S&P Downgrades Teva Pharma (TEVA) to 'BBB'; Outlook is Stable (AGN)

S&P Global Ratings today lowered its ratings on on Teva Pharmaceutical Industries Ltd. (NYSE: TEVA), including the corporate credit rating to 'BBB' from 'BBB+', and removed the ratings from CreditWatch, where they were placed with negative implications on July 28, 2015. The outlook is stable.

At the same time, we lowered the ratings on the senior unsecured debt to 'BBB' from 'BBB+' and removed the ratings from CreditWatch, where they were placed with negative implications on Nov. 25, 2015.

"The planned $40.5 billion acquisition of Allergan's (NYSE: AGN) generics unit, expected to close in July 2016, combines two of the leading players in the growing worldwide generic drug business and further strengthens Teva's position in the core generic pharmaceutical business, adding size and scale, pipeline depth, and increased geographic penetration," said S&P Global Ratings credit analyst Kim Logan. Pro forma for the acquisition, Teva's generic business will nearly double, firmly making it the largest generic drug maker in the world. We estimate that generics will account for roughly over 60% of Teva's revenues. The combined generic drug pipeline will have an estimated over 320 drugs, including over 110 first-to-file opportunities (which may have 180 days of marketing exclusivity), which will enable the company to drive growth in the segment. In an industry where size and scale is important, Teva's increased size and product pipeline will enable it to better counter increasing pricing pressure in the generics industry by putting it in a better negotiating position with payors and wholesalers in the U.S. that have been exerting greater pricing pressure in recent quarters. Still, given the intense competition in the generics industry and the constant price pressure, we project relatively flat sales for the segment through 2017.

We do not expect Teva to experience significant difficulties in integrating Allergan's generic business. Teva has been one of the more active consolidators in the generic drug industry and its management team has had a relatively successful track record in combining operations and realizing synergies, having acquired large players such as Barr Labs, Ratiopharm and IVAX in the past.

Our stable rating outlook on Teva Pharmaceutical Industries Ltd. reflects our view that both its specialty and generic franchises remain solid despite patent expirations on high-margin products in its specialty branded business, and its operating cash flow remains substantial. While we incorporate the possibility of increased debt-financed acquisition activity, we project leverage should remain under 2x longer term.

We could lower the rating if the company experiences unforeseen operational difficulties in integrating Allergan's generic drug business or a steeper-than-expected drop in high-margin Copaxone sales, causing a drop in EBITDA margins and cash flows. However, we believe the more likely downside scenario is Teva following up the Allergan generics acquisition with additional large debt-financed acquisitions. While we project Teva to remain acquisitive to a degree over the next several years, projected net adjusted leverage of over 4x over an extended period would lead us to contemplate a further downgrade.

Assuming an efficient integration of the acquired generic drug operations, realization of synergies, and stabilized Copaxone sales, we believe Teva will steadily de-lever. Management has stated its target of reducing leverage to the 2x range. However, we do not project leverage dipping under 3x, a catalyst for discussing the possibility of a ratings upgrade, until near the end of 2018, which is a little bit beyond our outlook period.

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