Bausch Health Companies Inc. recently announced its intention to spin off its eye-care business. The remaining entity (RemainCo) will focus on gastroenterology, aesthetics/dermatology, neurology, and international pharmaceuticals.

In this Credit FAQ, we answer investors' questions about RemainCo's business profile.

We are most concerned about the long-term top-line growth profile for RemainCo, as we struggle to identify significant growth drivers beyond its leading pharmaceutical Xifaxan, raising the question "is RemainCo a melting ice cube?" This places more importance on its internal research and development pipeline and mergers and acquisitions (M&A). However, its pipeline productivity has been mixed thus far and its acquisition record is limited under the current management team. The possible need for debt-funded M&A will also be a consideration when we assess the financial policy for RemainCo.

RemainCo will have significant single-product concentration risk in Xifaxan and increased exposure to potential drug pricing reforms. That said, our base case assumes the Xifaxan franchise is durable until its loss of exclusivity in 2028.

On the positive side, RemainCo compares favorably to many other single-product dependent specialty pharma peers, given its high-margin profile among its peers, and a reasonably diversified portfolio outside of Xifaxan.

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Frequently Asked Questions

The million-dollar question: Is Bausch RemainCo a melting ice cube?

The short answer is "maybe, but it has time." We estimate RemainCo would be a sizable pharmaceutical company with $4.9 billion in revenue and $2.5 billion in EBITDA (based on 2019 pro forma financials, after adding back share-based compensation, but excluding operating lease adjustments). Our base case assumes the Xifaxan franchise will be well protected until 2028, given the patent settlements with Teva and Sandoz, though there is still pending litigation challenging Xifaxan IP. This buys RemainCo time to (1) improve its dermatology franchise and (2) execute on its research and development (R&D) pipeline. However, the initial launch results of some new dermatology products were below expectations and the COVID-19 pandemic makes the revenue ramp even more challenging. We think the company has some underappreciated pipeline assets (which we will explore later in the report); however, it is impossible to predict the ultimate success of these assets. If neither strategy proves fruitful, we think it's likely the company will resort to M&A to offset the potential Xifaxan falloff.

What are S&P Global Ratings' expectations for RemainCo's capital structure and financial policy?

Precedent transactions took around 18 months to complete. Management recently guided to a target leverage of about 5.5x for RemainCo and about 4x for SpinCo, at the time of the spinoff. In our opinion, it would be challenging for the company to reach this level organically within 18-24 months, even if we assume a $1 billion debt repayment (through organic cash generation) in each of 2021 and 2022. That said, we think the company could execute inorganic transactions such as small divestitures or equity raises to reduce leverage, ahead of the official spinoff. Without factoring in any inorganic deleveraging, we would expect pre-spinoff Bausch S&P Global Ratings-adjusted net leverage of about 6.4x by the end of 2021 (through EBITDA increase).

Even if RemainCo's initial leverage could theoretically be substantially lower than current pre-spinoff leverage, our assessment of the company's financial position would place significant weight on RemainCo's financial policy and focus on the potential need for an acquisition to replenish its pipeline. The company's acquisition record is limited under the current management team. We think leverage will almost certainly increase if the company makes a material acquisition, given the high valuations of commercial-stage pharmaceutical companies command. Therefore, the balance between further debt paydown versus making acquisitions for future growth would be paramount in our RemainCo analysis.

What's RemainCo's exposure to potential drug pricing reform?

RemainCo will be more exposed to drug pricing reform without the eye-health business. In particular, we estimate that Medicare Part D, a program that sometimes comes under regulatory scrutiny, is a significant payer for Xifaxan and covers roughly one-third of Xifaxan prescriptions.

Under the new management team, Bausch has become less reliant on price increases (2% net price increase across its entire portfolio in 2019) to grow its earnings over the past years, although some key products, including Xifaxan, still benefited from annual price increases. Bausch increased the gross price of Xifaxan by about 8% on Jan. 1, 2020, which led to a net price (after rebates, discounts, etc.) increase of 6% in the first quarter compared to a year ago. We think the sustainability of such annual price increases is questionable, particularly if drug pricing reform involves substantial inflation cap measures.

What is S&P Global Ratings' view on the Xifaxan concentration?

The short answer is "not good, but acceptable." We estimate Xifaxan will account for 30% of RemainCo's pro forma 2019 revenue. The top product concentration is in line with peers such as Horizon Pharma Inc and Mallinckrodt Inc., but worse than Endo, Viatris (Mylan, Upjohn), Teva, and Perrigo (see Chart 2). Partially offsetting this concern is our view that Xifaxan should be a growing franchise until 2028, especially given the recent patent settlements with Teva and Sandoz. Additionally, when looking at the top-three product concentration, RemainCo is more diversified, with top-three products accounting for 38% of total revenue, favorable relative to the peer set.

Chart 3

What are other potential growth areas?

In our view, the only potential growth area outside Xifaxan is the "Ortho Dermatologics" business, but it is also the smallest revenue contributor today ($565 million in 2019, or 12% of estimated RemainCo revenue based on pro forma 2019 financials). The potential growth could come from some recent product launches, including Siliq, Bryhali, and Duobrii. However, we estimate these three products combined only generate less than $100 million in annual revenue today, possibly barely covering the potential upcoming loss of exclusivities.

What are the business strengths?

The aforementioned weaknesses are partially offset by some business strengths. RemainCo has larger scale than many specialty pharma peers that we rate. In fact, our estimated EBITDA margin (about 50%) for RemainCo is the highest among all of the selected peers (see Chart 3) and on par with some highly profitable biotech companies. That said, we believe the company could incur more costs to stand up the business (we model $60 million), and could invest a larger proportion of revenue on R&D or general and administrative expenses, now that the RemainCo has become a more focused entity.

Furthermore, we expect RemainCo to be less capital intensive following the sale of the Bausch + Lomb assets. Additionally, we think the company is reasonably diversified beyond Xifaxan, which accounts for 30% of RemainCo's revenue. The top-10 products account for about 52% of total revenue, based on 2019 data. Also, while the "International Pharma" (23% of RemainCo revenue based on 2019 pro forma data) and "Diversified Products" (24% of RemainCo revenue based on 2019 pro forma data) segments aren't going to be significant growth drivers, we think they should be able to produce steady cash flows going forward. Lastly, the company is a defendant in ongoing opioid litigation in Canada, but is not presently a defendant in such litigation in the United States, unlike peers such as Endo (B/Negative/--), Mallinckrodt (CCC-/CW Neg/--), Teva (BB-/Stable/--), and Mylan (BBB-/Positive/A-3). The company is a defendant in multidistrict antitrust lawsuits alleging price fixing, bid rigging, and customers and market allocation for generic pharmaceuticals.

Chart 4

What is your view on RemainCo's R&D pipeline?

Although we do not give much credit to Bausch's pipeline, given the company's limited success, we want to highlight two groups of assets that could help propel growth in the coming years if approved.

First, Salix licensed amiselimod, a late-stage oral compound that targets the sphingosine 1-phosphate receptor that plays a role in autoimmune diseases, such as inflammatory bowel disease and ulcerative colitis, from Mitsubishi Tanabe Pharma Corp. in April 2019. The company expects to initiate a phase 2 study in late 2020. Gilenya (a Novartis drug) that falls into the same drug class but with significant heart-related side effects, has achieved sales of $3 billion in 2019. Other newly approved drugs in the same class (Mayzent from Novartis and Ozanimod from Bristol Myers) have garnered high sales estimates.

Second, the company is testing several alternative formulations of rifaximin (generic name for Xifaxan) in new indications such as overt hepatic encephalopathy, sickle cell anemia, Crohn's disease, and small intestinal bacterial overgrowth. If successful, we think rifaximin could extend patients' lives versus the currently marketed Xifaxan formulation.

Conclusion

Bausch RemainCo is a more "typical" pharmaceutical company without the legacy eye-care business. This will increase the company's exposure to more typical pharmaceutical company risks including single-product concentration and regulatory risks. The lack of a clear long-term growth driver (beyond Xifaxan) increases the importance of pipeline success and/or M&A. On the other hand, RemainCo has a peer-high margin with low capital expenditure needs. The company is also reasonably diversified compared to many peers.

Related Research

• Bausch Health Companies Inc., Sept. 21, 2020