Mallinckrodt flirts with debt load after Nellcor Puritan Bennett deal

Mallinckrodt is a company walking on a tightrope. The St. Louis-based healthcare firm needed to diversify in order to avoid overreliance on its core businesses, such as the medical imaging contrast market, which has experienced severe pricing pressures. Mallinckrodt made a move to diversify in August by acquiring medical equipment manufacturer Nellcor Puritan Bennett, but in the process the company has assumed a debt load that has raised eyebrows in the financial markets.

Several events have highlighted the challenges facing Mallinckrodt. At a presentation Sept. 23 at the Donaldson, Lufkin, and Jenrette investors conference in New York City, Mallinckrodt executives reported that price pressures in the company's contrast business will result in first-quarter earnings from continuing operations below the first quarter of fiscal 1997 and 6 to 9 below consensus analyst estimates before nonrecurring charges. Mallinckrodt said the price pressures were due to increased compliance with purchasing contracts at several group purchasing organizations that are Mallinckrodt customers.

Earlier in September, Standard & Poor's cut its ratings on several forms of Mallinckrodt debt. In announcing the downgrades, S&P analysts said that recent reorganization moves, such as the Nellcor acquisition, were in the right direction because they will help Mallinckrodt diversify its core healthcare market. At the same time, however, the $2 billion in debt assumed in order to complete the tender offer may hinder the company's flexibility, according to S&P. S&P gave BBB ratings to Mallinckrodt's corporate credit rating and senior debt, which previously had been rated A-. S&P also rated Mallinckrodt's $2 billion bank credit facility as BBB.

What's a company to do? For one thing, Mallinckrodt is moving forward with the integration of Nellcor Puritan Bennett, a Pleasanton, CA-based medical equipment manufacturer with positions in oxygen monitoring, critical-care ventilation, and other respiratory-based products. At the New York City investors conference, Mallinckrodt reported that the integration of Nellcor is going well and that the business is living up to the company's expectations. Mallinckrodt executives also say they are taking steps to try to reduce the company's debt so that it is in line with historical levels.

Mallinckrodt's choice of Nellcor as a merger partner came as a surprise to the imaging community, where Mallinckrodt is primarily known for its contrast media and radiopharmaceuticals business. The deal makes sense from a broader perspective, however. Mallinckrodt is a major provider of endotracheal and tracheostomy tubes, as well as temperature management systems, according to spokesperson Peter Faur. The merger with Nellcor will bolster the division within Mallinckrodt that is dedicated to these medical devices, a division that recorded $320 million in sales in the last fiscal year.

"It's a market that we were already working in," Faur said. "In fact, many of our products in that market are complementary and not overlapping with the kinds of products that Nellcor has."

The merger will also reduce Mallinckrodt's dependence on the contrast media business, which has suffered a major erosion in prices in the U.S. over the past year. This drop in pricing levels was cited by analysts as the catalyst for the merger of fellow contrast firms Nycomed and Amersham International, a deal announced just weeks before the Mallinckrodt/Nellcor acquisition was made public (SCAN 7/9/97).

In recent years, Mallinckrodt has focused on medical products, divesting businesses outside the healthcare field. The first step was selling its veterinary and flavorings business, a move that occurred just prior to the Nellcor announcement. The Nellcor deal solidifies the transformation.

Together with Nellcor, Mallinckrodt estimates that it will have revenues of about $2.4 billion for the year ended June 30, 1997. About $1.1 billion will come from the critical-care business, which will draw most of its revenues from respiratory-related equipment sales; $900 million will come from the medical imaging business; and $400 million will come from the sale of specialty pharmaceuticals.

The nearly $2 billion price tag for the deal, and the amount of debt Mallinckrodt will assume to pay for it, has garnered the attention of the investment community, however. Analysts, including Elie Radinsky of Standard & Poor's Corporate Ratings Group in New York City, believe the company's debt, which will approach a debt-to-capitalization ratio of 70%, has negative implications for the company. S&P had the company on credit watch for several weeks, a status that was removed after the ratings cut was announced.

Mallinckrodt executives, however, believe the debt burden is manageable. Faur notes that although the debt-to-capitalization ratio fell to about 35% following the sale of the flavorings and veterinary businesses, Mallinckrodt commonly maintained about a 50% ratio, and expects to be back in that range again soon.

"Within 18 to 24 months, we ought to be able to work that down to the neighborhood of 60%, and in 24 to 36 months we would be in the area approaching 50% again," Faur said. "So yes, it is higher debt than we traditionally have taken on, but we do think we'll be able to manage it."