Reuters: Market News: TEXT-S&P summary: INC Research LLC

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TEXT-S&P summary: INC Research LLC Mar 30th 2012, 13:33 Fri Mar 30, 2012 9:33am EDT Rationale The ratings on Raleigh, N.C.-based INC Research LLC reflect its "weak" business risk profile (according to Standard & Poor's Ratings Services' criteria), because of volatile demand in the contract-based business, INC's need to successfully compete against larger and better-financed contract research organizations (CROs), and the need to quickly and effectively integrate the operations of Kendle. We believe INC's financial risk profile is "highly leveraged," because adjusted leverage is more than 6x following the acquisition of Kendle, and INC's leveraged buyout (LBO) in 2010. We believe INC's revenues will substantially increase after the Kendle acquisition. In the medium term, revenues will normalize to a mid- to high-single-digit range because of additional therapeutic expertise and early stage capabilities, benefits of cross-selling, and improved demand from pharmaceutical companies for outsourced contract research services. Over the next year, we expect INC's margins to improve by at least 100 basis points because of the effects of operating efficiency improvements undertaken by INC over the past year. We expect margin expansion to result in higher EBITDA that will modestly reduce leverage, although the debt incurred to purchase Kendle will keep leverage at 5x or more over the near term. INC's weak business risk profile reflects its participation in the CRO industry, susceptible to contract cancellations, nonrenewals, and demand volatility. It also reflects INC's need to successfully integrate Kendle with little disruption, to retain and attract customers. INC provides outsourced clinical pharmaceutical research services to the largest segment of the industry (Phase II-IV). The CRO industry is recovering from a period of industry weakness, as evidenced by book-to-bill ratios beginning to exceed 1x and cancellation rates normalizing in the 15%-20% range. Although INC and Kendle are participating in the recovery, pharmaceutical customers are increasingly favoring larger CROs with greater size, scale, and international reach. Moreover, Kendle suffered disproportionately, recording five straight quarters of sub-1x book-to-bill when competitor ratios climbed back to over 1x. Still, we believe the combination with Kendle gives INC increased scale: It is now the sixth-largest provider of Phase II-IV clinical services. It also strengthens and expands INC's therapeutic expertise and adds early stage capabilities enabling INC to bid on a broader range of trial work. INC is highly leveraged following its 2010 LBO and the Kendle acquisition. Pro forma leverage is more than 6x and funds from operations (FFO) to debt is about 10%. While INC might conduct tuck-in acquisitions, we do not expect any major debt-financed acquisitions or sponsor dividends in the near term. Liquidity We believe INC's liquidity is adequate, based on: -- Our belief that sources of cash should exceed mandatory uses over the next 12 to 24 months by more than 1.2x; -- Adequate cushion underneath the company's covenants, enabling access to its undrawn $75 million revolver; -- Expectations of positive free cash flows over the next two years; -- Even if EBITDA declines by 50%, we expect liquidity to continue exceeding needs; and -- We believe INC can absorb high-impact, low-probability events without refinancing. Recovery analysis The issue-level rating on INC's $375 million senior secured debt facility is 'B+' (one notch higher than the corporate credit rating) with a recovery rating of '2', indicating our expectation of a substantial (70% to 90%) recovery in the event of a payment default. The facility consists of a $75 million senior secured revolver due 2016 and a $300 million senior secured term loan due 2018. The issue-level rating INC's $300 million senior unsecured notes due 2019 is 'B-' (one notch below the corporate credit rating) with a recovery rating of '5', indicating our expectation of a modest (10% to 30%) recovery in the event of a payment default. (For the recovery analysis, see the recovery report on INC Research, published June 22, 2011, on RatingsDirect.) Outlook Our stable rating outlook on INC reflects increased scale as one of the top six players in the largest segment of the CRO industry following the acquisition of Kendle. In our opinion, it should be well positioned to benefit from the improving trends in the CRO industry. Although we believe that INC will be able to generate free cash flow over the near term, we do not believe that it will be sufficient to increase funds from operations to total debt to more than 12% or reduce leverage to less than 5x, metrics that would be consistent with an aggressive financial risk profile We could raise our ratings if INC reduces leverage to less than 5x and improves FFO to total debt to more than 12%. This would be accomplished by successfully integrating Kendle and continuing to win its share of new contracts. This would be accomplished by revenue growth of at least 8% and gross margins improving to at least 56%. We could lower the ratings if INC experiences integration issues which impact its ability to retain clients or win new contracts. Another unexpected downturn in the CRO industry could also result in a lower rating. In either situation, liquidity could be compromised and would reduce the covenant cushion to 10% or less. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Link this Share this Digg this Email Reprints

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