Fitch Ratings has downgraded Baxter International Inc. (BAX) and Baxter Healthcare SA's Long-Term Issuer Default Ratings (IDRs) and instrument ratings to 'BBB-' from 'BBB' and BAX's Short-Term IDR and commercial paper rating (CP) to 'F3' from 'F2'.

The Rating Outlook is Stable and the Rating Watch Negative has been removed from the ratings.

The downgrades are primarily driven by Fitch's expectation that leverage will remain elevated through 2025 and that debt repayment from the pending spin-off of its kidney care business is unlikely to reduce gross leverage to below 3.25x over the next 12 to 24 months, barring a high leverage point for the spinco or a meaningful outperformance in the remaining company's operating performance.

EBITDA leverage (gross debt/Fitch adjusted EBITDA) has sustained above Fitch's previous negative sensitivity of 3.0x since BAX's acquisition of Hill-Rom in late 2021, despite the company's prioritization of deleveraging over the past two years as unforeseen operational challenges have materially delayed the timeline.

The 'BBB-' rating also considers BAX's reduced scale and diversification post the Kidney Co spinoff, partially offset by an improvement in margin profile.

Key Rating Drivers

Impact of the Kidney Co Spinoff: The Kidney Care business unit generated $3.3 billion in revenue during the first nine months of 2023, reflecting flat growth compared to the prior year period, and constituted 30% of total revenue. This business will operate in market segments totaling approximately $15 billion. The spinoff company (Vantive) is expected to have leading positions in the areas in which it operates.

In Fitch's view, the spinoff will negatively impact BAX's business profile through a reduction in scale and diversification, and a weakened overall market position, considering BAX's significant revenue contribution from renal care businesses and its strong historical market position and reputation in renal care. These weaknesses are partially offset by an expected improvement in EBITDA margin and FCF margin, given Kidney Care's lower operating margins, and Fitch's expectation that a leaner product portfolio may allow management to more efficiently execute on operation optimization, supply chain management, and core portfolio growth.

EBITDA Leverage to Remain Elevated: BAX's EBITDA leverage has remained above 5.0x since the Hill-Rom acquisition. Fitch had initially expected EBITDA leverage to decline to below 3.0x by 2024 through strong execution, improving margins, debt reduction and meaningful synergy realization. However, macroeconomic headwinds in 2022, including increased freight costs; inflation that led to higher input and labor prices; hospital staff shortages that led to delay in certain product installations; and most significantly, supply chain challenges, which limited the company's access to raw materials and electromechanical components, have significantly impacted the company's operating performances.

The lower than expected EBITDA and FCF resulted in elevation in EBITDA leverage, meaningfully delaying the company's deleveraging timeline.

Fitch's current forecast assumes EBITDA leverage to remain at 5.0x at year end 2023 and decline to 4.3x and 3.6x in 2024 and 2025, respectively. Fitch expects deleveraging in 2024 to be predominantly driven by debt reduction with reserved proceeds from the recently completed BPS sale and the pending Kidney Co spinoff, and 2025 to be driven largely by remaining proceeds from Kidney Co spinoff and incremental voluntary repayment. Assumed debt repayment is critical to the company's deleveraging below its new negative leverage sensitivity of 3.75x, commensurate with a 'BBB-' rating, over the next 12 to 24 months.

Diversification Supports Down-Cycle Demand: The company's business model is fairly diversified from a product and geographic perspective. Fitch believes the critical nature of BAX's global business should generally support relatively stable cash flows during economic downturns, albeit volatile in recent periods due to working capital swings and one-time expenses. BAX's business targets Medical Products and Therapies (34% of YTD2023 revenue), Kidney Care (30%) Healthcare Systems and Technologies (20%), Pharmaceuticals (15%) and other (1%).

Although the improvement in diversification from the Hill-Rom acquisition is expected to be more than offset by the spinoff of Kidney Care businesses, the company's pro forma diversification profile remains comparable to peers of similar ratings. The company targets both mature and developing countries and generated roughly 48% of its 2022 revenue in the U.S. and 52% of its revenue outside of the U.S.

Near-term Volatilities in FCF: Fitch expects FCF will improve in 2023 and 2024 versus 2022 but remain depressed relative to historical ($944 million in 2021) and outer year projections ($750 million) due to meaningful business optimization and separation-related one-time costs. BAX historically generated solid FCFs supported by its stable end markets and the critical nature of its offerings. However, FCF after common dividends declined to -$36 million in 2022 from $944 million in 2021, due largely to significant working capital swings caused by inflationary pressures and substantial supply chain challenges.

Commitment to New Products: BAX is focused on improving its global core portfolio, and continuing to evaluate potential in its portfolio rationalization opportunities. The company continues to reallocate its investments into higher-margin, faster-growing businesses and is focusing on improvements to existing technologies and entirely new offerings. Fitch expects BAX to modestly increase R&D spending to restore growth to mid-single digits over the medium to longer term.

Derivation Summary

BAX is a large, diversified medical-device firm focused on a broad portfolio of essential healthcare products. The company's products are used by hospitals, kidney dialysis centers, nursing homes, rehabilitation centers, doctors' offices and by patients at home under physician supervision. BAX is 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 hospital capex and, to a lesser extent, utilization.

Given the company's combination of assets, no single company competes with BAX in all of its businesses, but it faces substantial competition in each of its segments. The ratings of BAX's medical device peers Boston Scientific Corporation (BBB+/Stable), Zimmer Biomet Holdings, Inc. (BBB/Stable) and Becton, Dickinson & Company (BBB/Stable), are considered in the analysis.

Parent-Subsidiary Linkage

Fitch takes a weak parent (Baxter International Inc.)/strong subsidiary (Baxter Healthcare SA) approach, reflecting its 'Parent-Subsidiary Linkage Criteria.' Fitch believes there is open ring-fencing and access and control. As such, Fitch rates the parent and subsidiary at the consolidated level with no notching between the two.

Baxter International Inc. is the parent and filing entity. This entity issues the majority of debt, including the U.S.-denominated unsecured revolver, CP, unsecured term loans 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

For modelling purposes, these assumptions assume Kidney Co spinoff completes on July 1, 2024:

Low single digit pro forma revenue growth;

EBITDA margins to improve over the rating horizon driven primarily by the spinoff of the lower margin Kidney Care businesses and, to a lesser extent, by operational efficiency improvement;

Right sizing of capex and common dividends post spinoff;

BPS sale proceeds, Kidney Co spinoff proceeds, and FCF predominantly deployed towards debt repayment;

No share repurchases or M&As assumed over the rating horizon.

RATING SENSITIVITIES

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

EBITDA Leverage durably below 3.25x;

--(CFO-Capex)/debt durably above 10%.

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

EBITDA Leverage durably above 3.75x without the prospect for timely deleveraging;

--(CFO-Capex)/durably below 7.5%.

Liquidity and Debt Structure

Solid Liquidity: Liquidity is supported by cash on hand of $5.8 billion at Sept. 30, 2023, full availability under its $2.5 billion revolving credit facility due 2026, and full availability under its EUR200 million revolving credit facility due 2026. The company also maintains a $2.5 billion CP program backed by its U.S. revolver, which had $514 million in outstanding borrowings at Sept. 30, 2023. Cash on hand included roughly $3.7 billion in after-tax cash proceeds from the BPS divestiture, which will predominantly be deployed towards debt repayment and the company has begun the process.

Debt Maturities: In October 2023, BAX repaid $950 million under its $2.0 billion three-year term loan facility and the entire $514 million of outstanding commercial paper borrowings with proceeds from the BPS sale. Fitch expects the company to pay down a majority of its short-term maturities (including those scheduled to mature through May 2024) utilizing cash on hand and proceeds from the BPS sale. Medium to longer-term maturities could be repaid or refinanced contingent upon the outcome and timing of the Kidney Co spinoff process and FCF generations over the rating horizon.

Issuer Profile

Baxter International Inc. provides a broad portfolio of essential healthcare products, including acute and chronic dialysis therapies; sterile intravenous solutions; infusion systems and devices; parenteral nutrition therapies; inhaled anesthetics; generic injectable pharmaceuticals; surgical hemostat and sealant products, advanced surgical equipment; smart bed systems; patient monitoring and diagnostic technologies; and respiratory health devices.

Summary of Financial Adjustments

EBITDA adjustments were made for asset and goodwill impairments, business optimization items, acquisition and integration costs, and divestiture related costs.

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

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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