NEW YORK--(BUSINESS WIRE)--Fitch Ratings has placed the ratings of Hewlett-Packard Company (HP) and its wholly-owned subsidiary Electronic Data Systems LLC (EDS) on Rating Watch Negative. The placement on Negative Watch follows HP's announced separation into two companies, consisting of HP Enterprise (HPE) and HP Inc. (HPI). The tax-free spin-off to shareholders is expected to be completed by the end of fiscal year (FY) 2015 (Oct. 31).
The rating actions affect approximately $26.6 billion of total debt, including the company's undrawn $7.5 billion unsecured revolving credit facilities (RCF).
The Rating Watch Negative reflects the loss of business diversity, anticipated greater financial performance volatility at HPE due to lower recurring revenue, risk of dis-synergies, particularly procurement, uncertainty regarding the ultimate liquidity profile and capital structure for HPI and HPE. The Negative Watch also reflects minimal strategic rationale for HPI to maintain a strong investment grade rating and greater risk of debt-financed acquisitions at HPE given the loss of considerable FCF generated by HPI.
In the latest 12 months (LTM) ended July 31, 2014, Fitch estimates HPI, which will consist of HP's Printing (consumer and commercial hardware, supplies and managed print services) and Personal Systems (consumer and commercial notebooks, desktops, workstations and tablets) segments, generated revenue of $57.2 billion (49% of total HP excluding eliminations), operating profit of $5.4 billion (49% of total HP) and an operating margin of 9.4%.
HPE will consist of HP's Enterprise Group (servers, storage, networking and technology services), Enterprise Services (infrastructure technology outsourcing and application and business services), Software, and HPFS segments. In the LTM ended July 31, 2014, Fitch estimates HPE, including corporate investments, generated revenue of $58.6 billion (51% of total HP excluding eliminations), operating profit of $5.8 billion (51% of total HP) and an operating margin of 9.9%.
Fitch expects HPI will assume the vast majority of HP's existing core debt, which totaled $9 billion at July 31, 2014. This reflects HPI's lower inorganic growth opportunities and greater and more consistent FCF generation relative to HPE due to lower capital intensity and cash conversion cycle, and greater recurring revenue. At a minimum, HPE will assume all of the debt associated with HP Financial Services (HPFS), which totaled $10.8 billion at July 31, 2014.
Fitch believes managing dis-synergies post separation, particularly in procurement, could prove difficult and may place HPI and HPE at a competitive disadvantage relative to larger rivals, such as Lenovo Group (Lenovo) and Dell Inc. (rated 'BB-' with a Stable Outlook). Lenovo became the third largest provider of industry standard servers after it completed the acquisition of IBM's x86 business for $2.1 billion on Oct. 1, 2014.
HP expects to offset procurement dis-synergies through joint purchasing agreements and improved nimbleness post separation. Furthermore, HP Financial Services will also continue to provide financing solutions to HPI customers and partners post separation.
KEY RATINGS DRIVERS
HP's ratings and Outlook reflect:
--Significant scale and broad portfolio, which provides purchasing leverage for shared components and strengthens the resiliency of its total revenue;
--Solid liquidity provided by nearly $14.5 billion of cash (primarily offshore), $7.5 billion of undrawn committed credit facility capacity and consistent annual FCF (post dividends) in excess of $5 billion for the past four fiscal years;
--Significant reduction in core debt. HP's core leverage was 0.7x as of July 31, 2014 compared with 1.1x a year ago;
--Strong worldwide market share, including leading unit market share in servers and printers and second largest share in PCs, IT services and networking;
--More than 30% of HP's total revenue is recurring, primarily via printer supplies, outsourcing and technology services, and software maintenance;
--Geographically diversified revenue base with majority of revenue derived from outside the U.S.
Ratings concerns center on:
--Sustainability of PC demand as commercial migrations attributable to Microsoft's end of support for Windows XP subsides;
--Aggressive industry pricing pressure in PCs and servers that has pressured profitability, mitigated by HP's realization of cost savings from restructuring actions;
--Long-term hardware revenue and profitability pressures if commercial customers aggressively adopt cloud computing in lieu of on-premise and the market for cloud services remains highly concentrated;
--Event risk in terms of a major acquisition following recent media reports that HP considered merging with EMC in a purportedly all stock transaction valued at $60 billion;
--Continued profitability pressures in Enterprise Group (EG), which represented approximately 36% of HP's operating income in the latest 12 months (LTM) ended July 31, 2014, down from 40% the prior year. EG operating income has decreased 8.5% in the LTM compared to the prior year.
The lower margin reflects a higher mix of lower margin industry standard servers (ISS), a competitive pricing environment, and continued secular decline in high margin business critical systems (BCS) revenue, which declined 18% in the LTM ended July 31, 2014. HP's technology services revenue and operating margin are also adversely affected as customers gradually migrate to UNIX servers offered by competitors (IBM and Oracle) or x86 servers that have lower attach rates and less profitable support contracts.
In addition to its solid cash position and consistent FCF, HP's liquidity is further supported by two undrawn revolving credit facilities, which had aggregate capacity of $7.5 billion as of July 31, 2014, and multiple revolving trade receivables facilities with $986 million of available capacity as of July 31, 2014. HP's revolving credit facilities consist of a $4.5 billion credit facility expiring in April 2019 and a $3 billion facility expiring in March 2017. Minimum interest coverage of 3x is the sole financial covenant.
Total debt was $19.8 billion as of July 31, 2014, consisting of short-term debt of $2.7 billion, primarily current portion of long-term debt, and long-term debt of $17.1 billion. Fitch estimates approximately $10.8 billion, or 55% of total debt, is attributable to HP's customer-financing business.
Fitch has placed the following on Rating Watch Negative:
--Long-term Issuer Default Rating (IDR) 'A-';
--Short-term IDR 'F2';
--Senior credit facilities 'A-';
--Senior unsecured debt 'A-';
--Commercial paper (CP) 'F2'.
Hewlett-Packard International Bank PLC
--Short-term IDR 'F2';
Electronic Data Systems LLC
--Long-term IDR 'A-';
--Senior unsecured debt 'A-'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage