Fitch Rates Illumina's Senior Unsecured Notes 'BBB'
(The following statement was released by the rating agency)Fitch Ratings-Austin-16 March 2021:
Fitch Ratings has assigned a 'BBB' rating to Illumina, Inc.'s senior unsecured notes issuance. Fitch expects proceeds to help fund the GRAIL acquisition and result in gross debt/EBITDA around 2.0x.
The company's innovative business profile, market leading positions and conservative credit profile help offset the risks associated with its focus on pre-commercialized and late-stage products. Illumina's lower leverage versus similarly rated peers balances the business risk surrounding the GRAIL acquisition, as its flagship product, Galleri, is not expected to receive FDA approval until 2023.
Fitch notes Illumina's existing market leading next-generation sequencing (NGS) technology and large installed base will allow for broader commercialization and uptake for Galleri. Illumina's EBITDA and FCF margins are typically higher than traditional peers, due to its focus on innovative technologies, and should provide sufficient cash flow to reduce debt post-acquisition while allowing the company to continue to focus on internal investments.
Key Rating Drivers
Innovative Model, NGS Leader: Illumina is the global leading manufacturer of NGS technology and has built a reputation for quality and innovation. NGS technology allows for high throughput processing of genetic sequencing, which materially reduces time and can reduce costs compared to traditional methods of disease diagnosis, which are often expensive and inconclusive while requiring extensive testing.
Illumina's focus is moving toward more clinical deployment, an area where its product portfolio is not as robust as competitors, but it holds the leading clinical genomics portfolio. The company is increasing its clinical mix through its own FDA-approved assays, strategic collaborations, and its recent announcement to acquire GRAIL, an innovative diagnostics-focused company for multi-cancer early detection. We expect sequencing end-markets to provide mid-teen revenue growth for Illumina over the forecast period, not including GRAIL.
GRAIL Initially Leveraging, Dilutive: Illumina has agreed to pay $8 billion for GRAIL, financed with roughly $4.5 billion in equity and the remaining in cash and debt, resulting in expected gross debt/EBITDA below 2.0x. Illumina's 'BBB' ratings assume the issuer will maintain leverage at or below 2x and leverage headroom and liquidity would improve from these levels should some portion of the $518 million of convertible notes due June 2021 convert to equity (currently trading at more than 50% premium to the initial conversion price).
GRAIL revenue will be limited after the anticipated limited launch of Galleri in 2021, as the company does not expect FDA approval until 2023, which would result in broader market uptake. We anticipate EBITDA margin dilution of approximately 300 bps from 2020 EBITDA margins of roughly 31%, with upside unlikely until 2023 when fixed costs can be leveraged due to broader market uptake. Illumina's broad installed base will allow for global commercialization and adoption for GRAIL's pre-commercial pipeline. The 'BBB' IDR acknowledges the risk of taking on debt for a portfolio of pre-commercial and late-stage assets.
GRAIL's Galleri multi-cancer early detection test has shown promising data and is on track for a laboratory developed test (LDT) launch in 2021, which will be limited to health systems and self-insured employers as the assay will not be reimbursed by payors. GRAIL's pipeline also includes Diagnostic Aid for Cancer (DAC), which will speed time to diagnosis when cancer is suspected, and Minimal Residual Disease (MRD), which will detect cancer after diagnosis and treatment. However, we do not expect these assays to contribute meaningfully until 2023 and beyond. The GRAIL acquisition also offers a longer-term data play for Illumina. Galleri's clinical data could help move genomic diagnostics forward with the genomic oncology data collected.
EBITDA/FCF Largely Sticky: Fitch anticipates EBITDA margins (approximately 28% once GRAIL is acquired) and FCF margins could fluctuate over the long term, as the company may prioritize large investments in innovative and developing technologies. Illumina's large installed base supports highly recurring revenue from consumables and services at 87% of 2020 revenues. Reliance on lower margin instrument sales (13% of revenue) has lessened over the years as the company gained traction with placements, now totaling over 17,000 worldwide. The GRAIL acquisition and subsequent anticipated product uptake should increase Illumina's clinical consumable end market exposure.
Strategic Collaborations of Interest: More recently, Illumina started to partner with diagnostics and pharmaceutical manufacturers to allow these firms to develop assays that solely use Illumina sequencing platforms and leverage its large installed base. There is a growing interest in the industry to leverage sequencing to help address the need for increased diagnostic and screening testing capacity. Sequencing-based diagnostics tests allow for scale and efficiency beyond PCR-based diagnostics, which are often time consuming and one dimensional. While Fitch does not expect strategic collaborations to contribute meaningfully to total revenue, these partnerships could drive longer-term uptake and broader use of sequencing in clinical settings.
Pandemic Pressures Improving: Fitch's forecast revenues of $3.83 billion for 2021 compares to $3.5 billion of revenue in 2019. This growth is supported by increased placements during 2020 and resumed utilization by clinical (more than 43% of sequencing consumables) and academic/research customers. Illumina's revenue decreased 9% for 2020 due to decreased shipments of consumables and instruments, but the company had a strong 4Q20 with 20% revenue growth compared to 3Q20 as clinical sequencing run rates exceeded pre-pandemic levels and research run rates returned to normalized pre-pandemic volumes.
The importance for genomic sequencing has also been proven during the pandemic and may create some traction as infectious disease genomic sequencing in clinical use increases. Cash is expected to remain strong, and the company did not need to tap the capital markets to fund liquidity.
Illumina is a more narrowly focused player on a product and end-market basis than the largest life sciences and diagnostics competitors but maintains leading market share in its existing markets. The company also has a stronger focus on highly innovative and developmental assets. Large peers are generally rated in the mid to upper 'BBB' category, including Thermo Fisher Scientific Inc. (BBB+/Stable), Bio-Rad Laboratories, Inc. (BBB/Stable), PerkinElmer (BBB/Stable) and Agilent Technologies Inc. (BBB+/Stable). Illumina has historically had industry leading EBITDA and FCF margins, but we believe Illumina's profitability is more susceptible to fluctuations given its heavy focus on internal and early stage investments. Illumina partially offsets these risks by managing to lower leverage than most peers.
Fitch's Key Assumptions Within the Agency's Rating Case for the Issuer
-- Annual revenue growth in mid-teens without GRAIL.
-- Fitch assumes GRAIL acquisition closes 6/30/21 and is relatively slow to materially contribute to operations.
-- EBITDA margins diluted by GRAIL acquisition; expectation for margin improvement does not begin until 2023 when GRAIL revenue contribution gains traction.
-- Fitch assumes 2021 convertible notes are paid off at maturity and share repurchases are suspended after 2020. Tuck-in M&A could also resume in out years but internal investments are prioritized.
-- FCF margin in the mid-teens.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
-- Successful commercialization of Galleri and FDA approval, allowing for continued ability to meet financial obligations and increased business diversification, resulting in less need for large acquisitions.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
-- Commercial failure of Galleri, GRAIL's flagship product, resulting in the need for further debt-funded acquisitions.
-- Gross debt/EBITDA sustained above 2x.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Liquidity Sufficient: Liquidity is supported by $1.8 billion of cash on hand at Jan. 3, 2021 and full availability expected under the new committed $750 million unsecured revolver. Available liquidity should be sufficient for day-to-day operations, capex and some debt reduction if needed.
Maturities Manageable: Illumina has $518 million of convertible senior notes due 2021 and $750 million of convertible senior notes due 2023. New debt to finance the GRAIL acquisition will likely have staggered maturities. We believe Illumina would be able to refinance if Galleri fails, due to the company's underlying business strength. The company has a $1 billion bridge facility in place to facilitate initial financing of GRAIL.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of 3 - ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on our ESG Relevance Scores, visit www.fitchratings.com/esg.
Date of Relevant Committee 04 March 2021
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