(The following statement was released by the rating agency) Fitch Ratings-New York-April 14: Fitch Ratings has affirmed DXC Technology's long-term Issuer Default Rating (IDR), senior unsecured debt and short-term ratings. The Rating Outlook remains Negative. This rating action follows DXC's announced issuance of benchmark senior unsecured notes due 2023 and 2025 to which Fitch is assigning DXC's existing senior unsecured rating of 'BBB+'. DXC intends to use the net proceeds for general corporate purposes including the repayment of outstanding indebtedness. Fitch now sees DXC's gross leverage exiting FY20 at approximately 4.5x, reflecting the company's full $4 billion revolver draw and pro forma to an assumed $1 billion issuance. While Fitch generally considers only gross leverage, DXC's pro forma net leverage is close to 2x reflecting the company's precautionary measures taken to bolster liquidity and pre-fund maturities, consistent with many other comparable investment-grade issuers. Fitch expects that DXC will continue to manage its capital structure consistently with its 'BBB+' rating and therefore over time should return leverage to 2.0x or below. To the extent that issuance and precautionary borrowings become permanent and operational prospects do not improve, which on balance are trending downward consistent with the Negative Outlook, a downgrade of one notch could be warranted. Key Rating Drivers Strategy Execution: DXC's CEO previously 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 cloud environment, consistent with Fitch's view, although this could change post-coronavirus. Management believes with appropriate investment and focus on execution it can ameliorate revenue declines, but it has subsequently withdrawn its prior fiscal 2022 targets. However, the company now says the market environment is more volatile, and that there has been a higher than anticipated impact from previously terminated accounts and price concessions, and weak performance to plan all together making fiscal 2021 more challenging. While DXC does not have a high share of consulting revenue that would likely be more discretionary in a reduced IT spend environment, the fact that the company has not performed to its sales targets going into a more challenging environment suggests that the company will be poorly positioned should the macro environment weaken further and that Fitch's prior expectation that DXC can stabilize its revenues is no longer feasible. Margin: Management remains committed to approximately 12% margin (adjusted EBIT, non-GAAP) in fiscal 2020 and earlier withdrew its 12%+ target by fiscal 2022. This compares with 15.8% in fiscal 2019 and the prior articulated target of 250bps to 350bps expansion by fiscal 2022. While Fitch believes the higher margin U.S. state and local HHS is offset by the lower margin workplace/mobility business, it appears that DXC's core business is experiencing an irreversible decline in margins. DXC's operating EBITDA margin has declined by about five points (unadjusted for Fitch's new finance lease treatement) since fiscal 2019. DXC's CEO previously committed to executing cost reductions while 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, particularly within the ITO and applications business as the basis for gaining increased digital business. This plan may be difficult to implement in a more challenged revenue environment, and while DXC has a track record of cost containment, Fitch believes DXC may face structurally lower margins over the forecast horizon as a result. Leverage: Gross leverage was 2.8x for the LTM period ending Dec. 31, 2019, reflecting issuance to fund the $2 billion acquisition of Luxoft Holdings, Inc. Additionally, the company continued to increase its use of receivable sales, which Fitch treats as debt. Fitch had previously expected DXC would reduce its leverage back to below its 2.0x leverage sensitivity by fiscal 2020 and now does not see this as occurring until fiscal 2021 at best. DXC's commitment to directing approximately $5 billion of debt with net proceeds from its announced business divestitures may only offset a structurally lower margin profile, which has been reduced considerably. Fitch now sees DXC's gross leverage exiting FY20 at 4.5x, reflecting the company's full $4 billion revolver draw and pro forma to an assumed $1 billion issuance. Financial Policy: In March, DXC stepped back from its November commitment to return $4.25 billion to shareholders, representing approximately 50% of its market cap at the time through dividends and share repurchases by fiscal 2022. Fitch had expected a greater proportion of proceeds to go toward acquisitions that enhance the company's growth profile. Based upon the announced nine month close for the HHS business and an ongoing sales process for the remaining assets, DXC may not have headroom to support a return to capability acquisitions until fiscal 2022 or beyond. Additionally, much of DXC's potential headroom will be contingent upon operating performance of its remaining business, which remains a challenge. DXC has generally demonstrated discipline toward maintaining its leverage profile consistent with Fitch's rating sensitivity while managing operational challenges, acquisitions and spinoffs. The company continues to reiterate its commitment to return its leverage to 2.0x or below and maintain its investment grade rating. ESG - Governance: 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. 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. 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 (WD; formerly BB-/Negative). With the disposition of its U.S. public sector business and its additional planned divestiture, 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 to 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 is presently less consistent with its 'BBB+' rating, and it appears top line challenges and execution challenges have pressured credit protection metrics amid a continued effort to rebalance its business from legacy to digital offerings on a sustained. DXC has limited prospective headroom to Fitch's leverage sensitivity, although it possesses financial flexibility to respond to operational challenges, to a degree. Key Assumptions Fitch's Key Assumptions Within the Rating Case for the Issuer: - Approximately 5% revenue decline in fiscal 2020 and core remaining revenue post-divestitures single-digit thereafter; - Operating EBITDA margin of 16% (unadjusted) in fiscal 2020 and roughly flat thereafter (approximately 150bps-200bps lower reflecting Fitch's finance lease treatment); - Repayment of $5 billion of gross debt and no further material increase in receivable sales debt outstanding; - Repayment of revolver in FY21 and use of issuance proceeds for debt reduction;
- $5 billion of net proceeds from divestitures, $50 million in annual tuck-in acquisitions, no share repurchases in fiscal 2021 and no more than $1 billion annually thereafter. RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: - Fitch does not anticipate positive rating action at this time, but could stabilize the rating if the agency believes that DXC is able to stabilize the revenue of its remaining core business on a sustained basis with an adjusted margin profile that is broadly consistent with its prior operating performance. Factors that could, individually or collectively, lead to negative rating action/downgrade: - Leverage sustained above 2.0x; - Sustained negative revenue growth; - Further reduction in scale or scope of business through divestiture; - Leveraged shareholder return. 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 Adequate Liquidity: Fitch views DXC's liquidity as adequate, supported by $6.56 billion in cash and cash equivalents, as of Dec. 31, 2019 pro forma for DXC's full draw of its $4 billion revolving credit facility. The company's liquidity is further supported by our expectation for $700 million to $800 million in post-dividend FCF annually over the ratings horizon (Note: Fitch now treats finance leases as operating expense including amortization of right-of-use assets, reducing FCF while adding back to financing activities). Manageable Maturities: DXC's maturities are well staggered. Fitch assumes DXC will repay maturities with net cash proceeds from its divestitures with now an anticipated $5 billion earmarked for debt reduction. ESG Considerations 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. Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3 - ESG issues are credit neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. 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. 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; New Rating; BBB+ ----senior unsecured; Long Term Rating; Affirmed; BBB+ 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 ----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
Media Relations: Elizabeth Fogerty, New York, Tel: +1 212 908 0526, Email: elizabeth.fogerty@thefitchgroup.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 27 Mar 2020) (including rating assumption sensitivity) https://www.fitchratings.com/site/re/10111917 Corporates Notching and Recovery Ratings Criteria (pub. 14 Oct 2019) (including rating assumption sensitivity) https://www.fitchratings.com/site/re/10090792 Parent and Subsidiary Rating Linkage (pub. 27 Sep 2019) https://www.fitchratings.com/site/re/10089196 Sector Navigators-Addendum to the Corporate Rating Criteria (pub. 27 Mar 2020) https://www.fitchratings.com/site/re/10112524 Short-Term Ratings Criteria (pub. 06 Mar 2020) https://www.fitchratings.com/site/re/10112342 Applicable Model Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s). 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