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Despite Its Risks, Ratings Firm Fitch Likes Potential of ABI-Invitrogen Merger

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With the proposed Applied Biosystems-Invitrogen merger set to close in the coming months, ratings firm Fitch Ratings weighed in on the deal this week, giving it mostly a thumbs-up.
 
In early August, Fitch initiated ratings on Invitrogen with an issuer default rating of BBB-, indicating low credit risk and a stable rating outlook. This week, the firm issued a report providing greater detail about its view of the impending $6.7 billion merger that includes factors influencing its ratings of Invitrogen.
 
Overall, Fitch said it saw much to like about the merger, citing strong liquidity and cash flow on both sides along with steady and increasing market demand for each company’s products. But Fitch also said one concern is the high debt levels associated with the deal and the potential for integration issues disrupting business.
 
Fitch also said that the space in which the two companies operate will be an advantage because of its reliable demand, significant growth opportunities, and a relatively low-risk operating environment, Fitch said in its report. Invitrogen and ABI shareholders will vote on the proposed merger on Oct. 16.
 
“Demand is tied to general health care spending and biological research, and is growing steadily as a result of favorable demographics and increasing demand for health care worldwide,” Fitch said.
 
Growth in the applied markets and international markets also should help all players in the space, and while patent expirations will have some effect in coming years, “there is not the rapid product substitution and competitive pressures of the pharmaceutical industry, for example,” according to the report.
 
Fitch also said that both Invitrogen and ABI are leading players in the life-science tools industry. In the case of Invitrogen, Fitch said it “enjoys a market-leading position in cell culture and molecular biology products and is well-known for offering complete kitted solutions and high-end products.”
 
It called ABI a leading tools manufacturer in several areas, including mass spectrometry and DNA sequencing. While saying that the company has seen recent weakness in its end markets and is feeling the heat from competitors that have been more aggressive in launching new MS platforms, Fitch said that ABI still “commands a leading market presence and also has a large installed base that will continue to generate reagent, consumables, and service revenue streams.”
 

“Although Fitch believes Invitrogen and ABI are somewhat protected by their brand recognition and proprietary technologies, the merger could still result in share losses.”

The report, however, did not address speculation that the combined company, which would take on the ABI name, may sell the mass-spec business, which some industry analysts say may be a bad fit for the new company.
 
Even Invitrogen CEO Greg Lucier, who would assume the same role in the newly combined company, has acknowledged ABI’s mass-spec business stands outside of the sales model planned for the new company in which ABI’s instruments would drive sales of Invitrogen’s reagents and chemistries. Nonetheless, he called the mass-specs “a very good business” and said “we intend to run it.” [See PM 06/19/08]
 
Other potential pluses that Fitch cited were ABI and Invitrogen’s complementary product lines and ability to bundle offerings and develop tools and packages that span a variety of lab workflows, and the combined company’s ability to exploit existing customer channels to increase sales of legacy products.
 
Invitrogen has said that in the first year after the merger the new company would see $60 million in synergies, mostly from cost-savings, and by the third year $175 million in annual synergies would be achieved. Fitch called these estimates “reasonable.”
 
Finally, pointing specifically to the 2006 merger of Thermo Electron and Fisher Scientific, Fitch said that there is a history of “consolidation which set a favorable precedent in the life sciences tools industry…Thermo Fisher’s performance since the merger has demonstrated that success is possible with this strategy.”
 
However, such a merger on the scale of the marriage of ABI and Invitrogen carries inherent risks, chief among them the high debt and leverage levels that the new company will face post-merger.
 
Specifically, Invitrogen has said it will obtain a $2.65 billion credit facility to finance the deal. Adding in existing debt that will remain outstanding, Fitch said the total debt amount accrued by the combined company post-merger will be approximately $3.6 billion.
 
Fitch said that although it expects annual cash flow from the new company to average more than $500 million during the next few years, the company’s ability to reduce debt with cash generated from operations carries “the risk that the rate and amount of debt reduction will be less than expected.”
 
That could occur if the company were to set aside cash for more acquisitions or for “shareholder-friendly activities” such as dividend payments in place of debt reduction.
 
Fitch also identified integration challenges to be a “substantial risk,” saying that the deal is the largest Invitrogen has ever pursued and could result in disruptions to existing operations. The warning has particularly resonance given that the company has a recent history of integration issues. In the midst of losing $191 million in 2006, company officials consistently cited problems with its integration of 15 acquisitions made during a three-and-a-half year period as a significant factor in its financial performance [See PM 11/02/06].
 
Finally, new innovations and customer targeting by competitors were identified by Fitch as risks. “The ability to innovate is extremely important, as customers are constantly seeking new, more effective ways to conduct scientific research,” Fitch said in its report. And citing Thermo Fisher, Fitch said it is using its significant customer reach “to drive large customers to standardize on its products. Although Fitch believes Invitrogen and ABI are somewhat protected by their brand recognition and proprietary technologies, the merger could still result in” a loss of market share.