Here's the text of the Moody's review. It seems that a key issue is whether ELAN will hit a cash crunch while simultaneously having difficulty accessing additional capital.
TEXT-Moody's cuts Elan Corp senior rating
Approximately $2.6 Billion of Rated Debt Affected
(Press release provided by Moody's Investors Service)
NEW YORK, March 19 - Moody's Investors Service lowered the debt ratings of Elan Corporation plc (NYSE:ELN - news) (senior guaranteed debt to Ba2 from Baa3). The downgrades reflect weak operating cash flow from core product sales together with Moody's expectation that the cash flow generation of Elan's core pharmaceutical product sales will remain modest relative to the company's high debt levels.
Although the company currently holds significant levels of cash and other investments, the values of certain balance sheet investments will likely be volatile because they are comprised of smaller pharmaceutical/biotechnology holdings. Also, Moody's is concerned that Elan may elect to use some of its balance sheet cash to step-up product acquisitions in order to boost future cash flows. The ratings remain under review for possible further downgrade because of uncertainties associated with the current SEC investigation into Elan's accounting practices.
The following ratings were downgraded and remain under review for possible further downgrade:
Athena Neurosciences Finance, LLC guaranteed notes (on a senior basis) and shelf: to Ba2/(P)Ba2 from Baa3/(P)Baa3
Elan Finance Corporation Ltd. guaranteed notes (on a subordinated basis):
to Ba3 from Ba1;
Elan Pharmaceutical Investments II Ltd.
guaranteed notes (on a subordinated basis): to Ba3 from
Ba1;
Elan Pharmaceutical Investments III Ltd.
guaranteed notes (on a subordinated basis): to Ba3 from
Ba1;
Dura Pharmaceuticals, Inc.
subordinated notes: to B1 from Ba2
The following ratings were assigned, and placed under
review for possible downgrade:
Senior Implied: Ba2
Issuer Rating: Ba2 on Elan Corporation plc
Elan's cash flows are derived from three sources -- core pharmaceutical product sales, product rationalization activities, and contract revenues; although we note that Elan does not report its results specifically in this manner. It is Moody's opinion that once separately identified, Elan's cash flows from core product sales would be of higher quality than other sources, because 1) they are not one-time in nature like product rationalization sales; 2) the revenue is not indirectly related to Elan-provided investments, as is the case with Elan's R&D joint venture license fees; 3) Elan is phasing out the R&D joint venture strategy, and is not expected to receive additional license fees from joint ventures, and 4) product sales should be more predictable and sustainable than milestone payments received from other (non-JV-related) research collaborations.
Moody's has concluded that Elan's 2001 operating cash flow from core product sales was considerably below our prior expectations, and was modest relative to current debt levels. In our opinion, the $594 million of reported cash flow from operations significantly benefited from 1-time product rationalization as well as license fees received from joint ventures. In assessing operating cash flow, Moody's included interest income and interest costs, including those on Elan's off-balance sheet debt; while these items do not reflect the ``operations'' of Elan's pharmaceutical product sales, Moody's believes these items would be included in the cash flow from operations for other pharmaceutical companies because they represent additional interest cost on borrowings; Moody's did not include investment gains or other non-operating income in its assessment of cash flow from operations.
Moody's estimates that Elan's 2001 free cash flow related to core product sales was negative, after capital expenditures and substantial restructuring outlays associated with the integration of Dura Pharmaceuticals, although these special charges should be non-recurring. In 2002, Moody's anticipates that Elan's cash flow should benefit from the products acquired in late 2001 (Sonata from Wyeth and pain products from Boehringer Ingelheim), and growth in the core products like Zanaflex and Skelaxin.
However, Elan has announced it expects higher R&D expenses to support clinical trials, and larger SG&A expenses for salesforce expansion. Therefore, Elan's operating cash flow attributable to core pharmaceutical products may remain modest relative to debt, absent further product acquisitions. In addition, Moody's anticipates 2002 capital expenditures in the range of $200 to $250 million in part to increase manufacturing capacity and to establish biologics capabilities, potentially resulting in continued negative free cash flow attributable to product sales. Beyond 2002, additional pressures could result from generic competition on key products (Zanaflex and Skelaxin).
Moody's believes that these factors contribute to Elan's stated objective of acquiring new products in 2002 which could generate $250 million of additional revenues. In reviewing Elan's balance sheet, Moody's notes that a sizeable portion of the Elan's invested assets, including those supporting $1 billion of EPIL debt, are in private companies, and in less liquid types of securities, such as preferred stock, warrants, loan notes, and convertible debt. Despite appraised market values in excess of EPIL debt, Moody's believes that the values of the investments will be volatile, since they are comprised of small pharmaceutical and biotechnology holdings. Moreover, questions exist regarding the ease with which these assets can be liquidated as the EPIL debt matures. Moody's ratings on the EPIL debt are based on the subordinated guarantees from Elan Corporation plc.
The presence of nearly $1.7 billion of cash, prior to any potential product acquisitions, should be sufficient to cover debt maturities of $62 million in June 2002 and any potential shortfall on the $160 million series of EPIL III debt, also maturing in June 2002. Thereafter, Moody's notes that approximately $1 billion of LYONs are putable in December 2003, and that the LYONs conversion price (in the low 40s) is significantly higher than the current price of Elan's shares. Although the LYONs could be repaid in cash or shares at Elan's option, Moody's believes that prior to December 2003 Elan may need to consider external financing. Debt maturities beyond 2003 include $450 million of EPIL II (June, 2004) and $390 million in EPIL III (March 2005). Moody's views positively the company's decision (earlier in 2001) to cease entering new joint venture arrangements. Over time, Moody's believes this could result in better quality of earnings and cash flow. In addition, we note the recent realignment of the sales and marketing organization, favorable prescription trends on certain key products, and the anticipated near term launch of Frova, a treatment for migraines.
The ratings remain on review for possible further downgrade because we believe that the current SEC investigation into Elan's accounting practices presents uncertainties in terms of both timing and outcome. Until the investigation is concluded, Moody's believes that Elan's ability to access new funds for business development activities or debt refinancing could be limited. Moody's further notes that a negative outcome related to the SEC investigation could have negative repercussions related to the shareholder lawsuits filed against Elan. Other factors could also pressure the ratings, such as, poor product performance, asset impairment charges, less than 100% realization of EPIL III assets to cover the June 2002 debt maturity, or significant depletion of balance sheet cash for acquisitions. Moody's anticipates continued frequent dialogue with Elan management related to cash balances, asset valuation, and sources of cash flow, which will be critical to Moody's continuing to monitor Elan's credit ratings.
Elan is a specialty pharmaceutical and drug delivery company headquartered in Dublin, Ireland, with current areas of pharmaceutical focus in neurology, pain management, oncology, infectious diseases and dermatology. |
