Fitch Affirms Computer Science's IDR at 'BBB' on Separation Announcement

NEW YORK--()--Fitch Ratings has affirmed the ratings for Computer Sciences Corp. (NYSE:CSC), including the Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook, on the announcement the company will separate the U.S. Public Sector (NPS) segment from the Global Commercial (Commercial) segment via a tax-free spinoff.

Fitch's actions affect $5.2 billion of debt, including the undrawn $2.5 billion revolving credit facility (RCF). A full list of ratings follows at the end of this release.

KEY RATING ISSUES

The ratings and outlook reflect Fitch's belief that, pro forma for the separation, strong credit protection measures and solid liquidity offset the weaker operating profile and provide the Commercial business some headroom at the current rating to complete its business transformation and resume positive revenue growth and strengthen free cash flow (FCF).

Fitch's rating actions incorporate expectation that CSC will capitalize the Commercial business with a financial profile consistent with a strong investment grade rating. This includes reducing debt with available cash to achieve gross leverage (gross debt to EBITDA) of 1 times and net leverage.

Fitch expects the roughly $1.5 billion special dividend payment to shareholders concurrent with the separation will be funded by a dividend from NPS.

The ratings and outlook reflect Fitch's expectations that Commercial revenues from cloud based solutions will offset negative revenue growth for on-premise contracts in the intermediate term, given the business' shift in investment focus. Fitch also believes positive near-term operating trends and sustained profitability are key to maintaining the rating.

Annual FCF will weaken following the separation but Fitch anticipates Commercial's shifting sales mix to more profitable and less capital intensive contracts. In conjunction with lower costs from substantial restructuring, Fitch expects $400 million of annual FCF through the intermediate term for the Commercial business.

CSC announced it will spinoff NPS from the Commercial business via a tax-free transaction, which the company expects to complete by October, 2015, pending regulatory approval. Concurrent with the separation, the Commercial business will pay a $10.50 per share ($1.5 billion at April 3, 2015) special dividend to shareholders.

CSC expects to incur $75 million of expenses to facilitate the separation, given the businesses already run independently. CSC plans to capitalize both standalone companies with financial profiles consistent with investment grade ratings, including 1x and 2.5x gross leverage for Commercial and NPS, respectively.

RATINGS SENSITIVITIES

Fitch believes negative actions could occur if:

--CSC deviates from its planned capitalization targets of 1x gross leverage and 0.5x net leverage for the Commercial business due to lower than expected debt reduction; or

--Fitch expects Commercial will not achieve positive revenue growth in the intermediate term or positive operating trends in the near term, including operating EBITDA margin erosion, indicating heightened investments in cloud based solutions are not sufficiently competitive to offset declines in on-premise contracts.

Fitch does not anticipate positive rating actions in the absence of expectations for sustained positive revenue growth and a strengthened FCF profile.

KEY RATINGS DRIVERS

Rating strengths include Fitch's expectations for:

--Strong credit protection measures for the rating due to the management's commitment to capitalize the Commercial business with 1x gross leverage;

--Strengthening profitability despite near-term top line headwinds, driven by cost cuts, including CSC's plan to increase its offshore employee mix to between 50% and 60% from over 40% in fiscal year 2015. As a result, Fitch expects operating EBITDA margin for Commercial will exceed 18% in the intermediate term versus a Fitch estimated 17.7% for fiscal 2015;

--Strengthening FCF profile, driven by Fitch's expectations for an increasing mix of more profitable and less capital intensive contracts. As a result, Fitch expects $400 million of pro forma annual FCF and FCF margin exceeding 5% through the intermediate term;

--Substantial customer and industry diversification with high renewal rates associated with long-term service contracts. Fitch believes recurring revenues and FCF will increase upon the resumption of positive revenue growth.

Weaknesses include Fitch's expectations for:

--Continued secular top line headwinds, as customers shift away from legacy on-premise to cloud based solutions. Fitch expects negative organic growth will continue through the near term but that a significant shift in investments over the past few years will drive revenue growth from next generation cloud based solutions in the intermediate term;

--Smaller size of next generation service offerings, which despite strong market growth rates, may be constrained by an industry-wide skilled labor shortage;

--Heightened fixed investment requirements to drive next generation cloud based solutions, which Fitch believes may reduce competitiveness in bidding new contracts or require significant partnering with direct competitors.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:

--Commercial gross leverage will be 1.0x.

--Secular shifts away from traditional on-premise service offerings and pricing pressures result in low-single digit negative organic revenue growth, despite strong growth rates from new service offerings and a more profitable sales mix.

--The $1.5 billion special dividend payment to shareholders concurrent with the separation will be funded by a dividend from NPS.

--CSC's sales mix shift, cost reductions and strengthened contract discipline will offset EBITDA erosion from revenue declines.

--An increased mix of less capital intensive contracts will drive consistent free cash flow.

--Shareholder returns will remain modest.

Fitch believes CSC's liquidity was strong as of April 3, 2015 and supported by:

--$2.1 billion of cash, approximately half of which is located outside the United States;

--$2.5 billion of available borrowing capacity under an undrawn revolving credit facility (RCF) due 2020;

--$450 million of available capacity under a receivables purchase facility;

--$250 million of available capacity under a committed leasing facility for capital expenditures on IT equipment and associated software.

Total debt was approximately $2.7 billion as of April 3, 2015, primarily consisting of:

--$350 million of 2.50% term notes due September 2015;

--$389 million note payable (Libor + 17 bps) due January 2016;

--$917 million of 6.50% term notes due March 2018;

--$445 million of 4.45% term notes due September 2022.

Fitch has affirmed CSC's ratings as follows:

--Long-term IDR at 'BBB';

--Senior unsecured debt at 'BBB';

--RCF at 'BBB'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology, Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985076

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Contacts

Fitch Ratings
Primary Analyst
William Dickson
Associate Director
+1-212-908-0808
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jason Pompeii
Senior Director
+1-312-368-3210
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations
Alyssa Castelli
+1-212-908-0540
New York
alyssa.castelli@fitchratings.com
or
Elizabeth Fogerty
+1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
William Dickson
Associate Director
+1-212-908-0808
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jason Pompeii
Senior Director
+1-312-368-3210
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations
Alyssa Castelli
+1-212-908-0540
New York
alyssa.castelli@fitchratings.com
or
Elizabeth Fogerty
+1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com