Investing.com -- S&P Global Ratings has placed Solventum Corp. on CreditWatch with positive implications, following the company’s announcement of a definitive agreement to sell its purification and filtration (P&F) business to Thermo Fisher Scientific Inc (NYSE: TMO ). The transaction, valued at $4.1 billion, is expected to significantly reduce Solventum’s leverage and increase its financial flexibility.

The ’BBB-’ issuer credit rating, senior unsecured debt rating and ‘A-3’ short-term rating of Solventum are now under review. The CreditWatch placement reflects the potential of this transaction to reduce Solventum’s debt and improve its overall credit profile. The potential for an upgrade depends on the extent of leverage reduction, operating performance and the company’s longer-term financial policy. The resolution of the CreditWatch placement will occur upon the completion of the divestiture.

S&P Global Ratings anticipates that Solventum’s leverage will decline to the mid-2x area in 2025, following the transaction. The company is expected to receive net proceeds of $3.4 billion from the transaction and intends to use most of the proceeds to repay a significant portion of its existing debt. This could potentially result in a one-notch upgrade. As of Sept. 30, 2024, Solventum had approximately $8.3 billion of debt outstanding, with S&P Global Ratings-adjusted leverage of 3.5x. The transaction is expected to close by the end of 2025.

The P&F business is expected to generate about $950 million, or about 12% of Solventum’s consolidated sales in 2024 with an operating margin of about 11%. Despite the sale reducing Solventum’s business diversity, the company will retain good product and geographic diversity, and leading market positions in some areas. The transaction also increases its financial flexibility to pursue strategic mergers and acquisitions (M&A), which are expected to play a more prominent role in the company’s growth strategy in the coming years.

Solventum is currently undergoing a complex separation from 3M Co. (NYSE: MMM ), and its performance has been mostly in line with expectations. However, the company has faced challenges with the separation and costs have been higher than anticipated due to mark-ups on 3M transition agreements and increased IT investment. Separation costs are expected to peak in 2025 before declining in 2026 and 2027. The company is also facing pressure to improve performance in line with its historical levels as part of 3M.

S&P Global Ratings believes that Solventum will maintain leverage below 3x as it transforms its business. Pro forma leverage is expected to be in the mid-2x area in 2025, with prospects to reduce leverage further through additional debt repayment. However, the company’s appetite for M&A is anticipated to increase by 2026, which could result in releveraging. Therefore, an upgrade will depend on the company’s ability to maintain credit metrics consistent with a ‘BBB’ rating. Solventum is expected to provide more clarity around its longer-term strategy and financial policy in its fourth quarter earnings call and upcoming investor day.

The CreditWatch placement of Solventum’s ratings reflects the potential for a one-notch upgrade, depending on the extent of leverage reduction, operating performance, and the company’s longer-term financial policy. The CreditWatch is expected to be resolved upon the completion of the P&F divestiture, likely by the end of 2025.

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