CHICAGO--(BUSINESS WIRE)--Fitch Ratings assigns a 'BBB+' rating to CA, Inc.'s (NASDAQ: CA) $500 million senior notes offering. Fitch's actions affect approximately $2.8 billion of total debt, including the currently undrawn revolving credit facility (RCF).
CA announced this morning it is selling $500 million of senior notes, comprised of $250 million of 5-year notes and $250 million of 10-year notes. Net proceeds will be used for general corporate purposes, including pre-funding the company's $500 million senior notes maturing Dec. 1, 2014.
KEY RATING DRIVERS
The rating and Outlook continue to reflect Fitch's expectation for solid annual free cash flow (FCF) and conservative financial policies, despite weak top-line trends over the near term.
Revenue growth should be negative for fiscal 2014, due to timing of the company's mainframe renewal portfolio and lower new product sales in fiscal 2013. CA's mainframe renewal portfolio is heavily weighted to the second half of fiscal 2014 and, given historical renewal rates of more than 90%, should translate to the resumption of revenue growth beyond the near term.
Over the longer term, sales growth within mainframe markets should remain minimal and driven by capacity expansion. More substantial revenue growth will depend upon the success of CA's enterprise go-to-market strategy, given solid market growth for information technology (IT) management solutions for small- to medium-sized businesses (SMB). Nonetheless, longer sales cycles in these target market may delay meaningful revenue growth.
CA's number 2 position in the mainframe market and high switching costs will drive ongoing recurring revenues and FCF. Operating profitability in the mainframe segment should remain in excess of 50%, versus high- and mid-single digits for CA's enterprise and services segments, respectively.
Operating profitability should be pressured over the near term, due to lower revenues and cash restructuring. Beyond the near term, operating profit margin should remain at more than 30%. Fitch estimates operating margin was approximately 31% in fiscal 2013, flat from the prior year.
Fitch continues to expect annual FCF of more than $500 million, driven by solid operating profitability and lower capital spending following the completion of CA's enterprise resource planning (ERP) systems investments. Pre-dividend FCF should continue to consistently exceed $1 billion, supported by the high customer renewal rates associated with the software industry.
Fitch anticipates CA will use FCF to fund small technology-focused acquisitions and share repurchases under the company's $1.5 billion authorization, of which $452 million was still available at June 30, 2013. Fitch believes acquisitions spending could exceed CA's average of $275 million in recent years, given fragmentation within the enterprise space.
CA's credit metrics will remain solid for the rating. Fitch expects FCF-to-total debt higher than 50%, total leverage (total debt-to-operating EBITDA) below 1.5x, and operating EBITDA-to-gross interest expense above 20x.
Leverage tolerance factors in significant deferred revenue balances and Fitch's expectations are that the ratio of cash balances and accounts receivables to deferred revenue (including long term) and other short-term liabilities will not diverge dramatically from historical levels.
The use of a portion of existing cash balances is accommodated at current ratings given the company's substantial billings backlog as well as Fitch's belief that deferred revenue balances carry high incremental operating margins. Importantly, Fitch does not anticipate a material reduction in bookings over time, given significant switching costs associated with the software industry.
Negative rating actions could occur if: i) revenues contract over a sustained period, signaling faster than anticipated shrinking of the mainframe market or less competitive technology enterprise offerings or ii) operating profit margin declines, likely from a failure to take share in enterprise markets and adequately scale down mainframe market costs.
Positive rating actions are less likely over the intermediate term, in the absence of meaningfully stronger contribution from the Enterprise Solutions business resulting in a more balanced sales mix.
Pro forma for the issuance, Fitch believes CA's liquidity at June 30, 2013 was solid and supported by: i) $3.1 billion of cash and cash equivalents, approximately 65% of which was located outside the U.S., and ii) an undrawn $1 billion RCF expiring June 7, 2018. More than $500 million of annual FCF also supports liquidity.
Pro forma for the issuance, total debt at June 30, 2013 was $1.8 billion and consisted mainly of: $500 million of 6.125% senior notes due 2014; $250 million of senior notes due 2018; $750 million of 5.375% senior notes due 2019; and $250 million of senior notes due 2023.
The ratings continue to be supported by:
--Strong share positions in, and high switching costs associated with, core mainframe and security markets, which constitute the majority of CA's revenue mix and drive recurring maintenance revenue;
--Annual FCF in excess of $500 million, largely from the diversification of CA's customer base;
--Conservative financial policies and solid credit protection measures, despite the company's significant dividend.
Ratings concerns center on:
--Lower than industry-wide revenue growth from very low revenue growth in mainframe software, which continues to constitute a significant proportion (albeit highly profitable) of total revenues;
--Operating profit margins for the faster-growth Enterprise Solutions businesses that are significantly below that of the Mainframe segment;
--Meaningfully larger competitors with superior financial flexibility.
Fitch rates CA as follows:
--Issuer Default Rating (IDR) 'BBB+';
--Senior unsecured revolving credit facility (RCF) 'BBB+';
--Senior unsecured notes 'BBB+'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research
--'Corporate Rating Methodology' (Aug. 08, 2012)
Applicable Criteria and Related Research:
Corporate Rating Methodology - Effective from 8 August 2012 - 5 August 2013