Fitch Ratings Downgrades Baxter International.

CHICAGO -- Fitch Ratings has downgraded the ratings on Baxter International Inc.'s (Baxter) senior unsecured debt, mandatory convertible Equity Units and bank credit facilities (in both U.S. and Euro denominations) to 'BBB+' from 'A-'. Baxter's U.S. and European commercial paper ratings are affirmed at 'F2'. Fitch also revises Baxter's Rating Outlook to Stable from Negative.

The change in rating reflects continued sluggish profitability versus expectations, still relatively high leverage and uncertainty generated by significant changes in senior management offset by decent cash flow and a portfolio of market leading businesses and product lines.

Baxter's earnings weakness and margin erosion stems from continued market pressures in BioScience, tempering previous growth and profit expectations, a high cost structure, gross margin pressure from currency issues and lower-than-expected demand for certain products given current wholesaler inventory levels. Debt levels remain relatively high owing, in-part, to Baxter's use of debt to finance previous acquisitions and having issued debt-like, Equity Units in December 2002, to settle forward purchase contracts (Fitch, however, does assign a degree of equity credit to the Equity Units). Further, Baxter's previous hedging strategy has resulted in nearly $900 million in underwater fair value currency hedges. While the imbalance represents a potential liability, the risk of Baxter having to settle this full amount in the near term is remote. However, this potential liability may limit Baxter's efforts to reduce balance sheet debt. Total debt at June 30, 2004, was approximately $4.6 billion (excluding equity credit) and cash was $760 million.

Fitch notes that while currently tested, Baxter still generates substantial cash flow from operating activities and its businesses are mostly market leaders with stable, if not spectacular, growth potential. Baxter should generate approximately $1.4 billion in net cash from operating activities in 2004. Free cash flow is expected to be approximately $400 million after approximately $650 million in capital expenditures (based on management stated goal to reduce capital spending) and $360 million in dividends.

With respect to future earnings growth, Fitch notes that the underlying demographics of the markets Baxter serves position the company to generate 5-10% organic growth without market outreach and expansion efforts (underserved populations, new technologies in Medication Delivery, expanding overseas markets, etc.) that Baxter continues to pursue. Additionally, announced restructuring and working capital efforts should provide earnings and cash flow momentum beginning in 2005. Fitch is encouraged by management's commitments to reduce debt and adopt a more conservative posture with regard to balance sheet management, hedging strategies, pension assumptions and related financial policies. Fitch notes, however, that the ultimate success of these efforts is contingent on execution and may be impacted by various forces outside management's control. As such, the current credit profile is more indicative of a 'BBB+'/Stable Rating Outlook as Baxter addresses its various operational and strategic issues.