On The Block

Fitch Places Aetna's Ratings on Negative Watch

$69 Billion CVS acquisition agreement looks to fund with 30% stock, 70% cash

Fitch Ratings has placed the ratings of Aetna Inc. (Aetna) and its rated subsidiaries on Rating Watch Negative. The rating action follows yesterday’s announcement that the company has signed a definitive agreement to be acquired by CVS Health Corporation (CVS) in a cash and stock transaction valued at approximately $69 billion. A full list of rating actions follows at the end of this release.

The agreement calls for the purchase price to be comprised of 70% cash and 30% CVS stock. CVS plans to fund the cash portion of the acquisition price with approximately $4 billion of cash on hand and approximately $45 billion of new debt.

The transaction is expected to close in the second half 2018.

Ket Rating Drivers

While Fitch believes that the potential strategic benefits associated with the combination of these companies are significant, today’s rating action reflects Fitch’s concerns around the combined company’s financial leverage metrics following the close of the transaction. CVS has provided a pro forma debt-to-EBITDA expectation of approximately 4.6x at close of the transaction, which is considerably above Fitch’s expectations for Aetna at its current rating level. However, CVS management has also indicated they would plan to de-lever over time closer to a 3.0x level.

Fitch believes there is a meaningful risk of potential operational and/or earnings disruptions that could arise in the course of executing the vertical integration of two very large and complex organizations. That said, Fitch also views the existing relationship the two companies have in terms of CVS’s capacity as the provider of certain PBM services to Aetna over the past eight years to be advantageous.

At this point, it is unclear what the final legal/holding company structure will be with respect to Aetna’s debt post close, or if the Aetna debt will be guaranteed by CVS.

Aetna’s current ratings reflect the organization’s strong business profile, including its major market position and substantial size and scale, as well as the company’s strong, consistent profitability and interest coverage. Fitch considers Aetna to be a leading health insurance and managed care company due to its large membership, significant revenues and earnings base, and strong competitive position. The breadth of Aetna’s provider network and its contracting capabilities are key competitive strengths.

The ratings also reflect the company’s elevated financial leverage metrics in recent years and ongoing sector-wide operational uncertainty tied to the future of the Affordable Care Act. In addition, the company’s ratings reflect broader risks derived from government involvement in health insurance and managed care companies’ ongoing business activities. Fitch’s long-held concern is that government efforts to advance public policy goals could adversely affect health insurance and managed care companies’ ability to manage their business and hinder their ability to generate cash flow supporting debt obligations.

Rating Sensitivites

There is a high level of uncertainty currently as to the likely level of Aetna’s Insurer Financial Strength (IFS) and holding company debt ratings post close. The level of the holding company debt ratings will be sensitive to the final legal/holding company structure, which will impact whether the Aetna debt ratings will be aligned with those of CVS, or notched from Aetna’s IFS ratings as is done currently.

At this point, it is unclear what the final legal/holding company structure will be with respect to Aetna's debt post close, or if the Aetna debt will be guaranteed by CVS

In the former case, Fitch notes that it does not currently rate CVS and would need to develop an opinion on CVS to maintain ratings coverage on the Aetna debt post close. Based on ratings guidelines, CVS’s leverage immediately post close would align with Fitch’s non-investment grade standards, and its run rate target leverage would align with BBB category standards.

In the latter case, the Aetna debt ratings would be sensitive to the post close IFS ratings levels.

Post close, Aetna’s Insurer Financial Strength (IFS) ratings will be sensitive to both the stand-alone profile of Aetna’s insurance companies, as well as the impact of being part of a larger, yet likely, lower rated parent organization. The impact of parentage could exert downward pressure on the IFS ratings, especially if higher levels of upstream dividends would be extracted from the operating companies than are taken currently.

Ongoing dialogue with management around the legal structure and priority of Aetna’s existing debt relative to CVS debt, the timeline for CVS reducing its financial leverage, final capital plans at Aetna’s insurance companies, and the likelihood of meeting integration and financial leverage targets will ultimately determine the severity of any downward rating actions to be taken at close.

Full List of Rating Actions

Fitch has placed the following ratings on Rating Watch Negative:

Aetna Inc.

–Long-Term Issuer Default Rating (IDR) ‘A’;

–Short-Term IDR ‘F1’;

–Commercial paper ‘F1’;

–$500 million of floating rate senior unsecured notes due Dec. 8, 2017 ‘A-‘;

–$1 billion of 1.7% senior unsecured notes due June 7, 2018 ‘A-‘;

–$375 million of 2.2% senior unsecured notes due March 15, 2019 ‘A-‘;

–$500 million of 4.125% senior unsecured notes due June 1, 2021 ‘A-‘;

–$600 million of 5.450% senior unsecured notes due June 15, 2021 ‘A-‘;

–$1 billion of 2.75% senior unsecured notes due Nov. 15, 2022 ‘A-‘;

–$1.3 billion of 2.8% senior unsecured notes due June 15, 2023 ‘A-‘;

–$750 million of 3.50% senior unsecured notes due Nov. 15, 2024 ‘A-‘;

–$771 million of 6.625% senior unsecured notes due June 15, 2036 ‘A-‘;

–$534 million of 6.75% senior unsecured notes due Dec. 15, 2037 ‘A-‘;

–$500 million of 4.5% senior unsecured notes due May 15, 2042 ‘A-‘;

–$500 million of 4.125% senior unsecured notes due Nov. 15, 2042 ‘A-‘;

–$375 million of 4.75% senior unsecured notes due March 15, 2044 ‘A-‘;

–$1 billion of 3.875% senior unsecured notes due Aug. 15, 2047 ‘A-‘.

Aetna Life Insurance Company

Aetna Health Inc. (a Pennsylvania Corporation)

Aetna Health Inc. (a Florida Corporation)

Aetna Health Inc. (a New Jersey Corporation)

Aetna Health Inc. (a Texas Corporation)

Aetna Health Inc. (a New York Corporation)

Aetna Health of California Inc.

–Insurer Financial Strength (IFS) ‘AA-‘.