Question

In 2009, Roche Holding AG (Roche) made an offer to acquire all remaining outstanding shares of US biotechnology company Genentech. To pay for the deal, Roche planned to sell a record $32 billion in bonds at various maturities from 1 year to 30 years, and in three different currencies (USD, Euro, British pound). For simplicity, let us assume they only issue 10 year dollar-denominated bonds. The 10 year interest rates on corporate bonds, and the median earnings to interest expense ratios (EBITDA/interest expense coverage ratio) for US rated industrial companies at the time were as follows:

Rating	Interest rate	Coverage ratio
AAA	4.0%	114.0
AA	4.9%	44.0
A	5.6%	12.8
BBB	7.0%	8.2

With the acquisition of Genentech, suppose we project that Roche will have earnings (EBITDA) of $23 billion, and their interest expense will be $32 billion (the debt) times the interest rate. If we use the coverage ratio to estimate the bond rating, and we use the bond rating to estimate the interest rate, what rating will we assign to Roche's debt?

AAA

AA

A

BBB

Answer 1

To assign the rating to Roche's Debt, first we will calculate the Coverage Ratio Interest rate of different credit rating.

-- Interest rate of 4%, Rating AAA

Coverage Ratio = EBITDA/Interest expenes

= 23/(32*4%)

Coverage ratio =18.0

Industrial Coverage Ratio = 114

-- Interest rate of 4.9%, Rating AA

Coverage Ratio = EBITDA/Interest expenes

= 23/(32*4.9%)

Coverage ratio = 14.7

Industrial Coverage Ratio = 44

-- Interest rate of 5.6%, Rating A

Coverage Ratio = EBITDA/Interest expenes

= 23/(32*5.6%)

Coverage ratio = 12.8

Industrial Coverage Ratio = 12.8

-- Interest rate of 7%, Rating BBB

Coverage Ratio = EBITDA/Interest expenes

= 23/(32*7%)

Coverage ratio = 10.3

Industrial Coverage Ratio = 8.2

Since, With Interest rate at 5.6% Coverage ratio comes out is 12.8 which matches with the Industrial Coverage Ratio.

Hence, Roche's Debt should be assign 'A' Rating

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