CFR on negative ratings watch

777 04/07/2013 Some of the Adcock products selling around South African Pharmacies. Picture: Giyani Baloi

777 04/07/2013 Some of the Adcock products selling around South African Pharmacies. Picture: Giyani Baloi

Published Jul 5, 2013

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Ann Crotty

Fitch Ratings has placed CFR Pharmaceuticals on a negative rating watch following this week’s announcement that CFR had made a potential offer to acquire 100 percent of Adcock Ingram for $1.3 billion (R13.1bn).

The decision to place CFR on a negative rating watch will probably cause concern among Adcock shareholders, who have responded with little enthusiasm to the R73.51-a-share offer from CFR.

The R73.51 will be paid in cash and shares in CFR, which aims to get a secondary listing on the JSE.

Yesterday Adcock shares gained just 12c to close at R65.50, a level that is in line with the offer made by Bidvest in April and which was rejected by Adcock management.

Analysts said that the unenthusiastic response by Adcock shareholders reflected not only that part payment would be in shares of a company that was unknown to them, but also that critical aspects of the potential offer were unknown.

“At this stage it is just a potential offer, so there is little in the way of firm details,” remarked one analyst, adding: “It may be that Adcock shareholders will become more enthusiastic when they are provided with more details and after the CFR management has engaged with the South African shareholders… right now the negative rating doesn’t help.”

A spokesman for CFR told Business Report yesterday that it was “completely normal” for Fitch to put out such a note given that the proposed transaction would be transformational for CFR.

In its note, Fitch said that key risks around the deal included the rapid pace of acquisitions at CFR as well as the increasing size of its targets, “which may dilute management’s ability to quickly obtain synergies and quickly return its capital structure to targeted levels”.

The offer for Adcock followed CFR’s $562 million acquisition last year of Lafrancol, a leading Colombian pharmaceutical company.

CFR, which was established in 1922 in Chile, was a family-owned business until its listing in Santiago in 2011. The founding family retains a 73 percent holding in the listed company.

Fitch notes that the proposed transaction would see South Africa becoming CFR’s most important single market, accounting for about 41 percent of revenue. Colombia would account for 18 percent, Chile 12 percent, Peru 8 percent and Argentina 7 percent.

“The transaction is viewed positively by Fitch from a business risk perspective,” said Fitch. It added that Adcock had modern production facilities that were underused.

“Synergies are expected to come from the acquisition of raw materials, centralisation of production of generics, expansion of the product portfolio and the sharing of best practices.”

To avoid a ratings downgrade, CFR will have to be successful with the $750m equity placement it is proposing to fund the transaction.

“To have the rating outlook returned to stable, CFR will need to successfully fund the transaction with no less than $750m of debt,” said Fitch.

The additional funding will come from $500m of new debt and $50m in cash.

Fitch said that it would also have to generate strong free cash flow from its existing businesses if it was to reduce its debt ratio to within targeted levels.

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