Moody's Cuts Glaxo's (GSK) L-T Issuer Rating to 'A2'; Credit Profile has Deteriorated Over Last Half-Year

Moody's Investors Service, ("Moody's") has today downgraded GlaxoSmithKline plc's (NYSE: GSK) long-term issuer rating to A2 from A1. Concurrently Moody's has affirmed the group's short-term P-1 rating. The outlook on all ratings is stable. This rating action concludes our review process initiated on 23rd April 2014.

The downgrade to A2 was triggered by two key factors:

1. The deterioration of GSK's credit profile over the past 6 months, mainly as a result of material currency headwinds and volume declines (-14% in H1 2014) and price pressures (-7% in H1 2014) of its key respiratory drug, Advair, in the US.

2. Material contingent liability arising from a put option granted to Novartis AG as part of a three-leg M&A transaction signed earlier this year.

RATINGS RATIONALE

-- GSK'S DETERIORATING CREDIT PROFILE

GSK's credit profile has deteriorated markedly over the past six months to 30th June 2014. Cash Flow from Operations/debt has dropped to 28% as per LTM June 2014, from 33.9% as per 31 December 2013, mainly as a result of volume declines (-14% in H1 2014) and price pressures (-7% in H1 2014) of GSK's key respiratory drug, Advair, in the US in addition to material currency headwinds. Moody's expects that GSK's operating performance and cash flow generation will remain under pressure as the group goes through a 6 month transition period for its respiratory franchise. Although the newly launched Breo Ellipta and Anoro Ellipta are ramping up, they cannot compensate for the pressure on Advair. Moody's does not expect that GSK's credit profile will improve over this period, and as a result, it is no longer aligned with the requirements for an A1 rating. Based on GSK's current and expected credit metrics, the group is weakly positioned in the A2 rating category. At the same time Moody's reiterates its view that the transaction with Novartis, especially through the strengthening of its over-the-counter business, will give GSK more earnings and cash flow stability and reduce its exposure to patent expiries. This consideration also mitigates GSK's current financial profile, which is weak for an A2 rated issuer.

-- MATERIAL CONTINGENT LIABILITY

The contingent liability from the put option granted to Novartis as part of a three-leg M&A transaction signed earlier this year will exert pressure on the group's credit profile, even though it is not exercisable before 3 years after the closing of the deal (expected in H1 2015). Moody's estimates that the put option could be valued in excess of GBP6 billion based on a valuation multiple of 8x EBITDA. The rating agency, however, expects that GSK will try to mitigate the potential effect of the put option on both GSK's long- and short-term credit profile, although some of the options available to GSK bear execution risk.

The affirmation of the short-term ratings of GSK and affected subsidiaries reflects Moody's view that the liquidity profile of GSK remains strong despite some pressures on operating cash flow generation in H1 2014. GSK's liquidity profile is supported by approximately GBP3.2 billion of cash on balance sheet and close to GBP3.4 billion availability under revolving credit facilities. Alongside the group's operating cash flow generation before working capital movements this should be more than sufficient to cover all liquidity needs mainly pertaining to (1) dividends (GBP3.8 billion); (2) debt maturities (GBP1.9 billion); and (3) capex (around GBP1.2 billion).

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook assigned to the ratings reflects Moody's opinion that GSK will be able to successfully navigate this period of transition in its respiratory franchise and that the current weakness in the group's credit profile is transitional. This view is supported by the group's strong portfolio of respiratory compounds having just been launched or in late stage development, as well as the group's strong track record in the respiratory market. At the same time Moody's notes that competition is heating up in the respiratory market, with several large pharmaceutical groups launching new products or having compounds in late stage development. The stable outlook is predicated upon GSK's ability to restore a CFO/debt ratio of above 30% (moving towards 25% including the put option) and a cash/debt ratio of more than 20% (above 15% including the put option into our debt adjustment) over the next 18 to 24 months, a level more commensurate with an A2 rating. CFO/Debt is expected to be impacted by 7 to 9 percentage points when including the put option into our debt adjustment and depending on the valuation multiple used; cash/debt is also expected to be impacted by 5 to 6 percentage points including the put option into our debt adjustment.

WHAT COULD CHANGE THE RATING UP/DOWN

Positive rating pressure is not anticipated in the short term. GSK could achieve a higher rating over time if CFO/debt were to move to above 40% (above 35% including the put option) and cash/debt to above 30% (above 25% including the put option) on a sustainable basis.

Negative pressure would build on the rating if GSK were not able to restore CFO/debt above 30% (moving towards 25% including the put option) and cash/debt above 20% (above 15% including the put option) over the next 18 to 24 months. Any indication that the group's respiratory franchise's medium to long term business prospects would deteriorate, through a further material decline in Advair market share and / or a weaker than expected take up in new products such as Breo Ellipta and Anoro Ellipta or other compounds in late stage development, could lead to further negative pressure on the rating.

The principal methodology used in these ratings was the Global Pharmaceutical Industry published in December 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

List of Affected Ratings:

Downgrades:

..Issuer: GlaxoSmithKline Capital Inc.

....Senior Unsecured Regular Bond/Debenture A2 from A1

....Senior Unsecured Shelf, Downgraded to (P)A2 from (P)A1

..Issuer: GlaxoSmithKline Capital Plc

....Senior Unsecured Medium-Term Note Program, Downgraded to (P)A2 from (P)A1

....Senior Unsecured Regular Bond/Debenture, Downgraded to A2 from A1

....Senior Unsecured Shelf, Downgraded to (P)A2 from (P)A1

..Issuer: GlaxoSmithKline plc

.... Issuer Rating, Downgraded to A2 from A1

....Senior Unsecured Medium-Term Note Program, Downgraded to (P)A2 from (P)A1

....Senior Unsecured Shelf, Downgraded to (P)A2 from (P)A1

Outlook Actions:

..Issuer: GlaxoSmithKline Capital Inc.

....Outlook, Changed To Stable From Rating Under Review

..Issuer: GlaxoSmithKline Capital Plc

....Outlook, Changed To Stable From Rating Under Review

..Issuer: GlaxoSmithKline plc

....Outlook, Changed To Stable From Rating Under Review

Affirmations:

..Issuer: GlaxoSmithKline Capital Plc

....Senior Unsecured Medium-Term Note Program, Affirmed (P)P-1

..Issuer: GlaxoSmithKline Finance Plc

....Senior Unsecured Commercial Paper, Affirmed P-1

..Issuer: GlaxoSmithKline LLC

....Senior Unsecured Commercial Paper, Affirmed P-1

..Issuer: GlaxoSmithKline plc

....Senior Unsecured Medium-Term Note Program, Affirmed (P)P-1

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