September 27, 2017 / 8:26 PM / in 24 days

Fitch Affirms Seagate Technology at 'BBB-'; Outlook Remains Negative

(The following statement was released by the rating agency) CHICAGO, September 27 (Fitch) Fitch Ratings has affirmed the ratings for Seagate Technology Plc (Seagate), including the Long-Term Issuer Default Rating (IDR) at 'BBB-'. The Rating Outlook remains Negative. Fitch's actions affect $6 billion of total debt, including the undrawn $700 million senior secured revolving credit facility (RCF). A full list of ratings follows at the end of this release. KEY RATING DRIVERS --Long-Term Growth Headwinds: Fitch expects revenue growth will remain constrained by ongoing cannibalization by SSDs in mission critical and personal computer (PC) markets, which still represent roughly 40% of units sales. Fitch recognizes strong demand trends in capacity nearline drives but remains cautious over HDD makers' ability to offset meaningful price per bit reductions with exabyte density growth. Drives for non-compute end markets, including gaming, digital video recorders and surveillance, should remain a tailwind but growing from a small base. Overall, Fitch expects Seagate to resume overall revenue growth in the intermediate term. --Restructuring Led Margin Expansion: Fitch expects profitability will improve from manufacturing footprint and operating expense reductions, resulting in operating EBITDA margin expansion to the low 20s from the mid- to high-teens through the cycle. Seagate has been restructuring its footprint to reduce operating expenses to $400 million per quarter exiting calendar 2017 and $385 million per quarter exiting fiscal 2018. A richer sales mix driven by the shift from lower-margin drives for PCs to growth in higher margin nearline capacity drives should also buoy profit margins. Fitch expects upside to profitability from operating leverage upon the company optimizing its manufacturing footprint and maintaining gross profit margins within its target 29%-33% range. Stabilizing FCF: Fitch expects FCF of more than $500 million annually, driven by stabilizing top line and restructuring-led profit margin expansion. Working capital days should remain stable with muted growth expectations and capital spending should remain near maintenance levels of 4%-4.5% of revenue, given the current footprint reduction. Over the longer term, Fitch anticipates FCF approaching $1 billion from a richer sales mix as capacity nearline drives replace devices for PCs. Nonetheless, the company is committed to a significant dividend (more than $750 million through the forecast period) and Fitch expects Seagate will use the dividend and gross stock buybacks to return two-thirds of pre-dividend FCF to shareholders. Elevated Total Leverage: Fitch expects total leverage will remain elevated but strengthen over the near term from improving profitability and expected repayment of the company's upcoming debt maturity in Oct. 2018. Fitch estimates total leverage was 2.4x for the fiscal year ended June 30, 2017. Over the longer term, we expect the company will manage debt levels to below 2.5x, particularly in light of Fitch's expectations for heightened volatility in operating results. Assuming the company repays the upcoming maturity, Fitch believes total leverage could decline to below 2x. DERIVATION SUMMARY The ratings and Outlook reflect Fitch's expectations for ongoing top line headwinds and questions regarding at what point positive trends in Seagate's long-term growth businesses, high capacity drives and non-client compute markets, will be more evident. Still, strengthening profitability from the shift to a richer sales mix and restructuring should drop through to FCF in the $500 million to $1 billion range, providing the company with ample flexibility to organically invest, manage debt levels to maintain total leverage below 2.5x through the cycle and return cash to shareholders. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: -Mid-single-digit sequential revenue growth in the Sept. and Dec. 2017 quarters, driven by higher nearline drive shipments, followed by normal seasonality in the March and June 2018 quarters. Revenue resumes low-single-digit growth in fiscal 2019 through the forecast period. -Seagate achieves $400 million of quarterly operating expenses exiting calendar year 2017 and $385 million exiting fiscal 2018. In conjunction with gross margin near the mid-point of the company's target range, operating EBITDA margin should be 21%-22% through the forecast period. -$90 million of restructuring charges, all of which will be cash in fiscal 2018, to support the company's recently announced restructuring program which Seagate expects to result in $90 million of annual cost savings. -Seagate returns two-thirds of pre-dividend FCF to shareholders via 5% dividend increase annually and share repurchases. RATING SENSITIVITIES Stabilization of the ratings at 'BBB-' could result if Fitch expects: --Sustained operating EBITDA and profit margin growth from restructuring and a richer sales mix, despite Fitch's expectation for ongoing revenue growth headwinds. --Evidence in the next few quarters that long-term growth markets, including nearline capacity drives and surveillance, will be sufficient to offset ongoing cannibalization of HDDs by SSDs in computer and mission critical enterprise. --Annual FCF approaching $1 billion made available for debt reduction to maintain mid-cycle total leverage closer to 2x and below 2.5x through a cycle. Negative rating actions could occur in the next few quarters if Fitch expects: --Continued negative revenue growth beyond the near term, indicating faster than anticipated cannibalization in mission critical and lower than anticipated growth in capacity drives. --Annual FCF sustained below $500 million from revenue declines and lower than expected gross margins, despite restructuring and the anticipation of a richer sales mix. --Total leverage sustained above 2.5x. LIQUIDITY Fitch believes Seagate's liquidity was adequate as of June 30, 2017 and was supported by: --$2.5 billion of cash and cash equivalents, which is essentially all readily available given the company's Irish domicile; --$700 million undrawn senior secured RCF expiring Jan. 15, 2020. Fitch's expectation for more than $500 million of annual FCF also supports liquidity. The company's financial policies include returning two-thirds of pre-dividend FCF to shareholders via dividend and stock buybacks. FULL LIST OF RATING ACTIONS Fitch has affirmed the following: Seagate Technology Plc --Long-Term IDR at 'BBB-'; --Senior Secured RCF at 'BBB-'. Seagate HDD Cayman --Long-Term IDR at 'BBB-'; --Senior Secured RCF at 'BBB-' --Senior Unsecured Debt at 'BBB-'. Contact: Primary Analyst Jason Pompeii Senior Director +1 312-368-3210 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Chaim Kurland Associate Director +1 212-908-0281 Committee Chairperson David Peterson Senior Director +1 312-368-3177 Summary of Financial Statement Adjustments - Fitch made no material financial adjustments to the published financial statements of Seagate Technology Plc. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Additional information is available on www.fitchratings.com. 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