he FDA to clarify the next steps regarding Cladribine, even in the best-case scenario (i.e., the drug eventually wins approval), the FDA¡¯s action further delays the product launch in the US. Consequently, this setback is likely to impact Merck¡¯s cashflow, which otherwise would have benefitted from incremental cash streams from 2011 onwards. Competition is intensifying in the market for MS drugs. Novartis AG (Aa2 negative) has already won approval from the FDA for Gilenya, its competing oral treatment for MS, and the CHMP has recommended that the EU regulator approve the drug, ensuring Novartis first-mover advantage. In addition, several of Merck¡¯s rivals have experimental MS drugs in their late-stage pipelines that may come to market in 2012-13. These new treatments, together with Gilenya, will have a negative impact on Rebif, Merck¡¯s existing intravenous MS blockbuster with revenues of €1.7 billion. However, given the complexity of switching drugs for existing MS patients, we expect this effect to be gradual. In our view, the recent setbacks with Cladribine, together with the non-approval of Erbitux for non-small cell lung cancer, may lead Merck to consider strategic initiatives, such as alliances or in-licensing of promising molecules, aimed at strengthening its late-stage pipeline. The non-approval of Cladribine should not hinder the company¡¯s deleveraging efforts following the acquisition of Millipore in 2010, as the company has benefited from a strong uptick in revenues and operating profits in the past year and from proceeds from the disposal of two non-core businesses announced in the fourth-quarter 2010.
5
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Francois Lauras Vice President - Senior Credit Officer +44.20.7772.5397 francois.lauras@moodys.com Victoria Maisuradze Vice President - Senior Credit Officer +7.495.228.6067 victoria.maisuradze@moodys.com
Partnership Is Credit Neutral for Total, Credit Positive for Novatek
French integrated oil and gas company Total SA (Aa1 stable) last Wednesday announced that it signed agreements to purchase a 12% stake in Russia¡¯s OAO Novatek (Novatek, Baa3 stable), the world¡¯s largest independent gas producer, and to join Novatek¡¯s Yamal liquefied natural gas (LNG) project as a strategic partner. The proposed transactions are credit positive for Novatek. Combined with the CEPSA sale announced in February, the Novatek purchase will leave Total¡¯s credit metrics largely unchanged. The agreements are in line with Total¡¯s strategic objective to redeploy capital towards long-term access to strategic reserves and growth areas, while accelerating sales of non-core assets, and should be beneficial in the long term. In particular, Total will acquire a 20% stake in the Yamal LNG project, which includes the construction of production, storage, and loading facilities for LNG to be sourced from the South-Tambeyskoye field. As of 31 December 2010, the field had proved and probable reserves of 802 billion cubic metres of natural gas and 31 million tons of gas condensate, according to Novatek. Last month, Total announced the sale of its 49% stake in CEPSA for €3.7 billion ($5.1 billion), which offsets the $4 billion that Total is to pay Novatek¡¯s two main shareholders for the initial 12% stake in the Russian company. The deal with Novatek allows Total to increase its stake in the company to 15% within 12 months and 19% within three years. Based on our estimates, we expect Total to have sufficient financial flexibility to accommodate the transactions without compromising its credit metrics, taking into account dividend payments and budgeted capital expenditures of $20 billion. That assumes the timely execution of the various asset sales already announced by the group and a gradual sell-down of its remaining 5.5% stake in sanofi-aventis (A2 stable), currently worth $5.5 billion. Novatek will benefit from the agreements with Total in a number of credit positive ways. For one, Total will gain a seat on Novatek¡¯s board, which will strengthen Novatek¡¯s corporate governance by bringing in the expertise of a major international player in the industry. The deal will also solidify Novatek¡¯s strategic alliance with Total, with which it is jointly developing the Termokarstovoye field, another large gas field in Russia. Furthermore, Novatek will benefit from Total¡¯s technical expertise and funding support, which are essential to developing the vast resources in the South-Tambeyskoye field. The deal will also necessitate a valuation of the Yamal LNG project, which will provide greater transparency into its cost. In 2009, Novatek produced 215 million barrels of oil equivalent and generated total revenues of $2.8 billion. The Total-Novatek deal is the latest example of deepening cooperation between flagship Russian oil and gas companies and global majors. In January, BP (A2 stable) and OJSC Oil Company Rosneft (Rosneft, Baa1 stable) struck a strategic alliance to explore and develop hydrocarbon resources on the Russian Arctic continental shelf. Rosneft also signed partnership agreements with Chevron Corporation (Aa1 stable) and Exxon Mobil Corporation (Aaa stable) to develop several blocks in the Black Sea in 2010 and 2011, respectively. Although credit positive, the strategic partnership has no ratings impact for Novatek, as it will not generate immediate financial benefits. However, it will enhance the platform for further growth and international knowledge exchange, which are important for the implementation of strategically important large-scale projects.
6
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Gretchen French Vice President - Senior Analyst +1.212.553.3798 gretchen.french@moodys.com
Accounting Problems Raise Risk at Weatherford
On 1 March, Weatherford International (WFT, Baa2 stable) disclosed the discovery of material errors relating to income taxes in its financial statements. The oilfield services and drilling company will have to adjust its 2007-10 financial statements by around $500 million, which has negative credit implications for the Switzerland-based company. The errors raise questions about WFT¡¯s company-wide controls and how effectively it is managed on a systems and administrative basis. Under a worst-case scenario, WFT risks financial reporting covenant violations that may speed up its debt-repayment obligations. WFT acknowledges that its reporting problems stem from inadequate staffing and tax expertise, poor review and approval practices relating to income taxes, and inadequate processes to reconcile income tax accounts effectively. Most of the discrepancy, about $460 million, came from an error in determining the tax consequences of intercompany accounts. The company plans to solve this problem by year-end 2011 by hiring more staff with tax expertise for several departments, providing additional training, and by enacting new processes and controls. Although WFT¡¯s management believes it has already completed much of the testing of its tax reporting calculations, the company says it still needs more testing time before it can file its 10-K for 2010 with the US Securities and Exchange Commission (SEC). The SEC has granted a 15-day filing extension for the company, which must now file its annual 10-K report by 16 March. If WFT fails to file by the new deadline, it will violate the reporting covenants under its bond indentures, starting a 90-day cure period during which it must either file its 10-K or seek another extension from the SEC. If WFT cannot do any of these, its indenture trustees will then have the option of accelerating WFT¡¯s payment obligations. Corporate tax-reporting problems are not unusual, and generally amount to a relatively benign ¡°material weakness¡± under Section 404 of Sarbanes-Oxley. For WFT, the accounting errors are noncash and will have no impact on key credit ratios. Even so, the company¡¯s success in addressing its accounting issues related to income taxes will remain an open question until it resolves this weakness and files its 10-K. More generally, the discovery of the errors reflects another example of the challenges WFT has faced as a result of its aggressive growth strategy. WFT has expanded both organically and through acquisitions, and now has operations in over 100 countries. This strategy has given the company substantial scale and a more diverse product line. But the company¡¯s investment in infrastructure and administrative personnel has not kept up with its rapid growth. In addition, WFT¡¯s working capital management and returns have lagged those of its investment-grade oilfield services peers, such as Schlumberger (A1 stable) and Halliburton (A2 stable).
7
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Richard Morawetz Vice President - Senior Credit Officer +44. 20.7772.5408 richard.morawetz@moodys.com
Carrefour¡¯s Divestitures Are Credit Negative
Last Thursday, Carrefour (A3 review for downgrade) announced the full spinoff of its Dia harddiscount division, as well as the partial sale of its Carrefour Property division. We view these pending transactions as credit negative since they will result in increased shareholder remuneration, which constrains Carrefour¡¯s financial flexibility to undertake future investment plans. In particular, the partial spin-off of Carrefour Property is intended to crystallise the market value of the company¡¯s property assets and distribute proceeds to shareholders. Carrefour will, nevertheless, retain 75% ownership of the Carrefour Property division, which will continue to be fully consolidated. The portion it will sell will be floated on the Madrid and Paris stock exchanges in July 201l. Its property assets were valued at €17.2 billion as of December 2010, of which Carrefour Property will retain 60% in terms of value. The properties to be floated are in the core markets of France, Spain, and Italy, while Carrefour will retain ownership of its emerging markets property portfolio. We expect that this partial deconsolidation of the property company will also increase dividend payments to the new minority shareholders of Carrefour. This is happening while the company is also stepping up its investments in its hypermarket stores. In our view, both the increased dividend payments and the increased investment will put negative pressure on its credit metrics over the next one to three years. Carrefour¡¯s reported net debt position increased by approximately €1.4 billion to €8.0 billion in fiscal 2010, mainly as a result of share buybacks. While this program has now been suspended with the announcement of the new transactions, we view it as further evidence of the existence of shareholder pressure at the company.
8
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Niel Bisset Senior Vice President +44.20.7772.5344 niel.bisset@moodys.com
E.ON Sells Its UK Power Networks, Reducing Debt
Last week, E.ON AG, the giant European power group (A2 stable) agreed to sell its UK power distribution business to PPL Corporation (Baa3 stable) in a deal that will reduce by roughly 17% its net debt, which stood at approximately €27 billion at the end of September 2010, a credit positive for E.ON. Under terms of the deal, PPL, whose rating and outlook were affirmed on the news, will buy Central Networks (comprising Central Networks East and Central Networks West) for £4 billion (€4.7 billion), including the assumption of £500 million of existing third-party debt and the repayment of £900 million intercompany debt. The high price of around 8x adjusted EBITDA of £500 million and an estimated 33% premium to a regulated asset value of approximately £3 billion imply that E.ON achieved a good price on the sale of Central Networks. The sale is an important part of its asset disposal programme, which targets proceeds of approximately €15 billion by year-end 2013. Combined with other asset sales, including its former Gazprom shareholding, proceeds from the programme will have reached in excess of €8 billion when the deal is finalised, expected by April. E.ON¡¯s progress on its disposal programme is credit positive because it strengthens the company¡¯s financial risk profile in advance of negative earnings pressure it faces over the next three years. Like with other European utilities, lower electricity prices and the negative gas/oil spread are likely to reduce E.ON¡¯s cashflow versus 2011. In addition, like other nuclear power producers in Germany, it will be required to pay the nuclear fuel tax from 2011 until 2016. E.ON¡¯s sale follows the €6.7 billion disposal by EDF (Aa3 stable) in October 2010 of its three electricity distribution companies. Both deals reflect large European utilities¡¯ efforts to reduce debt following an acquisition spree near the end of the previous decade. From a business risk perspective, the sale of Central Networks is consistent with E.ON¡¯s recently announced strategy to focus on competitive businesses and integrated markets in Europe. This sale should have a relatively limited impact on E.ON¡¯s proportion of earnings from low-risk activities, which we estimate will continue to represent roughly 22% of adjusted EBITDA on a pro forma basis. However, the outlook is for regulated activities to contribute proportionally less to E.ON as nonregulated power-generation assets come on stream and it carries out its new, more focused strategy. Given the less stable nature of non-regulated income, this would worsen its business risk profile and cashflow predictability.
9
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Noriko Kosaka Vice President - Senior Analyst +81.3.5408.4028 noriko.kosaka@moodys.com Mariko Miyake Associate Analyst +81. 3.5408.4208 mariko.miyake@moodys.com
Daiichi Sankyo Acquisition of Plexxikon Is Credit Negative
Last Tuesday, Daiichi Sankyo Company Ltd. (A1 stable) announced that it agreed to acquire Plexxikon Inc (unrated). Although we expect the acquisition to strengthen Daiichi Sankyo¡¯s pipeline of cancer products, it will diminish its cash position and increase its business risk, making it credit negative. The purchase price is approximately $805 million and additional payments potentially totaling $130 million will be made because of the imminent launch of PLX4032 for the treatment of malignant melanoma. The drug is now in its phase III trial and the company will file for EU and US marketi