S&P Affirms Ratings, Outlook on Boston Scientific (BSX) Following J&J Settlement

Standard & Poor's Ratings Services affirmed its ratings on Marlborough, Mass.-based Boston Scientific Corp. (NYSE: BSX), including its 'BBB-' corporate credit rating and senior unsecured rating. The outlook is stable.

"The rating affirmation incorporates our expectation that the company is committed to offsetting this type of adverse event by constraining shareholder distributions and acquisition spending, as needed, to reduce adjusted debt leverage below 4x, within a reasonable time frame," said Standard & Poor's credit analyst David Kaplan.

Boston Scientific announced a legal settlement with Johnson & Johnson relating to the Guidant acquisition, under which Boston Scientific will pay $600 million over the next two months. We expect the company to use cash on hand and from free cash flow for the payment.

This settlement increases our adjusted net debt leverage, as we did not expect a settlement of this size for this case. Moreover, this outlay will not reduce the legal reserves of $972 million, which we include in our measure of adjusted debt. We continue to monitor the company's liability relating to its other outstanding cases, especially the mesh litigation, where we think reserves may still increase.

Although our estimate of EBITDA takes into account legal and restructuring charges that we characterize as recurring, we have excluded the $600 million settlement as one time in nature, given the nonrecurring nature of the claim and the substantial size and lumpiness of this charge which would unduly distort 2015 metrics.

While this charge increases our adjusted net debt leverage by about 0.4x to about 4.5x, which is weak for our financial risk assessment of "significant," we expect leverage to decline to 4.2x for 2015 and to 4.0x or below for 2016. We expect a modest improvement in operating performance and an easing burden of ongoing legal expenses to drive that improvement in leverage. These expectations, along with Boston Scientific's strong free cash flow generation, and the ratio of free operating cash flow to debt of 16% in 2014 and 13% for 2016 supports the financial risk assessment ( notwithstanding the weakness in that metric for 2015, stemming from this legal settlement).

Our rating outlook on Boston Scientific Corp. is stable. We expect low- to mid-single-digit revenue growth in 2015 and 2016, with the help of double-digit growth in certain smaller product and geographic markets. We expect internally generated cash flow to fully cover acquisitions and earn-out payments and for the company to constrain acquisitions and returns to shareholders as needed to offset an increase in leverage from material adverse legal settlements.

Given the company's ability to redirect free cash flow to increase cash balances or reduce debt, we believe it's unlikely that legal settlements would lead to a downgrade. We could, however, lower the rating if we believed an adverse legal judgment or additional reserves increase debt to EBITDA materially above current levels without the company establishing a clear trajectory of reducing leverage to below 4x within two years. Given the current financial policy and our performance expectations, the rating has limited capacity for additional debt.

We could raise the rating if adjusted debt leverage improves to less than 4x, which could lead us to remove the negative modifier. This could occur in 2015 if the outstanding litigation issues are resolved overwhelmingly in the company's favor or if recurring legal and restructuring expenses subside, helping EBITDA margins increase by 300 basis points. We could also upgrade Boston Scientific if it redirected free cash flow to reduce debt or increase cash balances.

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