Investing.com -- Fitch Ratings has placed Solventum Corporation on Rating Watch Positive. This decision has been taken in light of Solventum's announcement that it is to sell its Purification & Filtration (P&F) business to Thermo Fisher Scientific Inc (NYSE: TMO ). The ratings under review include Solventum's 'BBB-' Long-term Issuer Default Rating (IDR) and senior unsecured debt, as well as its 'F3' Short-term IDR and commercial paper.

Solventum has stated that it intends to use the net proceeds from the sale to primarily pay down debt. The company anticipates that the divestiture will be finalized by the end of 2025, subject to regulatory approval and closing conditions.

Fitch's decision to upgrade Solventum's ratings, either near the time of closing or further in the future, will depend on the successful completion of the divestiture and debt reduction. Additionally, Fitch will need to be convinced that Solventum can maintain EBITDA leverage around 3.0x or lower, while simultaneously improving growth through external investment. To achieve this, Solventum will need to enhance organic revenue growth and its EBITDA margins.

Fitch believes that the sale of the P&F business segment will expedite Solventum's portfolio optimization by reducing leverage and providing more financial flexibility. This would enable Solventum to concentrate on its core growth segments. A more robust balance sheet will allow the company to pursue bolt-on acquisitions that advance product innovation and generate revenue growth and margin expansion.

Despite Solventum's operating performance for FY 2024 aligning with Fitch's expectations through Q3-2024, the company continues to face substantial operational headwinds. These include higher separation costs, significant manufacturing line moves, and changes to its distribution centers and logistics. Fitch believes these challenges will persist over the near to medium term while Solventum continues to shift its key commercial and R&D resources to areas with greater growth potential.

Solventum's financial growth will largely depend on its ability to capitalize on investments needed for effective separation from 3M. This will improve its standalone operational effectiveness, productivity, and efficiency. Fitch believes Solventum may take incremental actions to rebalance its portfolio over the near to medium term to achieve its growth targets.

Following the P&F segment divestiture, Fitch anticipates that Solventum will focus on capital investment and 'bolt-on' acquisitions. Fitch estimates EBITDA leverage and CFO-capex/debt ratios can remain between 2.5x-3.0x and above 12.5%, respectively. This is with modest revenue growth and margin expansion along with 'bolt-on' acquisitions funded by free cash flow (FCF). However, pressure for transformative mergers and acquisitions combined with initiating a dividend could negatively affect Solventum's credit profile.

Following the spin-off, 3M exclusively supplies certain chemical materials and inputs for Solventum products. This contributed around $3 billion to its 2023 revenue. Fitch expects these supply arrangements to remain stable and beneficial for Solventum's growth strategies. Its dependence on 3M is likely to decrease over time as its product portfolio evolves.

Fitch assumes that Solventum's legal proceedings will not have a material adverse effect on its reported earnings or cash flows. However, Fitch could take negative rating action on Solventum if the company's litigation risk appears to be rising because of regulatory, legislative, or legal changes related to the use of fluorochemicals (PFAS).

Resolution of the Rating Watch will occur around the time of the transaction closing and debt repayment which may occur more than 6 months from the announcement.

Solventum has access to ample amounts of internal liquidity in the form of CFO and cash balances over the forecast period through 2027. Following the closing of the divestiture of the P&F segment, Solventum is expected to retire all of its term loans and a portion of its existing senior unsecured notes. As a result, it will not have any maturities at least until 2027 depending on which notes it may retire with the divestiture proceeds.

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