News Column

Fitch Places Covidien's Ratings on Negative Watch

June 16, 2014

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has placed Covidien plc's ratings, including the 'A' Issuer Default Rating (IDR), on Rating Watch Negative. The action follows the announcement that Covidien will be acquired by Medtronic, Inc. for total consideration of $42.9 billion. The ratings apply to $5 billion of Covidien's debt outstanding at March 28, 2014. A full list of ratings follows at the end of this press release.

Key Rating Drivers:

Medtronic is expected to assume Covidien's outstanding debt upon the close of the transaction, anticipated to occur in late 2014 or early 2015, pending regulatory approvals. Fitch expects that the use of significant equity funding and cash on hand will reduce the amount of debt needed to fund the transaction and defray the impact on leverage of the combined company. However, pro forma leverage at the close is expected to be greater than the 1.5x level that is consistent with an 'A' IDR for Covidien. A downgrade of the rating is likely to be limited to one notch, but there are several issues that will influence the post-acquisition credit profile, including:

--The capital structure of the combined company, including where the Covidien debt is held and Fitch's perception of the strength of the operational, strategic and legal linkages with Medtronic, including any formal guarantees of the Covidien debt;

--The amount of debt used to fund the transaction. Fitch expects Medtronic will fund the cash consideration for the acquisition with a combination of debt and cash on hand;

--The pricing of the debt used to fund the acquisition, which will effect interest coverage levels and free cash flow (FCF) generation of the combined company;

--Fitch's view of the operational risk inherent in the integration of Covidien and any potential upside to financial results to be realized through synergies. Medtronic has so far identified $850 million of cost synergies to be realized in the two to three years post transaction;

--Medtronic's plans to apply cash to debt reduction in the 12-18 months post transaction.

Rating Sensitivities:

Maintenance of an 'A' IDR for Covidien requires total debt-to-EBITDA of 1.5x or below. There is tolerance for increased debt to fund the acquisition, as long as Fitch believes Medtronic is willing and able to reduce debt within the 18 months following the transaction. Medtronic has stated that pro forma debt-to-EBITDA will be 2.3x upon the close of the transaction. Fitch believes this pro forma leverage is achievable, but would require the company to use most of its cash on hand to fund the transaction. Since the transaction is not expected to close until late in 2014 at the earliest, cash-build in the second half of the year could also help fund the cost of the transaction.

The amount of cash generated by the combined company will depend upon the amount of debt financing and the associated interest expense. Based on a pro forma analysis not including the benefit of any financial synergies, Fitch believes the combined company will generate FCF of at least $5 billion annually, which could facilitate rapid deleveraging and provide support for the credit profile post transaction. A downgrade of the ratings is more likely to occur if Fitch believes Medtronic will prioritize use of cash for shareholder payouts and additional acquisitions in the year following the transaction. Historically, both Medtronic and Covidien have used a sizeable portion of cash for shareholder payouts, including dividends and share repurchases, and Medtronic has stated that it will continue to target paying out 50% of FCF before dividends to shareholders.

Sound Strategic Rationale for Transaction:

Fitch believes that there is a strong strategic rationale for the transaction, based as it is on an improved business mix, since there appears to be minimal overlap in major product areas. The combined company will certainly touch more clinical areas within healthcare; Medtronic is primarily focused on cardiac (cardiac rhythm management and stents) and orthopedic devices, while Covidien's product lines are focused on general and advanced surgical devices and products that are used across a wide spectrum of medical indications. The companies do share the same customer base of hospitals and physicians, so there may be the potential for revenue synergies through consolidated pricing power. The $850 million of synergies Medtronic has identified so far cover more reliable cost-containment items, such as supply chain management and eliminating redundant corporate expense.

In addition to an improved business mix and cost synergies, tax considerations also support the rationale for the combination. Medtronic will accomplish a tax inversion through the transaction, and plans to redomicile in Covidien's Irish tax jurisdiction. The current effective tax rates of the two companies are not drastically different, so the effect of lower taxes on income and cash flows will not be very large. However, Medtronic will have improved financial flexibility, since it will be able access non-U.S. cash balances with less onerous tax implications.

Fitch has placed the following ratings of Covidien on Rating Watch Negative:

Covidien plc

--IDR 'A';

--Short-term IDR 'F1'.

Covidien International Finance S.A. (CIFSA)

--IDR 'A';

--Short-term IDR 'F1'.

--Commercial paper program 'F1';

--Credit facility 'A';

--Senior unsecured notes 'A'.

CIFSA, which is the obligor of Covidien's debt, is a wholly owned subsidiary of Covidien plc. CIFSA directly or indirectly owns all of the operating subsidiaries of Covidien, issues debt, and performs treasury operations for Covidien, otherwise it conducts no independent business operations of its own. CIFSA's senior notes are fully and unconditionally guaranteed by both Covidien Ltd. and Covidien plc. Covidien plc replaced Covidien Ltd. as the ultimate parent company in June 2009.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=834873

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Bob Kirby

Director

+1-312-368-3147

Fitch Ratings, Inc.

70 West Madison Street

Chicago, IL 60602

or

Secondary Analyst

Megan Neuburger

Senior Director

+1-212-908-0501

or

Committee Chairperson

Michael Weaver

Managing Director

+1-312-368-3169

or

Media Relations

Brian Bertsch, New York, +1-212-908-0549

brian.bertsch@fitchratings.com

Source: Fitch Ratings


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