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Closing of Mylan / Upjohn merger highlights dislocation in curve

| November 6, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The impending merger of Mylan Inc (MYL) and Pfizer spin-off UPJOHN is expected to close November 16, 2020. The entity, renamed Viatris, will have all recently issued UPJOHN debt, Mylan Inc. and Mylan NV debt cross guaranteed and ranked pari passu; and all debt in the capital structure is expected to be rated (Baa3/BBB- (p)/BBB) post close. Evaluating the combined capital structure of MYL and UPJOHN shows a dislocation in the 30-year part of the curve, which provides an attractive investment opportunity in MYL long-dated paper. The closing of the merger and the subsequent cross guarantee of the debt should enable MYL 30-year spreads to collapse closer to UPJOHN, similar to the relationship seen in the rest of the curve. That implies an upside of nearly 30 bp for the more liquid MYL 5.2% 2048 issue.

Exhibit 1. MYL/UPJOHN Curve

Source: Bloomberg TRACE; Amherst Pierpont Securities

Merger Timeline

Having obtained all required antitrust clearances on October 30, 2020, it was recently announced that the spin-off of UPJOHN from Pfizer (PFE) is set to occur on November 13, 2020, setting the stage for the MYL/UPJOHN merger to close on November 16, 2020. With the funding of the $12 billion dividend payment to PFE already taken care of with UPJOHN’s June issuance, there should be no further delays and the deal is expected to close in line with recent guidance.

Improved Scale

The combination of MYL and UPJOHN is important for MYL as it will meaningfully improve the company’s scale across branded, generic and over the counter (OTC) pharmaceuticals. The pro forma revenue base is expected to be approximately $19 billion (up from $11.5 billion at year end 2019) while the margin profile will improve as UPJOHN’s EBITDA margin is in the high 30% range, compared with just under 30% for MYL. UPJOHN’s focus on branded generics not only helps to push the combined entity to become the largest company in the global generic space but increases its presence in emerging markets where branded generics tend to be marketed more heavily. In the US, generic competition is largely based on price point alone, however in emerging markets, branded generics tend to outperform unbranded as they are perceived to be of both higher quality and efficacy. The higher price point associated with branded generics does little to dissuade the emerging market consumer to competitor’s products given the better perception of this class of generic pharmaceuticals.

Business Model Transformation Supports Further Deleveraging

While MYL’s leverage has been steadily improving on an annual basis since 2016, the merger is expected to bring leverage below the 3.0x threshold within two years of closing. We note that MYL ended 2Q20 with total leverage of 3.4x, down two ticks from year-end 2019. MYL’s leverage hit a high in 2016 of roughly 4.3x post its acquisition of Meda AB. MYL management remains committed to repaying debt post close and as such has earmarked all debt maturing in 2020 and 2021 for repayment as part of their rapid deleveraging strategy. We note that total debt maturing between now and the end of 2021 is roughly $2.7 billion. Cost synergies of $1.0 billion are expected to be realized in the first four years post close which will support both EBITDA and cash flow growth. That said, we estimate that the combined entity could end 2021 with leverage of approximately 2.9x as total debt will be roughly $21.5 billion and EBITDA will be approximately $7.4 billion. By year-end 2022, estimates put leverage much closer to 2.5x, MYL’s stated leverage target. While management plans to pay an attractive dividend after the first full quarter post close, share repurchases will be on hold for roughly 2 years, until the aforementioned leverage target is achieved.

Exhibit 2. Viatris Time Line for Deleveraging & Capital Allocation

Source: Company reports

Merger Viewed Positively by Ratings Agencies

While Moody’s currently maintains a stable outlook on MYL/UPJOHN bonds the agency noted that the ratings could be upgraded if the combined entity is able to sustain leverage below 3.0x. The agency believes that in order to bring leverage below the 3.0x threshold, integration needs to run relatively smoothly in order to achieve the cost synergy target. S&P currently maintains a positive outlook which reflects their expectation that leverage of the combined company will decline below 3.0x within two years post close. S&P believes that management’s commitment to utilize cash flow for debt reduction coupled with the business model transformation which supports improved cash flow, will enable the company to hit its 2.5x leverage target. Fitch seems so to be the most optimistic as the agency has MYL’s BBB- rating on review for an upgrade. Fitch has noted that they will conclude the review upon completion of the merger and plan to upgrade MYL one notch to BBB, in line with UPJOHN’s rating. They have based the upgrade on their view that the combined entity will operate with a credit profile that is commensurate with a BBB rating given tis 2.5x leverage target.

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