase to above 7x, a departure from our prior expectation that leverage would decline below 6x this year.
-- We are lowering the corporate credit rating to 'B' from 'B+', the rating on the senior secured credit facilities to 'B+', and the rating on the existing senior notes to 'B-'. The '2' recovery rating on the senior secured credit facilities and the '5' recovery rating on the senior notes are unchanged.
-- At the same time, we are assigning PPD's proposed $500 million PIK option notes a 'CCC+' rating with a recovery rating of '6'.
-- The stable outlook reflects our expectation that PPD will continue to benefit from growing demand, but that sponsor ownership will result in financial policy that directs free cash flow to growth opportunities and shareholders, rather than to debt repayment.
Rating Action On Oct. 10, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on contract research organization Pharmaceutical Product Development LLC to 'B' from 'B+'. The outlook is stable.
In addition, we lowered our issue-level ratings on the company's existing debt by one notch in conjunction with the downgrade. We lowered our rating on the senior secured credit facility to 'B+'. The recovery rating on this debt is unchanged at '2', reflecting our expectation for substantial (70% to 90%) recovery in the event of payment default. We also lowered our rating on the senior 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 a payment default.
At the same time, we assigned the company's proposed $500 million holding company PIK option notes a 'CCC+' issue-level rating with a recovery rating of '6' (0% to 10% recovery expectation).
The rating downgrade follows the company's announcement that it will issue additional debt to fund a sponsor dividend less than one year following the 2011 leveraged buyout. Pro forma leverage will increase from the low 6x range to more than 7x, versus our prior expectation that leverage would decrease to below 6x by year end from EBITDA growth.
The ratings on PPD reflect the company's "highly leveraged" financial risk profile and "fair" business risk profile, according to Standard & Poor's Ratings Services' criteria. Our assessment of a highly leveraged financial risk profile incorporates our belief that leverage, which increases to over 7x pro 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 will be sustained in the high single digits, consistent with a highly leveraged financial risk profile.
On a year-to-date basis, PPD's low-double-digit revenue growth has exceeded our mid- to high-single-digit estimates, and EBITDA margins have been in line with our expectations. Based on year-to-date trends and strong first-half net authorizations, we believe PPD will generate low-double-digit revenue growth this year, which incorporates our expectation of mid- to high-single-digit growth for the late-stage segment of the CRO industry and modest market share expansion by the largest CROs (including PPD). Based on high-single-digit increases in net authorizations in the first half of 2012, we expect that 2013 revenue growth will be at least in the mid to high single digits. While we believe the company will realize some scale efficiencies as the business grows, we expect that these savings will be mostly offset by higher labor costs, resulting in flat EBITDA margins and funds from operations to total debt in the mid single digits over the next two years.
Our assessment of PPD's business risk profile as fair considers the cyclical nature of the CRO business and exposure to contract cancellation risk, which is only partly offset by PPD's position as one of the biggest players in a consolidating industry and its focus on more stable and predictable late-stage development work. PPD is the solid No. 2 player in late-stage clinical development services and is one of a relatively small number of CROs with a global footprint. We believe its scale and global presence will allow it to benefit disproportionally from industry growth as bigger pharmaceutical companies continue consolidating their development work with a small number of larger, global CRO partners. Based on our belief that outsourcing penetration will continue to grow, we expect demand for late-stage clinical testing to continue to grow at least at a low- to mid-single-digit pace over the next five years.
Our assessment of PPD's liquidity profile as adequate incorporates the following expectations and assumptions:
-- Sources of liquidity should exceed uses by at least 1.2x over the next 12 to 24 months.
-- Sources of liquidity include access to an undrawn $175 million revolving 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 debt amortization payment of $14.5 million.
-- We expect ample covenant cushions under a generous covenant test will allow for access to the company's revolver.
-- Even if EBITDA declines by 20%, liquidity will continue exceeding needs.
Recovery analysis For the complete recovery analysis, please see our recovery report on PPD to be published on RatingsDirect following this release.
Our stable rating outlook on PPD reflects our expectation that mid- to high-single-digit revenue and EBITDA growth over the near term will result in some positive free cash flow, but that adjusted leverage will remain above 7x for the next several quarters following the new debt issuance. We could lower the rating if an event jeopardized operating company liquidity and prompted the holding company to elect their PIK option. Given the company's cash balances and revolver availability, we think such a liquidity scenario would involve an unforeseen problem with quality or contract execution, resulting in contract losses and a diminished ability to compete for new work.
Our leverage expectations reflect our belief that sponsor ownership will continue to shape an aggressive financial policy, where cash flow is prioritized toward shareholder return, as opposed to permanent debt repayment. In addition, we do not expect to see a rapid near-term improvement in credit metrics, and we believe that any improvement over the longer term would be temporary. 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-Grade Credits, 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 List Downgraded To From
Pharmaceutical Product Development LLC
Corporate Credit Rating B/Stable/-- B+/Stable/-- Senior Secured B+ BB- Recovery Rating 2 Senior Unsecured B- B Recovery Rating 5 New Rating Jaguar Holding Company I
$500M sr PIK toggle nts due 2017 CCC+
Recovery Rating 6
Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at
. All ratings affected by this rating action can be found on Standard & Poor's public Web site at . Use the Ratings search box located in the left column. (New York Ratings Team)