Italy-Based Pharmaceutical Company Diocle S.p.A (DOC Generici) Assigned Preliminary 'B' Rating; Outlook Stable

  • Diocle S.p.A (DOC Generici), which is a pharmaceutical company that specializes in the sale and marketing of generic drugs, generated €208 million of revenue and €81 million of reported EBITDA in 2018.
  • The company's business is narrowly concentrated on Italian generics and it has limited scale, but this is somewhat offset by its established market position and the high barriers to market entry.
  • We are assigning our preliminary 'B' ratings to DOC Generici and the company's proposed €470 million floating rate note, which is being used to finance its acquisition by ICG group and Merieux Equity Partners.
  • The stable outlook reflects our opinion that DOC Generici will generate continued EBITDA growth supported by the ramp-up of new products, launch of its ophthalmology and cardiovascular ventures, and increasing generics penetration in Italy, while keeping a tight grip on expenditure.
MADRID (S&P Global Ratings) June 10, 2019—S&P Global Ratings today assigned the ratings as listed above.
The final ratings will be subject to our receipt and satisfactory review of all the transaction documentation. Accordingly, the preliminary ratings should not be construed as evidence of the final ratings. If the terms and conditions of the final documentation depart from what we have already reviewed, or if the financing transaction does not close within what we consider to be a reasonable time frame, we reserve the right to withdraw or revise the ratings.
Our preliminary B rating on DOC Generici follows its recent acquisition from ICG private equity group and Merieux Equity Partners. Post-transaction they will have about 83% and 12% ownership in the group while management will retain the remaining 5%.
The 'B' rating reflects DOC Generici's relatively modest scale of operations, high geographic concentration in Italy, and potential future regulatory framework risk, which constrains its business profile. However, the rating benefits from the company's stable market share in the oligopolistic Italian generics market, a favorable regulatory framework that creates effective barriers to entry and limits price competition, a track record of quick time-to-market product launches, and increasing generics penetration in Italy. With reported opening debt to EBITDA of 5.5x, we believe DOC Generici's financial profile is highly leveraged.
Furthermore, the group's ownership by private-equity sponsor ICG Group constrains our overall financial risk assessment. That said, we expect the company to continually expand its EBITDA base which should translate into a gradual deleveraging over our forecast horizon. We also expect the company to report free operating cash flow (FOCF) within the €36 million-€39 million range in 2019-2020.
DOC Generici is based in Italy, where all of the commercialization and distribution efforts of the company take place. The Italian generics market is based on a reference reimbursed generic price that is updated and published monthly by the AIFA, the Italian healthcare regulator. This reference price is set at a 45%-75% discount to the value of the originator for class A (reimbursable) products. The National Health Service will only reimburse the lowest priced generic in the reference price list. If there is a mismatch between the reference price and any other product in the market, the customer will have to pay the difference. However, and for instance, if the price of the originator and the reference price are the same, the customer will be fully reimbursed.
Because of this, the market is based on the price difference between the reference and the originator price, making price competition among generics players irrelevant. Furthermore, the Italian regulator has banned free commercial discounts to pharmacies and wholesale providers, replacing them with an 8% additional maximum fixed margin. This effectively eliminates price discount competition between pharmaceutical companies at the point of sale, which reinforces the market positions of the existing oligopoly of five players. In this group, DOC Generici secured 15.8% market share as of December 2018.
We believe Doc Generici's relatively small operations and lack of geographical diversification significantly constrain its business risk profile. However, we note that the Italian regulatory environment creates effective barriers to entry as new entrants cannot compete on prices or discounts to pharmacies. Furthermore, DOC Generici benefits from underlying positive market dynamics because generics penetration in Italy has increased. Class A products reached a 28% penetration rate in 2018 due to increased awareness and the supportive regulatory environment. We note that generics penetration in Italy is still lagging behind other key European countries, leaving significant headroom for growth.
We consider the group's regulatory framework risk to be limited at this stage. Under the current legislation, the Italian government automatically generates savings of 45%-75% on products facing patent expiry, which supports the budget. Moreover, the government is unlikely to decrease reference prices because they are already very low and further pressure could push generic companies out of the market, leading to product shortages. Having said that, we do not rule out future regulatory changes and we understand that any negative change in the regulatory environment will have a material effect on DOC Generici, which constrains our assessment.
In our opinion, DOC Generici has good profitability, with adjusted EBITDA margins of 36%-38%, owing to its solid and efficient supply chain management. The company is involved in the marketing and selling of drugs, while it outsources all of its manufacturing to other contract manufacturers. As a result, the company has limited working capital needs and capital expenditure (capex). This has allowed quick time-to-market product launches, which is an important aspect of the Italian generic industry because pharmacies tend to shortlist only three-to-four major generics brands. First movers benefit from a higher market share in relation to the new generic products, which is then difficult for competitors to contest. We believe that failure to continue timely new launches could put pressure on the company's market share and on the rating.
Despite having a well-balanced portfolio in molecules and therapeutic areas, we consider the group reliant on favorable patent cliff dynamics for organic growth. After three years of substantial patent expiries, patent cliffs are expected to moderate, which could lead to a smaller product pipeline and lower growth. Having said that, we expect DOC Generici to benefit from the ramp-up of its recently launched drugs, such as Olmesartan and Cholecalciferol, and from the roll out of its ophthalmology and cardiovascular franchises. We do not expect DOC Generici to engage in cross-border activities or to enter the challenging biosimilar market, due to its conservative business strategy.
We consider DOC Generici's supplier base to be well managed and based on long-standing relationships. The licensing contracts with developers typically span five years and the majority include a pass-through mechanism with a floor price, and no minimum set volumes. However, we note that the company exhibits concentration to Italian suppliers (46% of molecules), which further increases its concentration risk to Italy.
We believe DOC Generici's capital structure is highly leveraged as a result of its debt-funded acquisition by private equity firm ICG Group. We forecast adjusted debt to EBITDA of 5.5-6.0x in 2019, before decreasing to nearly 5.5x in 2020 thanks to the company's EBITDA expansion. For the same period, we forecast FOCF of €36 million-€39 million per year, supported by low capex, and low working capital requirements. Due to the group's asset-light nature, capex represents only about 2% of sales and is mainly related to the acquisition of dossiers of molecules to be launched after patent expiration, and to support the launch of the new ophthalmology and cardiovascular ventures.
We understand that the group followed a deleveraging profile under the ownership of its previous financial sponsors. Although we expect the company to follow a similar path, any material increase in debt as a result of acquisitions or dividend recapitalization could put pressure on the rating. Overall, private-equity ownership of the group and the uncertainty as to whether the new financial sponsors will sustainably support DOC Generici's deleveraging trajectory and FOCF generation weigh on our assessment.
The outlook is stable because we expect DOC Generici to generate continued EBITDA growth supported by the stability of the Italian regulatory environment, ramp-up of recently introduced products, launch of its ophthalmology and cardiovascular ventures, and increasing generics penetration in Italy. This should allow the company to sustain adjusted debt to EBITDA of 5.5x-6.0x in 2019 and 2020, while generating positive FOCF.
We could lower the ratings if DOC Generici's performance deviates materially from our base case so that adjusted debt to EBITDA is significantly above 6x or EBITDA interest coverage is below 3x for a protracted period. We could also lower the ratings if FOCF turned negative due to higher-than-expected capex or working capital outflows, or if the financial sponsor engaged in aggressive dividend recapitalizations.
We could raise the rating if we were convinced that the financial sponsor would consistently support the group's deleveraging trajectory such that adjusted debt to EBITDA could remain comfortably within the 4x-5x range, supported by sustained FOCF generation. We also could consider a positive rating action if the company markedly increased the scale and diversity of its product offerings, but we do not expect this in the near term.
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