Fitch affirmed the 'BBB-' Long-term Issuer Default Rating (IDR) of Royalty Pharma, plc (RPRX) and the 'BBB-' debt ratings on its existing senior unsecured notes.

The Rating Outlook is Stable.

RPRX 'BBB-' IDR reflects its solid portfolio of high-quality royalty streams and cash flows. These strengths are somewhat offset by the sales risks of biopharmaceutical products on which it receives royalties, the uncertainties related to the acquisition of interests in development-stage biopharmaceutical products and its revenue concentration in a few medicines.

Key Rating Drivers

Good Product Portfolio Supports Royalty Streams: RPRX has built a solid portfolio of high-quality royalty streams. As of YE December 2021, the portfolio comprised 35 approved and 10 development-stage products. The portfolio is supported by more than 15 pharmaceutical companies with some of the best-selling drugs on the market, including 12 products with more than $1 billion in sales.

Solid Cash Flows: Fitch Ratings believes RPRX's portfolio cash flows cover its outstanding debt by a comfortable margin. RPRX is expected to generate strong adjusted EBITDA margins (adjusted to reflect royalty receipts and expenses on a cash basis) due to minimal operating costs and substantial FCF after distributions to shareholders. Fitch expects the company to manage distributions to shareholders prudently to remain within its rating sensitivities and to maintain financial flexibility.

Oscillating Leverage: Fitch expects gross leverage measured by debt/adjusted EBITDA (after payments to non-controlling interests) to remain in the range of 3.0x-4.0x and FCF/debt to remain well above 10% over the forecast period. RPRX is expected to use incremental levels of debt for royalty investments, but adjusted EBITDA is expected to grow as a result of higher levels of royalty receipts offset by upfront R&D payments and the loss of terminating royalties; there may be periods in which leverage exceeds the aforementioned sensitivities. In the event gross leverage rises above 4.0x or FCF/Debt decreases below 10%, Fitch will evaluate RPRX's plans to reduce such leverage within a 12-18 months.

Portfolio Credit Risk: The portfolio is reasonably balanced by royalty receipts and therapeutic category, but reflects some concentration of risk by marketers. The individual marketers making up the largest balance of RPRX's royalty receipts for the YE Dec. 31, 2021 were Vertex Pharmaceuticals, Inc. (27%) and Biogen Inc. (14%). The majority of RPRX's financial royalty assets and receivables arise from contractual royalty agreements that entitle it to royalties on the sales of underlying biopharmaceutical products in the U.S., Europe and the rest of the world, with concentrations of credit risk limited due to the broad range of marketers and the variety of geographies from which product sales are derived.

Price Risk, Product Safety and Liability Issues: Drug pricing continues to be a contentious issue and is receiving deep scrutiny by legislators and regulators. Pharmaceutical manufacturers increasingly need to demonstrate the value of therapies to payers, patients and providers, with strong clinical outcomes driven by increased safety and efficacy. This dynamic may heighten the valuation risk for RPRX as it seeks new products for its portfolio. Product safety or liability issues could ultimately affect the utilization of specific products and the royalty streams of RPRX.

Competitive Environment: There are a limited number of suitable and attractive opportunities to acquire high-quality royalties available in the market. Therefore, competition to acquire such royalties is subject to intense competition. In addition, the length of a product's commercial life cannot be predicted with certainty. There can be no assurance that one or more products for which RPRX is entitled to a royalty will not be rendered obsolete or noncompetitive.

Derivation Summary

RPRX's 'BBB-' Long-Term IDR reflects its good base of contractual royalty streams generated from the sale of patent protected pharmaceutical products and its ample FCF relative to debt. Many of its royalty interests relate to products that lead their respective therapeutic classes.

These strengths are somewhat offset by the sales risks of biopharmaceutical products on which it receives royalties, the uncertainties related to the acquisition of interests in development-stage biopharmaceutical products, and its revenue concentration in a few medicines. In addition, the potential for leverage to increase over the near to medium term as RPRX seeks to grow may heighten all of these risks.

RPRX is expected to continue to generate solid FCF relative to debt through 2025. RPRX's returns have come from a blend of relatively low-cost financing compared to the returns on its royalty portfolio as well as increases in the price of royalty generating drugs. Whether such price increases continue or whether competing products emerge are key factors in maintaining adjusted EBITDA growth.

Direct peers are limited; RPRX competes against other potential royalty buyers, including the companies that market the products on which royalties are paid, financial institutions and investment funds. RPRX has relatively little competition for higher-priced royalty-bearing assets and has enjoyed a large share of the royalty funding market over the last decade.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer Include:

Continued strong adjusted EBITDA, with margins around 85% with operating expenses at approximately 9%-10% of adjusted cash receipts; patent challenges assumed to be minimal;

Dividends to unitholders increase at 10% per annum;

Leverage to remain between 3.0x and 4.0x and FCF/debt well above 10%; leverage metrics will be affected principally by the timing of incremental borrowings for acquisition activity, upfront R&D payments and revenue growth;

Acquisitions of approximately $2.0 billion per year over the forecast period; acquisitions are funded primarily with internally generated cash with minimal incremental debt forecast; total incremental debt is estimated to be $1.5 billion over the forecast period;

All debt maturities are assumed to be refinanced; no assumed debt prepayments.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Successful replenishment of terminating royalties with new investments;

Improvement in revenue diversity such that the top three drugs represent less than 40% of revenue;

Total debt with equity credit/adjusted operating EBITDA sustained below 3.0x; or FCF/debt sustained above 20%.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Significant disruption in royalty receipts on any core products;

A shift in the acquisition strategy towards development-stage products or reduction in revenue diversity;

Total debt with equity credit/adjusted operating EBITDA sustained above 4.0x or FCF/debt sustained below 10%.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Good Liquidity: RPRX's primary source of liquidity is cash flow from operations (CFO). RPRX generates solid earnings from its royalty streams using a modest amount of expenses; robust CFO comfortably covers interest expense and provides for potential additional debt reduction. FCF is generally very strong. Dividends are expected to increase over time at approximately 10% per year over the forecast horizon. Fitch estimates that the company will maintain ample levels of cash and marketable securities to support its investment and operating needs.

Debt Maturities Manageable: The debt maturity schedule is flexible with FCF more than adequate to meet maturities; however, Fitch expects RPRX to refinance all debt as it comes due and to maintain a well-laddered maturity schedule.

Issuer Profile

RPRX is the largest buyer of biopharmaceutical royalties and a leading funder of innovation across the biopharmaceutical industry. The company reported approximately $2.6 billion of royalty receipts for the YE Dec. 31, 2021.

Summary of Financial Adjustments

Historical and projected revenue and EBITDA are adjusted to reflect cash received from royalty interests, as well as cash paid for operating and research and development expenses.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Royalty Pharma plc has an ESG Relevance Score of '4' for Exposure to Social Impacts due to pressure to contain health care spending growth; highly sensitive political environment; and social pressure to contain costs or restrict pricing. This has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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