Moody's Affirms Ratings on Merck (MRK) Following Cubist Pharma Acquisition Announcement

Moody's Investors Service affirmed the ratings of Merck & Co., Inc. (NYSE: MRK)("Merck"). The affirmed ratings include the A1 senior unsecured notes guaranteed by Merck Sharp & Dohme Corp., the A2 senior unsecured notes that are not guaranteed, the A1 senior unsecured notes issued by Merck Sharp & Dohme Corp., and the Prime-1 commercial paper rating. The rating outlook is stable.

The rating affirmation follows the announcement that Merck will acquire Cubist Pharmaceuticals, Inc. (Nasdaq: CBST) ("Cubist") for approximately $9.5 billion.

"Despite good strategic rationale and high unmet medical need of Cubist's key products and pipeline opportunities, the debt-financed acquisition is credit-negative because of the high price being paid relative to EBITDA, cliff risk on the product Cubicin in 2018, and rising competition in the antibiotic space," stated Michael Levesque, Moody's Sr. Vice President.

"However, Moody's believes Merck will sustain debt/EBITDA below 2.5x while maintaining very high cash levels, excellent product diversity, and earnings growth," continued Levesque.

Ratings affirmed:

Merck & Co., Inc.:

A1 senior unsecured notes and bonds (guaranteed by Merck Sharp & Dohme Corp.)

A2 senior unsecured notes, bonds and revolving credit facility (not guaranteed by Merck Sharp & Dohme Corp.)

(P)A2 senior unsecured shelf

Prime-1 commercial paper

Merck Sharp & Dohme Corp.:

A1 senior unsecured debentures, notes, medium term notes and industrial revenue bonds

VMIG 1 industrial revenue bond

RATINGS RATIONALE

Merck's A1 rating on guaranteed debt obligations reflects the company's strong competitive position in the global pharmaceutical industry, its strong diversity, its high profitability and its strong cash flow. Merck will continue to maintain excellent liquidity arising from high cash and investment levels exceeding $20 billion. A key challenge for Merck will be offsetting the earnings drags caused by pressures affecting several product franchises with commercial success from its late stage pipeline. Moody's anticipates that ongoing cost restructuring will help Merck deliver earnings growth amid top-line pressure. Several late stage pipeline products have good potential, and the recent approval of oncology drug Keytruda creates an important new revenue stream.

The A2 rating on Merck's unsecured notes reflects their structural subordination to senior unsecured debt at the subsidiary level (primarily Merck Sharp & Dohme Corp.) and debt at the parent level (Merck & Co., Inc.) that benefits from a subsidiary guarantee from Merck Sharp & Dohme Corp. Moody's rates the non-guaranteed debt one-notch lower than the guaranteed debt reflecting typical notching practices for investment-grade issuers when structural subordination is significant.

The stable rating outlook reflects Moody's expectation that over the next two to three years Merck will sustain low-single digit growth and that that its debt/EBITDA will not increase beyond 2.5 times. While operating at the level of 2.5 times over the near-term, Merck has less cushion to absorb operating setbacks without facing pressure on its ratings.

Over time, the rating could be upgraded if Merck delivers solid top-line growth and improves its late-stage pipeline while sustaining debt/EBITDA below 1.5 times and CFO/debt above 50%. Conversely, the rating could be downgraded if Merck's debt/EBITDA exceeds 2.5 times or its CFO/debt falls below 30%. Factors which could cause this to happen include debt-financed acquisitions or share repurchases, failure to offset growth pressures with successful new product launches, or sales disruptions on any of its key product franchises.

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