Fitch Affirms Seagate Technology plc at 'BBB-'; Revises Outlook to Negative from Stable

CHICAGO--()--Fitch Ratings has affirmed the ratings for Seagate Technology plc (Seagate) and its wholly owned subsidiary, Seagate HDD Cayman, including the Long-term Issuer Default Rating (IDR) at 'BBB-'. Fitch has also revised the Rating Outlook to Negative from Stable. Fitch's actions affect $4.9 billion of total debt, including the undrawn revolving credit facility (RCF). A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

The ratings and Negative Outlook reflect Fitch's expectations for continued weak operating trends through at least the near-term, pressuring free cash flow (FCF) and weakening credit protection measures. Seagate announced weaker than previously guided key operating results ahead of the company's scheduled April 29, 2016 earnings call. For the third fiscal quarter ended April 1, 2016, Seagate reported lower revenues from weaker than expected demand and gross profit well below expectations, as targeted excess inventory reductions drove down utilization rates.

Fitch now expects break-even to $250 million of free cash flow (FCF, Fitch defined after dividends) and total leverage (total debt to operating EBITDA) to remain above 2.5x through the near-term. This compares to Fitch's previous expectations for solid operating performance, despite top line weakness and modest profit margin pressure, and annual FCF of more than $750 million through the intermediate-term.

Fitch expects the top line to remain pressured from secular declines in the personal computer (PC) segment, which represents roughly 40% of total revenues. Low single digit growth in near-line enterprise products will partially offset the continuation of negative PC trends. Fitch believes solid state drives (SSDs) are cannibalizing 15k spindle speed mission critical products and that HDDs remain well positioned in the 10k spindle speed products, despite unexpected lower demand. Going forward, Fitch anticipates diminished demand visibility will exacerbate operating volatility as Seagate pivots away from PCs.

Fitch expects profitability should improve from capacity and operating expense reductions noted in the pre-announcement. Non-GAAP (excludes stock based compensation) gross profit margin should return to the mid-20s and was 23% for the quarter ended April 1, 2016, versus prior guidance of 25.5% from lower than anticipated utilization rates. Operating expense reductions should drive operating EBITDA expansion to the higher from the lower end of the mid-teens, despite expectations for negative revenue growth.

Nonetheless, Fitch believes FCF also could be break-even to $250 million in fiscal 2017, depending upon the timing of savings and cash costs related to anticipated restructuring. Seagate's return of inventory to normalized levels and likely moderation of capital spending could provide some upside to fiscal 2017 FCF. Nonetheless, Fitch expects cash available for stock buybacks or open market debt repurchases may be limited.

KEY ASSUMPTIONS

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

--The continuation of negative trends over the fourth fiscal quarter will result in negative 20% revenue growth for fiscal 2016;

--Beyond fiscal 2016, Fitch expects mid-single digit declines in PC shipments and ongoing cannibalization of HDDs by SSDs will result in high single digit negative revenue growth for this business;

--Growth in near-line products will continue growing in low-single digits with some near-term softness in enterprise mission critical demand;

--Meaningful operating EBITDA margin declines to the lower mid-teens for fiscal 2016 but expansion to higher mid-teens in fiscal 2017 from anticipated footprint and operating expense reductions;

--Lower operating EBITDA and cash restructuring will result in break-even to $250 million of annual FCF over the near-term;

--Minimum cash for working capital is roughly $1 billion, constraining stock buybacks or open market debt repurchases over at least the near-term.

RATING SENSITIVITIES

Factors that could lead to a downgrade from investment grade:

--Fitch's expects top line growth in Enterprise markets will not offset declines in the PC market in the intermediate-term;

--Fitch expects total leverage will remain above 2.5x from weaker than anticipated restructuring driven operating EBITDA growth; or

--FCF remains below $250 million beyond the near term, from the company's failure to grow profitability from restructuring while rebalancing inventory and investments.

Fitch could stabilize the ratings if:

--Restructuring drives operating EBITDA growth, despite likely continued top line pressure;

--Positive sales momentum in enterprise markets, creating the expectation for the resumption of overall organic revenue growth in the intermediate-term;

--Seagate uses cash to meaningfully reduce debt through open market repurchases, enabling the company to maintain total leverage below 2.5x; or

--Seagate structurally strengthens FCF by suspending or meaningfully reducing the dividend.

LIQUIDITY

Fitch believes Seagate's liquidity is diminished but is adequate and supported as of Jan. 1, 2016 by:

--$1.3 billion of cash and cash equivalents; and

--An undrawn $700 million senior secured revolving credit facility (RCF) expiring Jan. 15, 2020 but would be accelerated to August 16, 2018 should the company no longer have investment grade ratings.

Fitch expects break-even to $250 million of FCF over the near-term but annual FCF should exceed $500 million longer term, supporting liquidity beyond fiscal 2017.

Financial covenants in the credit agreement consist of minimum fixed-charge coverage of 1.5x and maximum net leverage ratio of 1.5x. In addition, the facility requires minimum liquidity of $500 million. Fitch estimates net leverage was nearly 1.5x for the latest 12 months (LTM) ended Jan. 1, 2016 and could be closer to 1.7x for the LTM ended April 1, 2016, potentially requiring relief from lenders.

Total debt, all of which was issued by Seagate HDD Cayman, was $4.2 billion Jan. 1, 2016 and consisted of:

--$800 million of 3.75% senior notes due November 2018;

--$600 million of 7% senior notes due November 2021;

--$1 billion of 4.75% senior notes due June 2023;

--$1 billion of 4.75% senior notes due January 2025;

--$700 million of 4.875% senior notes due June 2027; and

--$500 million of 5.75% senior notes due December 2034.

FULL LIST OF RATING ACTIONS

Fitch affirms the following

Seagate Technology plc

--Long-term IDR at 'BBB-';

--Senior secured RCF at 'BBB-'.

Seagate HDD Cayman

--Long-term IDR at 'BBB-';

--Senior secured RCF at 'BBB-';

--Senior unsecured debt at 'BBB-'.

The Rating Outlook is Negative.

Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1002694

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Contacts

Fitch Ratings
Primary Analyst
Jason Pompeii, +1 312-368-3210
Senior Director
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Dustin DeMaria, +1 312-368-2071
Associate Director
or
Committee Chairperson
Stephen Brown, +1 312-368-3139
Senior Director
or
Media Relations, New York
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jason Pompeii, +1 312-368-3210
Senior Director
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Dustin DeMaria, +1 312-368-2071
Associate Director
or
Committee Chairperson
Stephen Brown, +1 312-368-3139
Senior Director
or
Media Relations, New York
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com