(The following statement was released by the rating agency) Fitch Ratings-New York-March 12: Fitch Ratings has affirmed DXC Technology's ratings, including the Long-Term Issuer Default Rating (IDR) at 'BBB+' and Short-Term IDR at 'F2'. The Rating Outlook remains Negative. Fitch's rating action follows DXC's announcement to direct substantially all of an anticipated $3.5 billion of after-tax net proceeds from the announced $5.0 billion sale of its state and local healthcare business entirely towards debt reduction. Additionally, DXC will direct the net after-tax proceeds of the planned sale of horizontal BPS and workplace mobility businesses towards debt reduction. Total expected net proceeds for the three assets remains $5 billion, although this is subject to market conditions. This follows DXC's November announcement that the company would seek to divest these three businesses with an intent to return at least $4.25 billion to shareholders, while committing to reduce debt by $2.5 billion in order to achieve its target debt to EBITDA of 2x or below, which would be consistent with Fitch's leverage sensitivity. The company's apparent shift in financial policy partially addresses Fitch's near term concern with the company's ability to return its credit protection metrics to a level consistent with its 'BBB+' rating and is an overall credit positive. DXC's gross leverage remained at 2.8x at Dec. 31, 2019, above our 2.0x negative gross leverage sensitivity, reflecting issuance to fund its $2 billion acquisition of Luxoft Holding, Inc., in addition to a 150bps sequential contraction in operating EBITDA margin in 3Q20 and 5bps in total YTD. While Fitch continues to believe the strategic rationale of the asset dispositions is reasonable, the actions 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, just as the operating environment is becoming more challenging. However, DXC's stated reason for directing proceeds towards debt reduction in order to maintain its investment grade credit rating as a conservative measure in response to the concern over the macro environment and DXC's lack of performance to plan belie implication that its go forward business trajectory is precarious and that the company may not be able to stabilize its core business revenue over the rating horizon as Fitch previously expected. DXC withdrew its fiscal 2022 forecast estimates and that in conjunction with DXC's recent deterioration in operating performance, particularly on the margin line in conjunction with sustained revenue guidelines. As such, Fitch now sees significant risk to its previous operating expectations at the time of the Outlook revision to Negative in November. DXC has said it will provide fiscal 2021 targets at its annual earnings call in May. Fitch will reassess its forecast and consider any potential rating implications based upon this input in addition to the overall macro environment. To the extent Fitch expects that DXC' business prospects will likely remain challenged potentially necessitating capability acquisition that may offset any debt reduction would likely result in a downgrade to the 'BBB' rating level. 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 could environment, consistent with Fitch's view. 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 making 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 apparently remains committed to approximately 12% margin (adjusted EBIT, non-GAAP) in fiscal 2020 and has withdrawn 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, which comprises it appears that DXC's core business is experiencing an irreversible decline in margins. DXC's operating EBITDA margin has declined by about 5bps 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 remained at 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. Financial Policy: DXC has now 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 towards 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 towards maintaining its leverage profile consistent with our 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 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 headroom to Fitch's leverage sensitivity, although it possesses financial flexibility to respond to operational challenges. Key Assumptions Fitch's Key Assumptions Within Our 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% in fiscal 2020 and roughly flat thereafter; - Repayment of $5 billion of gross debt and no further material increase in receivable sales debt outstanding; - $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 Developments That May, Individually or Collectively, Lead to Positive Rating Action - Fitch does not anticipate positive rating action at this time but could stabilize the rating if we believe that DXC is able to stabilize the revenue of its remaining core business on a sustained basis with a margin profile that is broadly consistent with its prior operating performance. 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 $2.56 billion in cash and cash equivalents, as of Dec. 31, 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 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. 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+ 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
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