(The following statement was released by the rating agency) Fitch Ratings-New York-November 18: Fitch Ratings has affirmed DXC Technology's long-term, issue and short-term ratings and revised the Rating Outlook to Negative from Stable. The rating action follows DXC's recent announcement to divest three businesses representing $5 billion revenue or approximately 25% of total. While the strategic rationale of the asset dispositions is reasonable, the divestiture will reduce DXC's scale and weigh on operating margin and potentially reduce flexibility going forward, particularly given the higher-than-corporate average contribution margin of the divested businesses. DXC intends to return at least $4.25 billion to shareholders while committing to reduce debt by at least $2.5 billion in order achieve its target debt to EBITDA of 2x or below, consistent with Fitch's leverage sensitivity. DXC's leverage was 2.5x at Sept. 30, 2019 reflecting approximately $2.1 billion in term loan issuance to fund its acquisition of Luxoft Holding, Inc. Fitch believes DXC will return its leverage to around 2x by FY22, although this is subject to further event risk, uncertainty over DXC's remaining core business performance, and the company's increased use of receivables financing that Fitch considers debt. While Fitch believes DXC can maintain its credit protection metrics consistent with its 'BBB+' rating, absent a material improvement in its business and a capital allocation policy that favors debt reduction and capability acquisition over shareholder return, the company's operating and financial profile will likely migrate to be consistent with the 'BBB' level over the next 12-24 months. The ratings for CSC Computer Sciences UK Holdings were withdrawn with the following reason: --No Longer Considered By Fitch to Be Relevant to The Agency's Coverage Key Rating Drivers Strategy: DXC's new CEO has laid out a strategy that reemphasizes the company's traditional/legacy businesses, IT outsourcing (ITO) and applications, in particular, which represents about 40% of the remaining business. This strategy is predicated on the view that the majority of enterprise workloads will continue to occur on-prem or in a hybrid could environment, consistent with Fitch's view. Management believes with appropriate investment and focus on execution it can ameliorate revenue declines from mid-teens to high single-digit by FY22. This would still be above a market decline rate of lower- to mid-single digits, offering some potential upside. DXC's digital business continues to show strong double-digit growth and should comprise about half of the pro forma business in FY22. DXC has emphasized conservatism in its guidance, suggesting higher confidence in attaining stabilization, particularly in conjunction with its stepwise change in margin guidance. Margin: Management has guided to approximately 12% margin (adjusted EBIT, non-GAAP) in FY20 and 12%+ by FY22. This compares with 15.6% in FY19 and the prior articulated target of 250bps to 350bps expansion by FY22. Fitch believes while the divested businesses include higher margin U.S. state and local HHS, this is offset by the lower margin workplace/mobility business, which comprises about 60% of the $5 billion in divested revenue, or roughly two times the healthcare business. DXC's new CEO has committed to executing cost reductions but is shifting to refining the cost structure as opposed to being as aggressive in cost takeout and investing in appropriate staffing levels and capabilities needed to execute effectively. Leverage: Gross leverage increased to 2.5x for the LTM period ending Sept. 30, 2019 reflecting approximately $2.1 billion term loan issuance to fund the acquisition of Luxoft Holdings, Inc. Additionally, the company has increased its use of receivable sales, which Fitch treats as debt. Fitch previously expected DXC would reduce its leverage back to below its 2.0x leverage sensitivity by FY20. DXC has committed to repaying at least $2.5 billion of debt with net proceeds from its announced business divestitures, which it estimates to be upwards of $5 billion. The company explicitly committed to return its leverage to 2.0x or below in order to maintain its investment grade rating. Financial Policy: DXC has indicated it will return $4.25 billion to shareholders, representing approximately 50% of its market cap through dividends and share repurchases by FY22. Fitch would expect a greater proportion of proceeds to go towards acquisitions that enhance the company's growth profile. However, DXC has demonstrated discipline towards maintaining its leverage profile consistent with our rating sensitivity while managing operational challenges, acquisitions and spinoffs. Derivation Summary DXC Technology Company's rating reflects its position as the third largest IT services company by gross revenues after International Business Machines (NYSE:IBM) Corp. (WD) and Accenture plc (NYSE:ACN) (A+/Stable). DXC's high-teens current operating EBITDA margin is at the higher end of its IT services peer group, higher than Accenture plc, Perspecta Inc.'s (BB+/Stable) and Conduent Incorporated (BB/Negative). With the disposition of its U.S. public sector business, Fitch now views DXC's scale and industry and geographic diversification as being weaker than its more highly rated peers. However, Fitch does expect DXC to continue benefit from next-generation IT capabilities akin to that of its larger, more highly rated peers Accenture plc and International Business Machines Corp, particularly as augmented by acquisitions which have been a meaningful part of DXC's strategy as a combined entity. DXC's financial profile remains consistent with its 'BBB+' rating, although top line challenges and execution challenges have pressured credit protection metrics amid a continued effort to rebalance its business from legacy to digital offerings. DXC has limited headroom to Fitch's leverage sensitivity, although it possesses financial flexibility to respond to operational challenges by moderating its increased shareholder returns. Key Assumptions Fitch's Key Assumptions Within Our Rating Case for the Issuer - Approximately 5% revenue decline in FY20 and $15 billion in core remaining revenue post-divestitures flat to modestly positive in FY22 and FY23; - Operating EBITDA margin of 19% in FY20 expanding by 50bps in FY21 and flat thereafter; - Repayment of $2.5 billion of gross debt and no further material increase in receivable sales debt outstanding; - $5 billion of net proceeds from divestitures, $250 million in annual tuck-in acquisitions, $4.25 billion in share repurchases from 1h'20 through FY22. RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action - Sustained positive organic revenue growth; - Post-dividend FCF margin approaching 10% through the cycle; - Gross leverage (operating EBITDA/total debt including receivables factoring) sustained below 1.5x. Developments That May, Individually or Collectively, Lead to Negative Rating Action - Leverage sustained above 2.0x; - Sustained negative revenue growth; - Further reduction in scale or scope of business through divestiture; - Leveraged shareholder return. Liquidity and Debt Structure Adequate Liquidity: Fitch views DXC's liquidity as adequate, supported by $2.88 billion in cash and cash equivalents, as of Sept. 30, 2019. Additionally, DXC had full availability under its $4 billion revolving credit facility. The company's liquidity is further supported by our expectation for in excess of $1 billion in post-dividend FCF annually over the ratings horizon. Manageable Maturities: DXC's maturities are well staggered. Fitch assumes DXC will repay maturities with net cash proceeds from its divestitures with $2.5 billion earmarked for debt reduction. Total funded, rated debt outstanding at Sept. 30, 2019 was $7.145 billion, comprised of (all issued by DXC Technology Company unless otherwise noted): --$0 outstanding on the $4 billion revolving credit facility maturing in 2023; --$687 million USD equivalent EUR 1 billion commercial paper (DXC Capital Funding); $539 million USD equivalent AUD term loan due 2021 (DXC Technology Australia Pty Ltd.); --$816 million USD equivalent senior unsecured EUR term loan due 2022; --$553 million USD equivalent senior unsecured GBP term loan due 2022 (CSC Computer Sciences International); --$816 million USD equivalent senior unsecured EUR term loan due 2023; --$482 million senior unsecured term loan due 2024; --$498 million senior unsecured notes due 2021; --$276 million senior unsecured notes due 2022; --$172 million senior unsecured notes due 2022 (Computer Services Corp); --$506 million senior unsecured notes due 2024; --$305 million senior unsecured notes due 2025; --$704 million senior unsecured notes due 2026; --$508 million senior unsecured notes due 2027; --$273 million senior unsecured notes due 2029; Fitch also includes the following unrated debt in DXC's quantum: --$1.76 billion in capitalized leases; --$650 million of receivables debt; --$697 million of borrowings for assets acquired under long-term financing; --$151 million of other borrowings. ESG Considerations Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of 3 - ESG issues are credit neutral or have only minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. DXC Technology has an ESG Relevance Score of 4 for Management Strategy due to the company's shortfall in execution of its strategy to achieve growth in its digital offerings that offsets legacy IT services offering declines, compounded by the decision to divest 25% of revenue providing reduced scale and flexibility, and is relevant to the rating in conjunction with other factors. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. DXC Capital Funding Limited; Short Term Issuer Default Rating; Affirmed; F2 ----senior unsecured; Short Term Rating; Affirmed; F2 DXC Technology Company; Long Term Issuer Default Rating; Affirmed; BBB+; RO:Neg ; Short Term Issuer Default Rating; Affirmed; F2 ----senior unsecured; Long Term Rating; Affirmed; BBB+ CSC Computer Sciences UK Holdings Limited; Long Term Issuer Default Rating; Withdrawn; WD DXC Technology Australia Pty Limited; Long Term Issuer Default Rating; Affirmed; BBB+; RO:Neg ----senior unsecured; Long Term Rating; Affirmed; BBB+ Computer Sciences Corp (NYSE:DXC).; Long Term Issuer Default Rating; Affirmed; BBB+; RO:Neg ; Short Term Issuer Default Rating; Withdrawn; WD ----senior unsecured; Long Term Rating; Affirmed; BBB+ CSC Computer Sciences International Operations Limited; Long Term Issuer Default Rating; Affirmed; BBB+; RO:Neg ----senior unsecured; Long Term Rating; Affirmed; BBB+ Contacts: Primary Rating Analyst Kevin McNeil, Director +1 646 582 4768 Fitch Ratings, Inc. 33 Whitehall Street New York 10004 Secondary Rating Analyst Jason Pompeii, Senior Director +1 312 368 3210 Committee Chairperson David Peterson, Senior Director +1 312 368 3177
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