Fitch Ratings has downgraded Baxter International Inc.'s (Baxter) and Baxter Healthcare SA's Long-Term Issuer Default Ratings (IDR) and long-term issuance ratings to 'BBB' from 'A-' upon the completion of its acquisition of Hill-Rom Holdings, Inc. (Hill-Rom).

The Rating Outlooks are Stable. Fitch has also affirmed Baxter International Inc.'s Short-Term IDR and CP and affirmed the 'F2' rating. The largely debt-funded transaction significantly increased leverage, and deleveraging will require strong execution, improving margins, debt reduction and meaningful synergies.

Key Rating Drivers

Acquisition Makes Strategic Sense: Fitch views the $12.7 billion (includes the cash payment to shareholders and assumed debt) acquisition of Hill-Rom as strategically constructive. The addition of Hill-Rom expands and strengthens Baxter's presence in the hospital setting. The transaction enhances Baxter's pipeline of technological product offerings, ongoing digital transformation activities and current digital transformation initiative.

Increased connected care capabilities should help patient treatment and management in various care settings, including the hospital, the physician's office and home. Baxter should be able to expand Hill-Rom's products presence in international markets, given its significant OUS footprint. Fitch also expects meaningful cost synergies by 2023 and increasing thereafter.

Acquisitive Posture to Persist: In the near term, Fitch believes the company will focus on deleveraging. Longer-term, Fitch believes the company will focus on targeted transactions that deepen its existing product portfolio or add adjacencies. The company has a very diverse portfolio of products, which presents the company with numerous acquisition targets.

Health-Essential Product Portfolio: Baxter provides medically necessary products, with leading market positions in many of its categories, and many of its products are capital intensive and require significant manufacturing expertise. Baxter's products maintain market share through differentiation on delivery method, quality manufacturing and the scale necessary to compete against other established manufacturers.

The company's portfolio includes more difficult-to-manufacture products that would require material investments and expertise for new entrants. The company's Advanced Surgery products are the portion of the portfolio that are most negatively affected by the coronavirus pandemic. Medication delivery and pharmaceutical products are also negatively affected by the pandemic.

End-Markets Support Down-Cycle Demand: The company's business model is fairly diversified from a product and geographic perspective and focuses on a chronic and critical care patient category. Fitch believes the critical nature of Baxter's global business should help support relatively stable cash flows during the pandemic. Standalone, Baxter's business maintains a narrower focus than its largest peers and targets renal (32% of fiscal 2020 total revenue), medication delivery (23%), pharmaceuticals (18%), nutrition (8%), advanced surgery (8%), acute therapies (6%), biopharmaceuticals (4%) and other (1%).

The company targets both mature and developing countries and generates 42% of its revenue in the U.S., 10% in Canada and Latin America, 27% in the EMEA region and 21% in the APAC region during fiscal year 2020. The acquisition of Hill-Rom will increase the company's product diversification profile.

Commitment to New Products: Baxter is also focused on improving its global core portfolio, and continuing its portfolio rationalization. The company continues to reallocate its investments into higher-margin, faster-growing businesses and is focusing on material improvements to existing technologies and entirely new offerings. Investment spending will likely be divided between internal development and externally developed targets. Fitch expects near- and mid-term pipeline launches will continue to support low- to mid-single-digit growth over the forecast.

Solid FCF to Continue: Fitch anticipates that Baxter will continue to gradually improve its operating profile, driven by moderate organic growth supported by its product pipeline and recent acquisitions. Margins should gradually increase through favorable product mix shift, meaningful acquisition-related cost synergies 2023 and some normal cost rationalization. Resulting normalized FCF should grow from $1 billion annually toward $1.4 billion after the acquisition despite assuming steadily increasing cash dividends to common stockholders.

Derivation Summary

Baxter is a large, diversified medical device firm focused on renal and hospital products. The company's products are used by hospitals, kidney dialysis centers, nursing homes, rehabilitation centers and patients at home under physician supervision. The Hill-Rom acquisition has also expanded Baxter's reach into doctors' offices. Although Baxter has global scale and reach, it is smaller and has a narrower focus than its largest medical device peers. Baxter is considered a leader in the categories in which it competes. Demand for the company's products is relatively reliable, although revenues are modestly sensitive to the macroeconomic environment through reimbursement rates (pricing) and, to a lesser extent, utilization.

Given Baxter's combination of assets, it has no direct rated comparator. The ratings of Baxter's medical device peers of Boston Scientific Corporation (BBB/Positive), Zimmer Biomet Holdings, Inc. (BBB/Stable) and Becton, Dickinson & Company (BBB-/Positive), are considered in the analysis. Fitch also considers the ratings of Agilent Technologies, Inc. (BBB+/Stable); although Agilent is a life sciences company, its scale and credit metrics are similar to those of Baxter.

Fitch applies parent subsidiary linkage to Baxter International Inc. (parent) and its stronger subsidiary, Baxter Healthcare SA (subsidiary). The IDRs of Baxter International Inc. and Baxter Healthcare SA are the same due to strong legal and operational ties between the entities. Baxter's primary European operating subsidiary is Baxter Healthcare SA and Baxter provides a downstream guarantee to the European revolver at Baxter Healthcare SA. Fitch consolidates the parent and subsidiary with no notching of the ratings given the open nature of legal ring-fencing and access & control.

Baxter International Inc. is the parent and filing entity; this entity issues the majority of debt, including the U.S. denominated unsecured revolver, CP, and unsecured notes. Baxter Healthcare SA is the primary European operating subsidiary of Baxter International Inc. and is the borrower of the EUR200 million unsecured revolver. Given the proportion of debt at each entity, Fitch identifies Baxter Healthcare SA as having the stronger credit profile.

Key Assumptions

Fitch's Key Assumptions Within the Agency's Rating Case for the Issuer:

Low-to-mid single-digit reported revenue growth;

Gradual incremental improvements to EBITDA margins throughout forecast, due to operating leverage improving from normalized business demand during 2021, SGA costs returning to near-historical levels, mix shift to higher-margin products and operational efficiency improvements;

Cash dividends gradually and consistently increasing over time;

FCF of roughly $1 billion per year;

Total debt/EBITDA around 3.0x or below over the rating horizon.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Total debt/EBITDA durably below 2.5x;

FCF/total debt durably above 15%.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Total debt/EBITDA durably above 3.0x without the prospect for timely deleveraging;

FCF/total debt durably below 10%.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: FCF was approximately $960 million for the LTM period ended Sept. 30, 2021. Fitch forecasts Baxter to remain solidly FCF positive annually throughout the forecast period.

Issuer Profile

Baxter provides essential health care products to hospitals, kidney dialysis centers, nursing homes, rehabilitation centers, doctor's offices and by patients at home under physician supervision. Baxter manufactures products in over 20 countries and sells them in over 100.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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