Fitch Ratings has downgraded Bausch + Lomb Corporation's (BLCO) Long-Term Issuer Default Rating (IDR) to 'B+' from 'BB-' due to the deteriorating credit profile of Bausch Health Companies and Bausch Health Americas (collectively BHC) following a recent court ruling that involves key patents that increase the likelihood of meaningfully lower cashflows from affected drugs over the medium term.

In addition, Fitch has maintained BLCO's secured term loan at 'BB+'/'RR1'. Further details on BHC's credit profile are available at www.fitchratings.com.

Fitch has revised the Rating Watch Positive on BLCO's ratings, including the instrument ratings, to Rating Watch Evolving. The Rating Watch Evolving reflects the potential for BLCO's ratings to move higher should it become an unrestricted subsidiary, and BHC's ownership diminishes through the distribution and/or sale of its remaining interests. Conversely, BLCO's ratings could move lower if BHC's ratings are downgraded prior to, or in the absence of, the aforementioned separation. Fitch could also downgrade BLCO's ratings should it reconsider the strength of the linkage between the entities. BHC has not announced any plans that change their intentions for, or relationship, with BLCO.

Key Rating Drivers

BLCO Solid Eye Care Business: Bausch + Lomb Corporation (BLCO) is a leading global eye health company with a portfolio of over 400 products. Fitch expects BLCO will maintain an investment grade capitalization upon its separation from BHC, and transition from a secured borrowing base to unsecured. Fitch views BLCO as significantly smaller than Boston Scientific Corp. (BBB/Positive), Baxter International (BBB/Stable), Becton, Dickinson & Company (BBB/Stable) and Zimmer Biomet Holdings, Inc. (BBB/Stable).

BLCO also operates in consumer health and prescription pharmaceuticals, providing some additional sector diversification compared to Boston Scientific and Zimmer Biomet. It also presents a moderate degree of regulatory risk regarding drug pricing.

BLCO's Ratings Tied to BHC's: Until the complete separation, BHC's 'B+' IDR is the primary driver of BLCO's ratings. Fitch views the ringfencing and access and control factors as porous as opposed to open or insulated, thereby allowing BHC's credit profile to influence BLCO's. Fitch notches BLCO's ratings up two from BHC's, and until the separation any changes in the linkage could lower BLCO's ratings.

Moreover, changes to BHC's ratings would influence BLCO's until they are assessed on a stand-alone basis. An investment-grade rating would likely have leverage below 3.5x and an unsecured capital structure. Fitch will assess BLCO's Corporate Governance and its impact on ratings and ESG Relevance Scores relating to the separation. Additional detail on BHC's ratings is available at www.fitchratings.com.

Separation Mechanics Unaffected: The mixed ruling affecting BHC does not directly influence the timing of a complete separation of the entities, as management has already stated their intention. The net leverage needed to unrestrict BLCO from BHC's secured debt is on a trailing basis, and the timing of potential cashflow losses are prospective.

Assessing Changes to Incentives for Separation: BHC is not legally obligated to complete the separation. The likelihood of achieving the leverage needed to unrestrict it is lower given continued weakness in EBITDA and lower equity market valuations. This reduces potential additional proceeds from the sale of more of BHC's ownership in BLCO. Moreover, BLCO's stronger credit profile could become crucial in supporting BHC's credit profile, including providing covenant headroom.

Conversely, if BHC could unrestrict BLCO and effectuate the separation, it may further incentivize the company to do so, given increasing uncertainty at BHC. Advancing the separation would ensure BLCO's relatively healthy business and balance sheet are isolated from BHC's creditors. In addition, BHC's shareholders ownership in both entities would remain the same if a distribution in kind.

Coronavirus Impact Moderating: BLCO's business is recovering from pandemic-related negative impacts. Cataract and laser vision correction surgeries faced significant challenges as these procedures are generally considered elective or deferrable. Looking back, 2Q20 will likely remain the trough in revenues. Fitch believes growth will continue as population immunity increases, more therapeutics and diagnostic tests become available and protocols by providers mitigate the risk and patient concerns associated with having these procedures. Nevertheless, potentially vaccine resistant and virulent variants could lead to setbacks in procedure volumes.

Supply Chain/Inflation: Supply chain constraints and inflationary pressures present challenges to many firms in the healthcare sector. BLCO is generally managing these issues through building stocks of raw materials and API. In addition, the company is adding redundancies in its suppliers.

Reliably Increasing Demand: Aging demographics, improved income demographics in emerging markets, increasing digital screen times and the ongoing increase in the incidence of diabetes will likely drive low- to mid-single digit growth in the demand for eye health products and services during the intermediate term. A significant number of BLCO's products enjoy leading market positions and strong brand recognition. Consumables and contracted services account for roughly 78% of BLCO's revenues, and the company's product portfolio has only limited exposure to market exclusivity losses.

Pipeline to Support Growth: Innovation is important in order to remain competitive in the eye health market. Fitch believes the company's R&D efforts will help to drive intermediate- and long-term revenue growth while also supporting margins. BLCO makes consistent and significant investments in new product development. Its R&D efforts span all three businesses with intensity geared more towards Surgical and Opthalmic Pharmaceuticals. Fitch expects the company will also continue to pursue innovation in its Vision Care business with more incremental technological advancements.

Margin Expansion: Fitch assumes that margins will improve over the forecast period. Improving sales mix and manufacturing efficiency gains should increase gross margins. Fitch forecasts SG&A, as a percent of sales, to decline due to the strong management of other operating costs. In addition, increasing revenue should provide additional operating leverage. Less than 15% of BLCO's revenues are exposed to branded pharmaceuticals pricing issues in the U.S.

Consistently Positive FCF: Advancing sales, improving margins, solid working capital management and moderate capital expenditure requirements should support consistently positive and increasing FCF. Fitch does not expect that BLCO will pay dividends or engage in share repurchases during the near term. Capital deployment will focus on internal investment, external collaborations and targeted acquisitions.

For a global eye health company, Fitch believes BLCO has relatively minimal contingent liability risk regarding product liability, intellectual property and other regulatory issues. As such, Fitch forecasts BLCO's leverage (total debt/EBITDA) will decline over the forecast period to below 2.5x, primarily through EBITDA growth. The current level of balance sheet debt is generally viewed as a permanent component of the capital structure, and Fitch expects maturities will be refinanced.

Derivation Summary

BLCO's 'B+'/Evolving Watch reflects its status as a majority owned subsidiary of Bausch Health until the separation. Fitch believes BLCO is a stronger than the weaker parent, and notches BLCO's ratings from the consolidated parent's IDR. The notching is based on Fitch's view of the ringfencing as porous, as opposed to open or insulated, due to the potential for some cashflow leakage under the credit agreement's investment and dividend covenants (i.e. limited efficacy documentation).

In addition, Fitch views access and control as porous, as opposed to open or insulated, as BLCO is a separate public company with only minority shareholders and some overlapping Board of Directors with BHC. Until the separation, BLCO's ratings will be influenced by BHC's.

BLCO is significantly smaller than Boston Scientific Corp. (BBB/Positive), Baxter International (BBB/Stable), Becton, Dickinson & Company (BBB/Stable) and Zimmer Biomet Holdings, Inc. (BBB/Stable). BLCO also operates in consumer health and prescription pharmaceuticals, providing some additional sector diversification compared to Boston Scientific and Zimmer Biomet. It also presents a moderate degree of regulatory risk regarding drug pricing.

BLCO is somewhat less diversified than Becton, Dickenson and Baxter. In addition, BLCO is solely focused on eye health, while all of its peers address a number of disease markets, with Zimmer Biomet also being somewhat less diversified than the others. Zimmer Biomet and Becton, Dickenson have a similar financial profile to BLCO, and Fitch expects the company to maintain gross debt/EBITDA between 2.5x-3.0x.

Parent-Subsidiary Linkage

The approach taken is a weak parent (BHC)/strong subsidiary (BLCO). Using Fitch's Parent-Subsidiary Linkage criteria, the agency concludes that there is porous ring fencing and porous access & control. As such, Fitch rates the parent and subsidiary at the consolidated level while notching the subsidiary's rating up by two.

Key Assumptions

Fitch's Key Assumptions Within The Rating Case for BLCO:

Mid- to high-single-digit organic revenue growth driven by the uptake of new product commercialization moderately offset by increased competitive pressure for some established products;

Annual FCF generation greater than $400 million during the forecast period with moderately improving operating EBITDA margins;

Dividends are not included in the forecast, but if instituted would decrease FCF by the same amount as Fitch defines as CFFO-capex-dividends

Cash deployment prioritized for tuck-in acquisitions.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch viewing BLCO on a standalone basis;

An upgrade at BHC. Rating Sensitivities for BHC are detailed in the Rating Action Commentary dated August 3, 2022.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Evidence of factors related to ring-fencing and access and control that would lead Fitch to rate BLCO on a consolidated basis with BHC or with one notch rather than two notches;

A downgrade at BHC. Rating Sensitivities for BHC are detailed in the Rating Action Commentary dated Aug. 3, 2022.

Resolution of the separation of BLCO and/or further clarity on BHC's patent defense may occur more than six months into the future which may influence the timing of the resolution of the Rating Watch.

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

BLCO Liquidity: Fitch expects BLCO will have sufficient financial flexibility with an undrawn $500 million, five-year secured revolving credit facility, and aside from manageable annual term loan amortizations, no debt maturities given a $2.5 billion secured five-year term loan.

Debt Instrument Notching: For issuers with 'B+' Long-Term IDRs and below, Fitch assigns instrument ratings through a bespoke analysis. The recovery analysis assumes that BLCO would be considered a going concern in bankruptcy and that the company would be reorganized rather than liquidated. Fitch estimates a going concern enterprise value (EV) of $3.5 billion for Bausch Health and assumes that administrative claims consume 10% of this value in the recovery analysis.

The going concern EV is based upon estimates of post-reorganization EBITDA and the assignment of an EBITDA multiple. Fitch's estimate of Bausch Health's going concern EBITDA of $500 million is roughly 38% lower than the FYE 2021 EBITDA. The assumed going concern EBITDA reflects a scenario where the pandemic continues to weigh on certain business segments during the intermediate term and the company experiences shortfalls in commercializing the R&D pipeline, thereby resulting in a restructuring or default.

Fitch assumes a recovery EV/EBITDA multiple of 7.0x for Bausch. This is generally in line with the 6.0x-7.0x Fitch typically assigns to medical device/specialty pharmaceutical manufacturers.

Fitch applies a waterfall analysis to the going concern EV based on the relative claims of the debt in the capital structure, and assumes that the company would fully draw the revolvers in a bankruptcy scenario. The $3.0 billion of fully drawn senior secured credit facility are rated 'BB'/'RR1', three notches above the IDR.

Issuer Profile

Bausch + Lomb Corporation (BLCO) is currently a majority-owned subsidiary of Bausch Health Companies Inc (BHC) and a leading global eye health company with a portfolio of over 400 products. The company has a global research, development, manufacturing and commercial footprint of approximately 12,000 employees and a presence in approximately 90 countries.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Bausch + Lomb Corporation has an ESG Relevance Score of '4' for Exposure to Social Impacts due to pressure to contain health care spending growth; highly sensitive political environment, and social pressure to contain costs or restrict pricing, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors. Pharmaceuticals account for less than 17% of the firm's total sales.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means 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 Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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