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Fitch Rates Everett SpinCo 'BBB+' & Upgrades Computer Sciences Corp. to 'BBB+' Ahead of Merger
March 6, 2017 / 7:19 PM / 7 months ago

Fitch Rates Everett SpinCo 'BBB+' & Upgrades Computer Sciences Corp. to 'BBB+' Ahead of Merger

(The following statement was released by the rating agency) CHICAGO, March 06 (Fitch) Fitch Ratings has assigned the following ratings to Hewlett Packard Enterprises Company's wholly-owned subsidiary, Everett SpinCo, Inc. (Everett): --Long-term Issuer Default Rating (IDR) 'BBB+'; --$1.05 billion senior unsecured notes offering 'BBB+'; --$2 billion senior unsecured term loans 'BBB+'. The ratings have been assigned in anticipation of Everett's merger with Computer Sciences Corporation (CSC), which is targeted for April 1, 2017 pending the outcome of a March 27, 2017 shareholder vote. Fitch has also upgraded the long-term ratings for Computer Sciences Corporation (CSC) and its wholly-owned subsidiary, CSC Computer Sciences UK Holdings Ltd, to 'BBB+' from 'BBB' ahead of the merger. Fitch affirmed the short-term ratings for CSC and CSC Capital Funding Ltd. at 'F2'. The Rating Outlooks on Everett, CSC and its wholly-owned subsidiaries are Stable. Fitch's actions affect $10.4 billion of total debt, including an anticipated $3.7 billion five-year revolving credit facility (RCF). A full list of rating actions follows at the end of this release. Following consummation of the merger, Everett will change its name to DXC Technology Company (DXC) and CSC will merge with Everett's wholly-owned subsidiary, Everett New Merger Sub Inc. (Merger Sub) with CSC as the surviving entity and remain a wholly-owned subsidiary of DXC. CSC has amended its credit facilities and certain other financing arrangements with lenders, which have agreed to waive events of default arising as a result of the merger and replace CSC with DXC as borrower and guarantor under certain credit facilities and financing arrangements. Fitch expects all senior unsecured debt will be pari passu with the exception of $300 million of legacy Electronic Data Systems LLC (EDS) senior notes, which benefits from an irrevocable guaranty by HP Inc. ('BBB+'/Outlook Stable) and at least initially will remain at the CSC subsidiary. The ratings and Outlook reflect Fitch's increased confidence in DXC's ability and commitment to rapidly delever and maintain conservative financial policies. Fitch expects DXC will achieve $1 billion of it targeted $1.5 billion of merger related cost synergies in year one and use a meaningful portion of free cash flow (FCF) for debt reduction. As a result, Fitch expects total leverage (total debt to operating EBITDA) well below 2x within 12 months of the merger, versus a Fitch estimated 2.2x at closing. CSC has established a credible deleveraging track record given the company's use of FCF from elevated leverage associated with the partially debt-financed acquisitions of UXC and Xchanging. CSC announced on May 24, 2016 its plan to merge with ES via a Reverse Morris Trust transaction, which provided for Hewlett Packard Enterprise (HPE) first spinning out the majority of its ES segment (Everett) to HPE shareholders. The subsequent merger of CSC and Everett will deliver approximately $8.5 billion to HPE's shareholders, including a i) $4.5 billion equity stake in DXC, ii) $3 billion cash dividend, iii) assumption of $81 million of Everett mortgage notes and $300 million of legacy Electronic Data Systems senior notes and iv) transfer of no more than $570 million of Everett net pension liabilities to CSC. DXC will use net proceeds from the $1.05 billion senior notes offering and drawing on the $2 billion of term loans to fund the dividend. KEY RATING DRIVERS --Increased scale and diversification: Fitch expects the merger will result in increased diversification and scale, particularly in next generation information technology (IT) service offerings, which Fitch believes is key attracting and retaining high-skill workers. The merger creates the third largest IT service provider, adds critical mass in pharma, travel and transportation and telecom verticals, further diversifies geographic and customer exposure and significantly expands DXC's rapidly growing next generation IT revenue base. --Profit margin expansion roadmap: Fitch expects profit and cash flow margin expansion from significant merger related cost synergies. DXC is targeting $1 billion of realized merger related cost synergies in and $1.5 billion of run rate synergies exiting the first year post-close. As a result, Fitch estimates operating EBITDA margins will structurally expand to more than 20% from Fitch's expectations of 15.5% for the fiscal year ending March 31, 2017. The merger related cost synergies include a significant amount of cost take-outs incremental to ES' multi-year pre-merger restructuring actions. --Top-line growth pressures: Fitch expects organic constant currency revenue growth will remain constrained over the intermediate-term by the impacts of legacy account transitions at both CSC and ES. However, Fitch expects strong revenue growth in next generation IT service offerings (cloud, cyber and applications), which will be more than $3 billion on a combined basis, offsetting declines in legacy offerings. As a result, Fitch expects flat organic constant currency revenue growth through the forecast period. --Strengthened FCF: Fitch expects annual FCF to strengthen from higher profitability and CSC's and ES' exit of unprofitable contracts over the last few years. Fitch forecasts $1 billion to $2 billion of annual FCF, providing sufficient domestic cash flow for debt reduction. Fitch estimates DXC's pre-dividend FCF mix should track the company's 50% U.S. revenue mix, resulting roughly $200 million to $700 million of domestic cash flow available for debt reduction after dividends. Approximately $1.5 billion of cash payments for restructuring and integration in fiscal 2018 will constrain near-term FCF, which Fitch anticipates will drive lower share repurchases given the company's focus on debt reduction. --Incremental acquisition activity: Fitch expects DXC will focus on achieving merger related cost synergies through at least the in near-term, given the magnitude of cost take-outs. Nonetheless, Fitch expects DXC ultimately will remain acquisitive, given market fragmentation and opportunities to acquire next generation IT capabilities through tuck-in acquisitions. Fitch anticipates smaller tuck-in deals with cash flow and use equity to partially fund larger deals. --Conservative financial policies: Fitch expects DXC will continue its conservative financial policies, despite the uptick in leverage to fund the deal. Fitch expects rapid leverage reduction within year one from debt reduction with FCF and restructuring driven profitability expansion. Over the longer-term, Fitch expects the company to maintain total leverage below 2x. Liquidity will remain solid with $1.5 billion of total cash and a $3.7 billion RCF and share repurchases gated by what's left after acquisitions. --Cost synergies execution risk: Fitch believes execution risks associated with significant cost take-out programs are consequential, particularly within the context of large scale mergers. Reduced headcount, workflow automation and efficiency initiatives should improve long-term profitability but could be disruptive to service level agreements, potentially adversely impacting short-term profitability or customer relationship. KEY ASSUMPTIONS --Flat organic constant currency revenue growth through the forecast period from strong next generation IT service offerings growth offsetting declines in legacy offerings; --DXC achieves merger related cost synergies targets, including $1 billion realized in fiscal 2018 and exits fiscal 2018 with $1.5 billion of run rate merger related cost synergies; --Operating EBITDA expanding to more than 20% from the mid-teens from merger related cost synergies; --DXC uses near-term domestic FCF for debt reduction to drive total leverage below 2x; --Dividends per share grows 10% annually; --The company uses domestic FCF after acquisitions for share repurchases. RATING SENSITIVITIES Positive rating actions could occur if Fitch expects: --Sustained positive organic revenue growth, resulting from growth in next generation IT services more than offsetting legacy services declines; --Annual FCF approaching $3 billion through the cycle. Negative rating action could occur if Fitch expects: --Total leverage sustained above 2x from weaker than expected profitability; --CSC does not expect positive organic revenue growth in the intermediate term or positive operating trends in the near term, indicating a loss of share in next generation IT services. LIQUIDITY Pro forma for the merger, Fitch believes DXC's liquidity will be solid and consist of: --$1.5 billion of cash and cash equivalents; --$3.7 billion RCF, of which $3.025 billion should be undrawn and available. The RCF will be upsized to $3.7 billion from 2.95 billion upon consummation of the merger. Fitch's expectation for $1 billion to $2 billion of annual FCF also supports liquidity. Pro forma for the merger, total debt should be $7.4 billion and consist of: --$675 million of RCF; --$1 billion of Euro commercial paper; --$227 million of GBP term loan due 2019; --$375 million of term loan A due 2020; --$571 million of USD term loan due March 2021; --$72 million of AUD term loan due 2021; --$1.3 billion of 5-Yr USD term loan A due March 2022; --$315 million of 5-Yr Euro term loan A due March 2022; --$445 million of CSC 4.45% senior notes due 2022; --$1.05 billion of new senior notes; --$300 million of EDS notes; --$1.03 billion of capital leases & other. FULL LIST OF RATING ACTIONS Fitch has assigned the following ratings: Everett SpinCo, Inc. --Long-term IDR 'BBB+'; --Short-term IDR 'F2'; --$1.05 billion senior unsecured notes offering 'BBB+'; --$2 billion senior unsecured term loans 'BBB+'. CSC Australia Pty Ltd. --Long-term IDR 'BBB+'; --Senior unsecured term loans 'BBB+'. Fitch has taken the following rating actions: Computer Sciences Corporation (CSC) --Long-term IDR upgraded to 'BBB+' from 'BBB'; --Short-term IDR affirmed at 'F2'; --RCF upgraded to 'BBB+' from 'BBB'; --Senior unsecured term loans upgraded to 'BBB+' from 'BBB'; --Senior unsecured notes upgraded to 'BBB+' from 'BBB'; CSC Capital Funding Ltd. --Short-term IDR affirmed at 'F2'; --Commercial paper affirmed at 'F2'. CSC Computer Sciences UK Holdings Ltd. --Long-term IDR upgraded to 'BBB+' from 'BBB'; --Senior unsecured term loans upgraded to 'BBB+' from 'BBB'. Electronic Data Systems LLC --Senior unsecured notes downgraded to 'BBB+' from 'A-'. The Rating Outlooks on all entities are Stable. Contact: Primary Analyst Jason Pompeii Senior Director +1-312-368-3210 Fitch Ratings, Inc. 70 West Madison St. Chicago, IL 60602 Secondary Analyst Dustin DeMaria Associate Director +1-312-368-2071 Committee Chairperson David Peterson Senior Director +1-312-368-3177 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Date of Relevant Rating Committee: March 3, 2017 Summary of Financial Statement Adjustments: Fitch made no financial statement adjustments that depart materially from those contained in the published financial statements of Computer Sciences Corporation, Hewlett Packard Enterprise Services or DXC. 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