Fitch Affirms Allergan at 'BBB-'; Outlook Stable

Fitch Ratings has affirmed the ratings of Allergan plc (Allergan; NYSE: AGN) and subsidiaries at 'BBB-'. The Rating Outlook is Stable.

A full list of rating actions, which apply to approximately $32.8 billion of debt outstanding at Sept. 30, 2016, follows at the end of this release.

KEY RATING DRIVERS

Scaled and Growing

Allergan is among the largest pharmaceutical companies in the world, with a diversified, durable, and growing product portfolio and a strong product pipeline. Fitch expects Allergan to generate mid- to high-single-digit organic sales growth, strengthened through strategic acquisitions, over the ratings horizon. However, expectations for EBITDA and FCF growth have moderated somewhat during 2016.

Strong Liquidity, Robust FCF

Liquidity is strong, given large cash balances remaining from the sale of its generics business to Teva Pharmaceutical Industries Ltd. (NYSE: TEVA; 'BBB'/Stable), and about 100 million Teva shares, which may be monetized mid-2017. Fitch expects Allergan to generate robust pre-dividend FCF of $4 billion or more in 2017 on. Strong FCF supports management's commitment to repay all debt maturing in 2017-2018 and continued public commentary suggesting that M&A will be funded with internal liquidity. Furthermore, Allergan's Irish domicile provides an efficient tax structure and allows the firm to use its cash without material repatriation penalties.

Differentiated R&D Strategy

Allergan is pioneering a somewhat new R&D strategy termed "Open Science" by the firm. While Fitch agrees that the strategy should have lower development risk than that of most traditional pharma firms, we recognize that large cash outflows related to in-licensing and milestone payments ($542 million YTD 2016) will offset lower organic/adjusted R&D expenses, which lead to somewhat inflated EBITDA margins and understated leverage figures.

Notably, this dynamic is likely to moderate in the longer term, as Fitch expects acquired R&D to become a smaller proportion of total R&D activities as the firm grows. Fitch's treatment of these expenses is discussed further below.

Shareholder Payouts Reduce Divestiture Benefits

Large-scale share repurchase activity and the initiation of a dividend commits a sizeable portion of liquidity and FCF to shareholders, therefore reducing the benefits of the generics divestiture for bondholders. However, at current levels, shareholder payouts should not threaten the repayment of debt maturing in 2017-2018, funded with remaining liquidity and FCF, to the advantage of bondholders.

Active Acquirer, Now More Targeted

Fitch expects Allergan will remain an active acquirer, using steady FCF and large cash balances for targeted growth-oriented assets. Deals are expected to be generally smaller and funded with internally-generated liquidity, supporting a more stable debt leverage profile than during the past five years. However, management has stated that large leveraging M&A is not out of the question.

Dis-/Integration Risks

A short period of several transformational acquisitions and divestitures poses the risk of operational inefficiencies and/or financial dis-synergies. Fitch's assessment of Allergan's management team is strong; though a continued active M&A strategy adds to the risk of a transactional or operational misstep.

RATING SENSITIVITIES

Allergan's 'BBB-' ratings consider run-rate gross debt/EBITDA in the range of 3x-3.5x. Possible temporary increases are permitted if expected to be followed by a period of de-leveraging. Annual post-dividend, post-milestone FCF of at least $1 billion-$2 billion should provide ample ongoing liquidity for continuing bolt-on acquisitions of established businesses and in-process R&D assets.

Several facets of Allergan's credit profile could support higher ratings than the current 'BBB-', including its growth outlook, profitability, and durable product portfolio. Positive ratings momentum is slowed to the degree internal liquidity is directed toward share repurchases and committed dividend payouts. Nevertheless, a capital deployment strategy that provides a period of time without large, leveraging M&A that allows gross debt/EBITDA trending to 3x or below on a reported basis will be required before an upgrade to 'BBB' is considered. In the meantime, Fitch expects Allergan to operate with solid financial flexibility at current ratings.

A downgrade could be considered if the firm were to pursue a significantly large debt-funded acquisition (particularly before repaying 2017 bond maturities and in light of directing large amounts of divestiture proceeds toward shareholders) that would cause gross debt/EBITDA to be sustained above 3.5x for a period of greater than 18-24 months. Given the well-diversified nature of Allergan's product portfolio, a downgrade scenario involving operational difficulties is unlikely.

KEY ASSUMPTIONS

Fitch makes the following key assumptions in its ratings case forecast for Allergan:

--Organic sales growth in the mid-single digits in 2016, accelerating to high single digits in 2018-2019; total revenues exceeding $16 billion in 2018.

--Heightened SG&A associated with recently-launched products and growing R&D costs offset gross margin improvements, resulting in steady EBITDA margins around 50%.

--All debt maturities repaid (not refinanced) in 2017-2018, leading to debt balances of $30.1 billion and $26.4 billion and gross debt/EBITDA of 4.0x and 3.3x at YE2017 and 2018, respectively.

--M&A funded only with internal liquidity in 2016-2017.

STRONG FINANCIAL FLEXIBILITY

Fitch does not expect further debt repayment in 2016 and expects annual FCF in excess of debt maturities in 2017-2018. Estimated debt maturities, pro forma for recent debt repayment, include: $2.7 billion in 2017; $3.75 billion in 2018; $1.95 billion in 2019; $4.65 billion in 2020; and $19.7 billion thereafter.

Unlike many of its U.S. pharma peers, Allergan is able to use substantially all of its cash flows free from the relatively high U.S. taxes associated with repatriation of earnings generated outside the U.S. Notably, this advantage relative to U.S. domiciled peers could wane depending on possible reformation of the U.S. tax code.

FOCUS ON BRANDED "GROWTH PHARMA"

Allergan has emerged from several transformative acquisitions and, now, divestitures, as a wholly branded pharmaceutical company, with a meaningful presence in eye care (Rx and consumer), medical aesthetics & dermatology, central nervous system, gastroenterology, women's health, urology, and anti-infective therapeutic categories. The firm has placed itself in a self-described category of "growth pharma," aspiring to double-digit annual sales growth.

There are relatively few synergy opportunities for firms operating both branded and generic pharma businesses in North America. Branded products require significant investment in R&D and S&M, while pure generic drugs require less R&D and almost no S&M. With a limited presence outside the U.S. in its branded pharma business, Allergan's divestiture of its generics business - albeit a meaningful EBITDA and FCF contributor - was strategically sound. Furthermore, the global generic drug industry is in the midst of large-scale consolidation, and Allergan management decided that the firm would not be a consolidator in generics and needed to divest the business in order for it to be optimally successful.

STRONG GROWTH FROM DIVERSIFIED, DURABLE PRODUCT PORTFOLIO

Allergan's product portfolio is diversified, durable, and growing. Growth is further strengthened by a relatively promising R&D pipeline and a few key recent new product launches.

Allergan's top-selling product (Botox) is expected to account for less than 20% of total sales, and the top 5 products (Botox, Restasis, Fillers, Namenda/Namzaric, Lumigan/Ganfort) will generate less than 45% of total sales. Botox on its own generates sales from both cosmetic and various therapeutic indications (~45%/~55% split), further supporting diversification.

Namenda and Restasis are contending with new forms of competition - generic Namenda IR was launched in July 2015 and Shire launched a competing dry-eye treatment in August - but most of the rest of Allergan's top-selling products are not expected to face direct competition during the ratings horizon.

Allergan stemmed losses from Namenda IR's patent expiration through patient switching to an extended-release formulation, Namenda XR. Recently launched Namzaric is a therapy that combines Namenda XR and generic Aricept for the treatment of Alzheimer's. Such combination is common already in practice, so Fitch shares Allergan's expectation that Namzaric could grow to replace a sizeable portion of today's Namenda XR sales over the ratings horizon. We forecast sales of Namenda/Namzaric to remain fairly steady, but with some net erosion in the 2016-2018 timeframe.

Shire's Xiidra is expected to gain market share slowly given Restasis' long-standing position as the only therapy for the treatment of dry eye specifically. Most growth will likely come from overall market growth. However, longer-term sales erosion could occur depending on outcomes and emerging prescribing patterns, but probably not materially before 2018. Even still, the overall market for dry eye is growing as the disease is diagnosed with increasing frequency in the U.S. Markets outside the U.S. are largely underpenetrated.

Recent product launches should provide solid growth for Allergan for the foreseeable future. Key products recently launched include Linzess, Viberzi, and Vraylar. We forecast sales of $823 million, $1.19 billion, and $1.57 billion for these products in 2016, 2017, and 2018, respectively.

"OPEN SCIENCE" R&D MODEL

Allergan has demonstrated that its R&D strategy will rely primarily on the acquisition of programs and products from other sources over the discovery activities of traditional pharma. Spending for such transactions YTD in 2016 is nearly $2 billion. Continuing business organic R&D (before acquisitions) is expected to approximate $1.5 billion for the year.

This strategy is somewhat unique in the industry, such that the firm has coined the term "Open Science" to describe its model. Management asserts that this strategy is a more efficient and transparent use of shareholder investment, since traditional discovery activities will inherently include failures and since success rates and amounts invested in failed therapies are almost never disclosed. In theory, we tend to agree with Allergan's claims, but the model is too new and the trends too nascent to form any conclusions concrete enough to help or hurt the credit profile.

While large established pharma firms usually spend a relatively steady percentage of revenues for R&D activities, Allergan's R&D-related cash outlays will probably be more sporadic. Furthermore, upfront spending to acquire R&D assets represent only a portion of spending, as nearly all the deals the firm has consummated thus far include a sizeable portion of total consideration in the form of milestone payments and/or sales-based royalties. This strategy helps de-risk these investments, and may help smooth costs, but will require internal liquidity and ongoing strong cash generation.

Fitch-Specific Treatment

U.S. GAAP requires that upfront acquisition costs and development milestones paid for R&D programs/products be expensed as R&D. Sales-based milestones are expensed as a portion of cost of sales. Approval-based milestones are capitalized and amortized as expenses over time, recognized as investing or financing cash flows when paid. This treatment can result in sporadic EBITDA and FFO figures and convoluted R&D productivity measures.

Because the acquisition of in-process R&D assets is expected to comprise a material portion of Allergan's R&D strategy, Fitch has decided to treat all such transactions as acquisitions of businesses, removing related one-time expenses from COGS and R&D. Upfront acquisition costs are instead recognized in investing cash flows (as acquisitions) and milestone payments are recognized as non-recurring operating cash flows. In this way, we account for the discretionary nature and the otherwise lumpy effects of upfront acquisition costs, removing them from EBITDA and FFO and classifying them as acquisitions to be funded with FCF. Milestone payments, too, are removed from EBITDA and FFO. However, these payments are not discretionary, and classifying them as non-recurring operating cash flows appropriately reduces FCF available for debt service, acquisitions, and share repurchases. Importantly, going-forward R&D costs related to acquisitions are not removed from reported R&D expenses, resulting in projected EBITDA and FFO that correctly takes into account the increasing R&D spend that follows after the acquisition of an in-process R&D asset.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Allergan plc

--Issuer-Default Rating (IDR) at 'BBB-'.

Warner Chilcott Limited

--IDR at 'BBB-'.

Actavis Funding SCS

--Senior unsecured notes at 'BBB-'.

Allergan Finance LLC (fka Actavis, Inc.)

--IDR at 'BBB-';

--Senior unsecured notes at 'BBB-'.

Forest Laboratories, Inc.

--IDR at 'BBB-';

--Senior unsecured notes at 'BBB-'.

Allergan, Inc.

--IDR at 'BBB-';

--Senior unsecured notes at 'BBB-'.

The Rating Outlook for all IDRs is Stable.

Date of Relevant Rating Committee: Dec. 7, 2016

Summary of Financial Statement Adjustments

Financial statement adjustments that depart materially from those contained in the published financial statements are outlined in the section titled "Fitch-Specific Treatment" above. Other adjustments are customary for U.S. Corporates, including the removal of stock-based compensation and other non-cash and non-recurring expenses from Fitch's EBITDA calculation.

Additional information is available at www.fitchratings.com

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1016169

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1016169

Endorsement Policy

https://www.fitchratings.com/regulatory

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT 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.

Copyright © 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.

The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.

For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001

View source version on businesswire.com: http://www.businesswire.com/news/home/20161208006235/en/