Higher Interest Rates May Lie Ahead
The Sucampo deal came at a cost. Mallinckrodt was required to pay all cash. What cash it did not have on hand the company had to borrow. The expectation that the acquisition would increase debt/EBITDA above 5x is what prompted S&P to act. The company incurred $90 million of interest expense in Q4 2017, which equated to an interest rate of about 5.5%. The company’s bonds due April 2023 now have a yield-to-maturity of about 10.5%. This is up from around 8.0% at the end of Q3 2017.
If the company ever has to refinance any of its $6.7 billion debt load it will likely come at a few hundred basis points higher than what it’s currently paying. Prior to the deal Sucampo’s Q3 2017 revenue was up 6% Y/Y while EBITDA was flat. In effect, Mallinckrodt hitched its wagon to a company with no earnings growth. Now its credit metrics have deteriorated, its bond yields have spiked and the stock is hovering near a 52-week low of just over $14.
The stock is so low that it could be difficult to raise equity even if management wanted to. Mallinckrodt’s only option to right the ship and service its debt load could be to launch new drugs. This could be asking a lot of a company with a reputation as a pharma roll-up.
Conclusion
The S&P downgrade to below investment grade reflects Mallinckrodt’s deteriorating credit metrics. The company could be in dire straits as it top-selling drug appears to have cracked. The decline in the share price likely portends investors have soured on the Sucampo deal. Until the company can show consistent revenue and earnings growth MNK remains a sell.
