Fitch Ratings has downgraded Teva Pharmaceutical Industries Limited's (NYSE: TEVA) Issuer Default Rating (IDR) to 'BBB-' from 'BBB' with a Negative Outlook. The rating action reflects that Teva is facing significant operational stress at a time when it needs to reduce debt and leverage from its August 2016 acquisition of Actavis' generic drug business. Pricing pressure in the U.S. will weigh on operations in the near term, requiring the company to reduce debt both through FCF generation and asset divestitures. Additional uncertainty stems from an ongoing search for a CEO and CFO and potential generic competition against Copaxone 40mg.

KEY RATING DRIVERS

Deleveraging an Imperative: Teva needs to reduce leverage following its acquisition Actavis' generic business in August 2016 for approximately $40.5 billion. Estimated pro forma leverage was above 4.0x at deal close, and Fitch looks for leverage to near 3.5x during 2018. Teva has a number of levers to achieve deleveraging, including reducing costs to stabilize EBITDA and paying down debt with FCF (including reducing its dividend) and asset sales proceeds. Teva is in the process of restructuring and integrating the Actavis acquisition, as well as seeking buyers for various non-core assets, such as its European oncology and pain products and global women's health business.

Near-Term Industry Headwinds: Pricing pressure, particularly in the U.S., will likely continue to meaningfully weigh on revenue and margins in the near term. This is particularly concerning for the less differentiated product segments. Fitch expects aging populations in developed markets and increasing access to healthcare in emerging markets will support volume growth for Teva and its generic pharma peers. Increasing generic penetration in key markets like Japan and certain European nations will provide a platform for growth.

Asset Sales Required: Teva is taking meaningful steps to reduce costs and stabilize margins. However, operational stabilization and dividend reduction, alone, will not be enough to provide the EBITDA and FCF needed to reduce leverage to near 3.5x by year-end 2018. The company will also need to use the proceeds from asset divestitures to pay down debt. Management has identified $2 billion in asset sales by the end of 2017, but the transactions are not finalized. As with all asset sales, the valuation multiples (sales price/EBITDA) are variable and important inputs into the deleveraging potential.

Acquisition Strengthens Leading Position: The acquisition of Actavis Generics (Gx) solidified Teva's position as the largest generic drug firm in the world, combining the #1 (Teva) and #4 (Actavis Gx) players. The firm has unmatched scale in most relevant pharmaceutical markets. Scale has begun to factor even more prominently for generic drug makers in recent years, as the largest of purchasers have consolidated dramatically in the U.S. and Western Europe. The combination gives Teva a more competitive value proposition for these very large global purchasers.

Generic Copaxone 40mg Possible: Teva's best-selling product, Copaxone (approximately 18% of sales; approximately 40% of operating profits) is gradually declining in revenue as generic competition for the 20 mg version more than offsets the price increases on the patent-protected 40mg dosage form. Generic competition for Copaxone 40 mg could enter the U.S. market this year, depending on the outcome and timing of ongoing litigation, as well as the ability for Teva's competitor to obtain manufacturing approval for its product. The longer it takes to resolve these issues the better-positioned Teva will be to pay down debt from FCF in the near term.

Search for New CEO: Teva's CEO left the firm in February 2017, and the board is currently conducting a search to replace him. During the interim, Dr. Yitzhak Peterburg, who has served as Chairman of the Teva Board of Directors since January 2015, will serve as CEO. The CFO publicly announced his planned retirement in April 2017 and will be leaving the firm within a few months.

DERIVATION SUMMARY

Teva Pharmaceutical Industries Limited's rating of 'BBB-' reflects the company's relatively stronger position than its smaller industry peer, Mylan N.V., on the basis of scale, geographic end markets and the level of differentiation of its products. This gives Teva a roughly 0.5x higher turn in leverage sensitivity for its 'BBB-' rating compared to Mylan. Teva continues to increase its focus on innovative pharmaceuticals and difficult-to-manufacture, chemically complex drugs, which generally command relatively more defensible prices and margins. However, the commoditized portion of its generic drug portfolio is more prone to pricing pressure. The company has been a consistent generator of positive free cash flow, although it has been dampened recently by operational stress. In addition, pricing pressure and acquisition related debt has stressed current leverage relative to the 'BBB-' rating.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
--Mid-single-digit percentage organic revenue declines, primarily driven by pricing headwinds;
--Operating efficiency gains and stabilization by late 2018 /early 2019;
--Repayment of all debt due in 2017 to 2018 and repayment of term loans to reduce gross debt/EBITDA to near 3.5x during 2018;
--Annual FCF of $3 billion to $3.5 billion during 2017-2018, incorporating the recent dividend reduction and asset sales sufficient to meet debt maturities over the near term.

RATING SENSITIVITIES

Future Developments That May, Individually or Collectively, Lead to Stable Rating Outlook
--Teva's 'BBB' ratings consider run-rate gross debt/EBITDA around 3.5x-3.7x (durably below 4.0x), through a combination of debt reduction funded by asset sales and free cash flow.
--The company achieves steady operating performance, including adequately addressing its cost structure in the face of near- to intermediate-term pricing headwinds in the U.S.
--Copaxone 40mg does not face generic competition in 2017.
--Consistently positive FCF with the dividend reduction in place until leverage reduction is achieved.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
--A one-notch downgrade would incorporate the company operating with gross debt/EBITDA durably above 4.0x.
--The company does not return to sustainably stable operating performance, in part due to an even more onerous-than-forecasted pricing environment the U.S.
--The company is unable to achieve asset sales at sufficient valuation multiples that offer meaningful deleveraging.
--FCF, while positive, declined to levels that meaningfully increase Teva's reliance on debt issuances for modest share repurchases and targeted acquisitions.
--Generic competition against Copaxone 40mg drives rapid share loss, as opposed to a more moderate decline.

LIQUIDITY

Cash Prioritized for Deleveraging: While Fitch expects Teva to generate meaningfully positive FCF, the company needs to prioritize it for debt repayment. In addition, the company also needs to divest assets in order to reduce leverage to near 3.5x by year-end 2018. Hence, the company has little financial flexibility to pursue business development and shareholder friendly transactions.

FULL LIST OF RATING ACTIONS

Fitch has downgraded the following ratings:

Teva Pharmaceutical Industries Limited
--Long-Term IDR to 'BBB-' from 'BBB'.

The Rating Outlook is Negative.

Teva Pharmaceuticals USA, Inc.
--Senior unsecured bank facilities to 'BBB-' from 'BBB'.

Teva Pharmaceutical Finance Company LLC
--Senior unsecured notes to 'BBB-' from 'BBB'.

Teva Pharmaceutical Finance IV, LLC
--Senior unsecured notes to 'BBB-' from 'BBB'.

Teva Pharmaceutical Finance Company, B.V.
--Senior unsecured notes to 'BBB-' from 'BBB'.

Teva Pharmaceutical Finance IV, B.V.
--Senior unsecured notes to 'BBB-' from 'BBB'.

Teva Pharmaceutical Finance V, B.V.
--Senior unsecured notes to 'BBB-' from 'BBB'.

Teva Pharmaceutical Finance Netherlands II B.V.
--Senior unsecured notes to 'BBB-' from 'BBB'.

Teva Pharmaceutical Finance Netherlands III B.V.
--Senior unsecured notes to 'BBB-' from 'BBB'.

Teva Pharmaceutical Finance Netherlands IV B.V.
--Senior unsecured notes to 'BBB-' from 'BBB'.

Fitch has assigned the following rating.

Teva Pharmaceuticals USA, Inc.
--Long-Term IDR 'BBB-'.

The Rating Outlook is Negative.