Moody's: Pharma debt rises 177%, patent expiries could negate cash flow

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Debt across the pharmaceutical industry skyrocketed to $270 billion in 2009--a 177 percent increase from 2006--and according to Moody’s Investor Service, the pharmaceutical industry could experience problems acquiring profit and cash flow due to looming patent expiries.

According to a special comment released by the New York City-based company, to abate debt, “drug makers have made debt-financed acquisitions and have repurchased shares to shore up lagging stock prices.”

The company attributed the escalation of debt to the credit crunch of October 2008. According to the report, debt is largest for three large pharmaceutical companies—Pfizer, Roche and GlaxoSmithKline, increasing approximately $40.7 billion, $34.3 billion and $15.5 billion from 2006 to 2009, respectively.

Moody's speculated that the pending patent expirations in 2012 will lead to consolidation and more mergers and acquisitions (M&A) of companies within the industry. “The rise in industry debt leaves reduced cushion in credit metrics, and pharmaceutical ratings are therefore vulnerable to ongoing downward pressure,” said the company.

Additionally, the company found that from 2006 to 2009, cash levels have grown by $40 billion—from $193 to $233 billion as of Dec. 31, 2009. While the company said that the “net debt” of $36 billion is more “favorable than its gross debt position,” debt still trumps cash growth.

“Rising debt in the global pharmaceutical industry, driven by three years of acquisitions and stock buybacks, leaves credit metrics for the industry with less breathing room for more debt-financed M&A or unforeseen operating challenges,” the publication stated.

Additionally, the company adjusted for debt by adding unfunded pension liabilities, five times rent and estimated taxes on off-shore cash holdings. Even after these adjustments debt rose 85 percent to $313 billion and cash rose by 12 percent to $183 billion. Speculated net debt for the industry was estimated to be $130 billion.

Since 2006, the ratio of cash coverage of debt has also declined from 95.4 percent to 58.4 percent in 2009—a ratio of 100 percent would indicate a zero-net debt. Cash flow from operations/debt declined from 73.4 percent to 55 percent from 2006 to 2009.

While free cash flow debt has been somewhat sustained between 2006 and 2009—33.5 percent versus 29.3 percent—the company said that the patent expiries will likely set off a decline in these rates.

While trends for the industry have taken a downturn in the last few years, Moody reported that the pharmaceutical industry is still better off than others, including the automotive, transportation and retail and consumer product markets, and could hold the highest leverage on debt/earnings before interest, taxes, depreciation and amortization basis.

Moody also found that the pharmaceutical industry obtained a high number of intangible assets that have reached a total of $400 billion (85 percent of book equity).

The company concluded that there are many implications and risk factors that may damper the industry as debt levels rise.

According to Moody's, increased debts have the potential to leave less room for unforeseen events including product withdrawals, generic at-risk launches or new litigation exposures without rating consequences. In addition, debts may also affect M&A that could lead to integration risks, failure to obtain cost synergies or not meet expectations for product sales trends.