OREANDA-NEWS. Fitch Ratings has assigned Ephios Bondco PLC (Ephios) a final Issuer Default Rating (IDR) of 'B'. The Outlook is Stable. Concurrently, Fitch has assigned a final rating of 'B+'/'RR3' to Ephios's EUR1,485m senior secured notes due 2022 and assigned Ephios Holdco II PLC's (Ephios Holdco) EUR375m senior notes due 2023 a final rating of 'CCC+'/'RR6'. Fitch has also removed Ephios's super senior revolving credit facility (RCF) expected rating of 'BB-(EXP)'/'RR2' from Rating Watch Positive and assigned a final rating of 'BB'/'RR1'.

The assignment of the final ratings follows the completion of the acquisition of synlab Holding GmbH (Synlab) and Labco SA (Labco) and their combination under Ephios, the receipt of final documents materially conforming to information previously received and the publication of some pro-forma consolidated figures for the first nine months of 2015 reflecting the performance of the combined group in line with expectations. All the final ratings are the same as the expected ratings last affirmed on 18 August 2015.

As a result of the transactions, Ephios Holdco is now the top holding entity within the enlarged restricted borrowing group and its debt obligations are included in our IDR analysis. Therefore, concurrently with the assignment of final ratings, Fitch has transferred the final IDR of 'B' to Ephios Holdco from Ephios.

The inclusion of Ephios Holdco within the restricted group is supported by the fact that its notes benefit from the same guarantees as those provided to Ephios's senior secured notes, albeit on a subordinated basis, by certain subsidiaries of Ephios. Ephios Holdco's notes also benefit from a second-ranking share pledge over Ephios.

KEY RATING DRIVERS FOR EPHIOS HOLDCO'S IDR
Weak Financial Metrics
The capital structure backing the acquisition of Synlab and that of Labco under Ephios maintains high funds from operations (FFO) adjusted gross leverage close to 8.0x. Although such high leverage is not commensurate with a 'B' IDR we expect gradual deleveraging over the next two years driven by the combined group's positive free cash flow (FCF). We also expect FFO fixed charge cover to improve mildly from our forecast low point of around 1.7x post-merger.

Moderate Deleveraging Prospects
The rating conservatively assumes that Ephios Holdco will conduct a consolidation strategy of sourcing and executing low risk bolt-on acquisitions of laboratories at attractive multiples and extracting synergies, driven by the fragmented nature of the European laboratory testing market and weak organic growth prospects. As a result we expect FFO adjusted gross leverage to only gradually reduce to below 7.0x by 2017, a level compatible with an IDR of 'B' for the sector. We would consider any large, transformational M&A as event risk.

Leader in European Laboratory Services
The rating reflects Ephios Holdco's market position as the largest clinical laboratory services group in Europe by revenue, benefiting from a top-three player position in its core markets. This scale and geographical diversification reduce the exposure to single healthcare systems and therefore help, in our view, strengthen the resilience of cash flows and earnings.

Steady Profitability
The merger dilutes Labco's legacy EBITDA margin as Synlab has significant exposure to Germany, a lower-margin market. We believe that Ephios Holdco is somewhat reliant on extracting cost savings from this greater scale, which may be limited due to little overlap between Labco's and Synlab's existing operations. As a result we only expect a mild improvement in profitability by 2017.

Subdued Organic Performance
Fitch expects the pricing environment to remain challenging in Ephios Holdco's key markets, namely Germany (29% of 2014 pro forma sales), France (24%), Italy (12%), Spain (8%) and Switzerland (8%). Sustained reimbursement pressures by ultimate payers such as governments and insurance companies are likely to constrain organic growth prospects in the medium term. As volumes have proven resilient to economic cycles, underpinned by broadly favourable demographics and socioeconomic factors, we expect larger players, such as Ephios Holdco, to withstand the negative impact of tariff pressure on their profitability.

KEY RATING DRIVERS FOR THE INSTRUMENTS

Weak Creditor Protection
The super senior RCF and the senior secured notes share the same security package, primarily comprising share pledges over Ephios, Ephios France SAS, Ephios Acquisition GmbH as well as over subsidiaries representing around 60% of the consolidated EBITDA as of end March 2015. However, the senior notes issued by Ephios Holdco benefit from a junior ranking share pledge over the same entities. The super senior RCF includes a single leverage covenant while the senior secured notes and the senior notes are protected by incurrence-based covenants, subject to permitted baskets.

Going Concern Distressed Valuation
We expect a going concern restructuring to yield stronger recoveries for creditors than liquidation in a default scenario. We assume a distressed sale of the group as a whole at Ephios Holdco or possibly Ephios Bondco level because a liquidation of individual labs could prove challenging given laboratory ownership regulatory constraints in various European jurisdictions, in particular clinical pathologists' pre-emptive rights in France. Therefore, we have valued the group on the basis of a 6.0x multiple applied to an EBITDA that is 20% below the last 12-month combined EBITDA as of end September 2015, factoring in acquisitions already completed and adding back UK operations' start-up costs.

Poor Recoveries for Ephios Holdco's Noteholders
The ratings of 'CCC+'/'RR6' for Ephios Holdco's senior notes reflect poor recovery prospects for noteholders in a default scenario given their subordination to the super senior RCF and certain other obligations of non-guarantor subsidiaries as well as the senior secured notes in the debt waterfall. We have assumed full recoveries on the super senior RCF given its fairly small share and its seniority in the debt waterfall as well as the fact that Germany is now the group's centre of main interest instead of France. As a result, Fitch has assigned Ephios's RCF a final rating of 'BB'/'RR1'.

KEY ASSUMPTIONS
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate.

Key Fitch forecast assumptions include:
- Low to mid-single digit organic growth in key markets.
- Impact of launch of UK activities, strikes in France and increase of VAT in Spain on 2015 EBITDA and FFO margins.
- EBITDA margin improving towards 20% by 2017 (post-merger: 18%), due to cost savings and economies of scale achieved from the enlarged group.
- Up to EUR100m of bolt-on acquisitions per year after 2015.
- No dividends paid.

RATING SENSITIVITIES
Positive: Future developments that could, individually or collectively lead to a positive rating action include:
- Meaningful deleveraging such that FFO adjusted gross leverage (pro forma for further bolt-on acquisitions) falls to 6.5x, combined with FFO fixed charge cover improving towards 2.0x.
- Positive FCF as a proportion of sales sustainably in the mid to high single digits.
- More conservative financial policy reflected in lower debt-funded M&A spending, or growth funded more conservatively by existing cash flows or equity funds.

Negative: Future developments that could, individually or collectively lead to a negative rating action include:
- FFO adjusted gross leverage (pro forma for acquisitions) above 8.0x on a sustained basis.
- FFO fixed charge cover (pro forma for acquisitions) below 1.3x on a sustained basis.
- EBITDA margin below 17% due to failure to extract synergies and more integration issues than expected.
- FCF margin falling to slightly positive territory while maintaining a debt funded acquisition strategy.
- Large, debt-funded and margin-dilutive acquisitions, combined with profitability erosion in key markets, reflecting a more challenging operating environment.