CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A+' rating to International Business Machines Corporation's (IBM) GBP300 million 2.625% seven-year senior notes issuance. Fitch's action affects approximately $49 billion of debt, including IBM's undrawn $10 billion credit facility. A full list if rating actions follows at the end of the release.
KEY RATING DRIVERS
The ratings and Outlook reflect Fitch's continued expectations for stabilizing operating trends, including the resumption of positive organic revenue growth in the intermediate term. IBM's investments in strategic imperatives (data, cloud and engagement) should drive double digit growth and achieve sufficient scale in these markets and begin to offset long-term secular decline in legacy information technology (IT) demand.
Fitch still expects mid-single digit negative revenue growth in 2015, largely due to currency headwinds. Positive growth in systems hardware from mainframes and improving momentum in global technology services is mitigating continued weakness in global business services and software, although services backlog has resumed growth and key branded middleware also is showing signs of stabilizing.
Fitch expects profit margin expansion following the divestitures of the less profitable semiconductor foundry and industry standard server (ISS) businesses in 2014. Fitch forecasts operating EBITDA margin will approach 27 % through the intermediate-term, versus a Fitch estimated 26% for the latest 12 months (LTM) ended June 30, 2015. At the same time, a higher mix of sales from strategic imperatives should drive more stable profitability.
Fitch expects strong annual free cash flow (FCF) ranging from $8 billion to $9 billion through the intermediate-term, driven by profitability growth and lower capital spending following the divestiture of the more capital intensive foundry business. Fitch expects the company will meet its commitment of using 75%-85% of annual FCF for share repurchases, which Fitch believes could result in incremental debt, given Fitch's estimate that more than half of FCF is generated outside the U.S.
Nonetheless, Fitch expects credit protection measures will remain solid for the rating. Pro forma for the senior notes issuance, total leverage (total debt to operating EBITDA) as of the LTM ended June 30, 2015 was flat year-over-year at 1.7x. Core leverage (which excludes debt related to the financing business) decreased to below 1x for the LTM ended June 30, 2015, pro forma for the senior notes issuance, from 1.3x in the comparable prior year period.
The ratings and Outlook reflect IBM's:
--Highly diversified customer base from both an industry and geographic perspective.
--Considerable recurring revenue model from IBM's information technology (IT) services, software and financing, which in aggregate account for approximately half of total revenue and reduces revenue and profit volatility.
--Strong Market Position: Breadth and quality of product and service offerings, resulting in leading revenue market share in IT services, middleware software, servers and number three share of the total disk storage market.
--Significant liquidity, supported by a solid cash position, committed credit facilities and strong free cash flow (FCF).
--Strong core (non-financing) credit protection metrics for the 'A+' rating category.
Fitch's concerns include:
--Consistent, material increases in cash dividends long-term, which, in the absence of commensurate growth in profitability, could pressure free cash flow and financial flexibility, necessitating further increases in core debt to fund acquisitions or share repurchases.
--Significant and consistent research and development (R&D) investments required to keep pace with innovation, which constrains meaningful profit margin expansion but also supports barriers to entry in certain markets.
--Expectations for debt financed acquisitions in new IT to accelerate transformation.
--Long-term threat to highly profitable mainframe demand and associated operating system software (z/OS) from increasing penetration of industry standard servers (ISS).
KEY ASSUMPTIONS
--Roughly flat revenue growth on an organic and constant currency basis for 2015, driven by growth in IBM's strategic imperatives beginning to offset ongoing secular declines in legacy markets. Stronger than anticipated hardware should partially offset weaker than expected growth in services.
--Beyond the near-term, Fitch expects flat to low single digit revenue growth on an organic and constant currency basis, driven by faster growth in strategic imperatives markets.
--Profitability will expand due to a richer sales mix following recent divestitures. Fitch anticipates operating EBITDA margins in the 26%-28% range through the forecast period.
--Research and development and capital spending levels remain consistent through the forecast period, pro forma for the divestiture of the highly capital intensive foundry business.
--Annual cash pension contributions will remain in the $500 million to $600 million range.
--Shareholder returns will consist of dividends growing at 10% annually and share repurchases equalling 75%-85% of FCF.
--Acquisitions will be debt financed but core debt levels, otherwise will remain flat.
RATING SENSITIVITIES
The ratings could be downgraded if Fitch expects:
--A shift to more aggressive financial policies, including sustained core leverage in excess of 1.25x;
--Continued mid-single digit organic negative revenue growth (constant currency basis) or profitability pressures within IBM's traditional recurring core franchises, signalling a weakening operating profile despite the company's strategic imperatives growth focus.
Fitch believes the company's lack of a strategic rationale to maintain a higher rating at the expense of financial flexibility required for acquisitions or shareholder-friendly activities limits further positive rating actions.
LIQUIDITY
Pro forma for the senior notes issuance, Fitch believes IBM's liquidity will remain strong and, as of June 30, 2015, was supported by:
--$9.1 billion of cash and equivalents; and
--An undrawn $10 billion RCF expiring in Nov. 10, 2019, which fully supports IBM's commercial paper programs.
$8 billion to $9 billion of annual FCF also supports liquidity.
The funded status of IBM's worldwide defined benefit (DB) pension plans was 97% funded at year-end 2014. Excluding unfunded nonqualified DB pension plans, the funded status of IBM's U.S. and worldwide plans at year-end 2014 was 102% and 90%, respectively. IBM estimates cash contribution to the defined contribution plans to be approximately $1.2 billion during fiscal 2015. The company is not legally required to make any contribution to the U.S. defined benefit pension plans, but estimates contribution to its non-U.S. defined benefit and multi-employer plans to be approximately $600 million.
Pro forma for the senior notes issuance, total debt was $39.1 billion as of June 30, 2015 consisting of $5.3 billion of short-term debt and $33.6 billion of long-term debt. Fitch estimates $26.1 billion (67%) of total debt is attributable to IBM's global financing business with the remaining debt attributable to core (non-financing) operations. IBM has long-term debt maturities of approximately $800 million in the remainder of 2015.
The main purpose of IGF is to facilitate clients' acquisition of IBM systems, software and services by providing financial and capital management solutions. IGF has a solid long-term operating record, provides strategic advantages to IBM in terms of attracting and retaining customers by delivering total solutions. IBM also generates an annuity-like revenue stream associated with multi-year leases.
IGF's primary focus on IBM's products and clients mitigates some risks associated with financing via a deep knowledge of its client base and clear insight into the solutions being financed. Asset quality metrics have remained relatively solid as a result of the relatively conservative underwriting culture and strong risk management capabilities. IGF's capitalization remains solid for the rating category and leverage levels continue to hover near management's target of 7x.
FULL LIST OF CURRENT RATINGS
Fitch currently rates IBM as follows:
--IDR 'A+';
--Senior unsecured revolving credit facility 'A+';
--Senior unsecured debt 'A+';
--Short-term IDR 'F1';
--Commercial paper (CP) rating 'F1'.
Date of Relevant Committee: June 23, 2015
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosures
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=988864
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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