March 10, 2017 / 10:27 PM / 4 months ago

Fitch Downgrades Hewlett Packard Enterprise to 'BBB+'; Outlook Stable

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(The following statement was released by the rating agency) CHICAGO, March 10 (Fitch) Fitch Ratings has downgraded the ratings for Hewlett Packard Enterprise Company (HPE), including the Long-Term Issuer Default Rating (IDR), to 'BBB+' from 'A-'. The Rating Outlook is Stable. Fitch's actions affect $20 billion of total debt, including the undrawn $4 billion Revolving Credit Facility (RCF). A full list of rating actions follows at the end of this release. The ratings and Outlook reflect Fitch's expectations for meaningfully weaker than previously expected operating performance, driven largely by lower demand in core hardware markets. HPE specifically noted lower demand from one large customer in Industry Standard Servers (ISS) during the quarter ended Jan. 31, 2017, but Fitch believes this weakness is more likely structural than transitory. Surging prices for NAND and DRAM memory resulted in Storage segment weakness on both the top and bottom lines, although Fitch expects the transition by NAND makers to 3D capacity (from 2D) will alleviate constrained supply beyond the near term. At the same time, solid growth in Networking and continued momentum in Technology Services (TS) should continue but likely remain insufficient to offset top line pressures. KEY RATING DRIVERS Challenged Hardware Markets: Fitch expects HPE's core hardware market, ISS, will remain challenged beyond the near term. Pro forma for the divestitures, ISS represent roughly half of the company's core revenue base and is facing secular headwinds from a shrinking enterprise market, while tier 1 hyper-scale providers increasingly buy customized white boxes from Taiwanese original design manufacturers (ODM). Higher mix ISS markets, including high performance computing (HPC) and hyper-converged infrastructure are growing by double digits but are small and inadequate to offset negative enterprise market growth in the intermediate term. Acquisitions Core to Strategy: Fitch believes acquisitions are essential to HPE's long-term growth prospects given the company's higher mix of legacy IT capabilities. Fitch expects HPE will focus on acquiring new IT offerings to strengthen its hybrid cloud platform, such as the company's recent announcements that it will acquire privately held software-defined, hyper-converged infrastructure provider, SimpliVity, and predictive all-flash and hybrid-flash storage solutions provider, Nimble Storage Inc. (Nimble). However, acquisition multiples are likely to remain elevated and, therefore, potentially leveraging transactions, given HPE's modest domestic liquidity and commitment to capital returns. Significant Shareholder Returns: Fitch expects shareholder returns will remain significant, given top line headwinds. HPE has committed to returning at least 100% of pre-dividend FCF to shareholders. The company will fund nearer-term shareholder returns with proceeds from spinoffs and other divestitures, domestic cash flow and some tax efficient repatriation. However, given the vast majority of cash and majority of cash flow (a Fitch estimated 60%) is offshore and would trigger tax liabilities upon repatriation, Fitch expects longer-term shareholder returns would likely require incremental borrowing absent meaningful U.S. tax reform. Conservative Capital Structure: Fitch expects HPE's core leverage (total debt less financial services debt to operating EBITDA less financial services profitability) will remain conservative (below 1.5x) through the intermediate term. HPE has historically moderated debt balances and shareholder returns to maintain consistently conservative credit protection measures, given the strategic importance of the rating to HPE's Financial Services (FS) business. Reduced Diversification Following Divestitures: Fitch expects reduced diversification following the imminent spinoffs of the Services (April 1, 2017) and Software (Sept. 1, 2017), which represent 37% and 6% of fiscal 2016 consolidated revenue, respectively. Challenging hardware markets over at least the near term will exacerbate HPE's reduced diversification. At the same time, Fitch believes the significant majority of HPE's profitability and FCF are from the Enterprise Group, specifically the TS business. In addition, Fitch believes the spinoffs will enable management to focus on top line growth rather than restructuring the Services business or software acquisitions to broaden the Software business' offerings. Significant Installed Based: Fitch expects HPE's significant installed base drives meaningful maintenance and support revenue (30% of revenue and 60% of operating profit), as well as growth opportunities. TS' advisory and consulting practices should enable HPE to migrate customers across on-premise and cloud environments, both public and private, and attach additional HPE hardware and maintenance and support services. Revenue from TS will represent more than 25% of consolidated revenue and should grow by low single digits, while adding meaningfully higher than corporate-wide operating profit margins. KEY ASSUMPTIONS --ISS declines by 10% in fiscal 2017 and in the low- to mid-single digits through the intermediate term; --Networking grows by mid-single digits through the forecast period; --Storage declines by 10% in fiscal 2017, mid-single digits in fiscal 2018 and resumes positive growth thereafter; --TS grows by low-single digits through the intermediate term; --FX reduces revenue growth by 2% in fiscal 2017 and is neutral thereafter; --Operating EBITDA margins expand to the high teens (more than 18%); --HPE refinances debt maturities; --Dividends grow by 10% annually and HPE curtails share repurchases to maintain core leverage below 1.5x; --Acquisitions of roughly $750 million annually through the intermediate term, all requiring domestic funding. RATING SENSITIVITIES Negative rating actions could result if Fitch expects: --Negative constant currency organic revenue growth beyond the near term, likely from structurally lower demand in industry standard servers and weaker than expected performance in TS; or --Share repurchases remain intensified amidst Lower profitability and FCF, resulting in debt funded shareholder returns and core leverage sustained above 1.5x. Positive rating actions could occur if Fitch expects: --Positive CC organic revenue growth from greater than expected contributions from new technologies and TS; and --Annual FCF reaching sufficient scale to provide HPE with flexibility to organically fund acquisitions and invest in next generation offerings while maintaining core leverage below 1x. LIQUIDITY As of Jan. 31, 2017, Fitch believes liquidity was solid and consisted of: --$9.1 billion of cash and cash equivalents (excluding cash related to FS), the vast majority of which Fitch believes was located outside the U.S.; --Undrawn $4 billion RCF that fully backstops commercial paper programs in the U.S. and Europe. Beyond fiscal 2017, more than $1.5 billion of annual FCF also supports liquidity. FULL LIST OF RATING ACTIONS Fitch has taken the following ratings actions: Hewlett Packard Enterprise Company (HPE) --Long-Term IDR downgraded to 'BBB+' from 'A-'; --Short-Term IDR affirmed at 'F2'; --Commercial Paper (CP) affirmed at 'F2'; --Senior unsecured RCF downgraded to 'BBB+' from 'A-'; --Senior unsecured notes downgraded to 'BBB+' from 'A-'. Hewlett-Packard International Bank PLC --Short-Term IDR affirmed at 'F2'; --CP affirmed at 'F2'. Electronic Data Systems LLC --Long-Term IDR downgraded to 'BBB+' from 'A-' and withdrawn due to the transfer of outstanding EDS debt to Services in connection with that business' imminent spinoff and merger transaction. Contact: Primary Analyst Jason Pompeii Senior Director +1-312-368-3210 Fitch Ratings, Inc. 70 West Madison St. Chicago, IL 60602 Secondary Analyst David Peterson Senior Director +1-312-368-3177 Committee Chairperson Philip Zahn Senior Director +1-312-606-2336 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Date of Relevant Rating Committee: March 9, 2017 Summary of Financial Statement Adjustments - Fitch assigns debt on HPE's balance sheet not associated with Financial Services to the core business and subtracts Financial Services profitability from HPE's consolidated operating EBITDA to arrive at Core Leverage (Total Debt less Financial Services Debt to Operating EBITDA less Financial Services profitability). 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