Moody's Downgrades CDK Global (CDK) to 'Ba1'; Outlook Lifted to Stable
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Moody's Investors Service ("Moody's") downgraded CDK Global, Inc.'s (Nasdaq: CDK) senior unsecured debt ratings to Ba1 from Baa3 and changed the outlook to stable from negative. As part of the rating action, Moody's assigned CDK a Ba1 corporate family rating (CFR), Ba1-PD probability of default rating, and an SGL-1 speculative grade liquidity rating. Given the competitive risks, investment needs, possible acquisitions and shareholder returns, Moody's believes that CDK's financial policies are evolving towards higher financial leverage, which is more consistent with a speculative grade profile.
The Ba1 CFR reflects CDK's leading US market position as a provider of technology and services to the automotive retail dealer community and Moody's expectation that the company will maintain very strong liquidity. Moody's expects consistent free cash flow generation over the next few fiscal years and profit improvement driven by moderate revenue growth and the comprehensive business transformation program. Moody's expects operating margins to rise above 30% over the next couple of years up from the sub-20% levels it operated under prior to its spin-off from Automatic Data Processing.
Yet, the company has been engaged by activist shareholders, and Moody's believes that activist pressure to reward shareholders was a large factor in the company's decision to adopt more aggressive financial policies, ahead of achieving the targeted operating efficiencies of its business transformation program.
In June 2016, CDK announced an acceleration of its $1 billion capital return program to be fulfilled by the end of calendar 2016, ahead of the previous completion target of the end of calendar 2017. The anticipated borrowings to complete the accelerated program will bring the company's adjusted debt to EBITDA leverage above 3.0 times by the end of 2016. Moody's believes these leverage levels will be more in line with the company's financial policy going forward, as the benefits of CDK's comprehensive business transformation plan will likely continue to be allocated to shareholder payouts and not to preserve credit protection measures that underpin an investment grade rating. Moody's analyst Gerald Granovsky said, "Moody's believes that CDK will need financial flexibility for additional borrowing capacity to fund the payouts to its shareholders and to pursue strategic acquisition opportunities that would accelerate revenue growth." Moody's believes that the company's evolving financial policy is consistent with a Ba1 CFR.
The rating is supported by CDK's market share leadership which provides the company with scale economies, long lasting relationships with the large dealership groups and major auto OEMs, and an entrenched suite of products that are critical to many dealerships' daily activities, which allows CDK to avoid significant performance declines in periods of depressed demand that periodically impact this industry.
CDK's SGL-1 rating reflects the company's very good liquidity position, supported by solid cash balances of $250 million to $300 million that Moody's expects will be maintained through fiscal year-end 2017 and steady annual free cash flow of over $200 million. The company's liquidity is supplemented by a $300 million revolving credit facility maturing in September 2019, which Moody's expects will remain largely undrawn, other than temporary borrowings to manage working capital. Given CDK's credit profile, Moody's expects the company to remain well within the financial maintenance covenants tied to its debt.
The ratings for the senior unsecured credit facilities (Ba1, LGD4) and senior unsecured notes (Ba1, LGD4) reflect the overall probability of default of the company, as reflected in the PDR of Ba1-PD, and the expectation for average family recovery in a default scenario.
The stable outlook reflects CDK's strong credit profile at its rating level, as it affords it the flexibility to manage operating and business challenges, and the expectation of further operating improvements from its ongoing business transformation.
What Could Change the Rating - Up
CDK's rating could be upgraded if the company demonstrates, over an extended period, a return to highly conservative financial policies. Ratings could also be upgraded if the company's transformation program is successful and the company manages to a 2.5 times debt to EBITDA leverage target.
What Could Change the Rating - Down
Ratings could be lowered if the CDK continues to pursue more aggressive financial policies. Ratings would also be pressured if the company's adjusted debt to EBITDA is sustained around 4.0 times or if there is significant deterioration in the company's free cash flow generation. Additionally, any meaningful market share losses or reversal of efficiency gains, such that operating margins fall back below 20% (Moody's adjusted) could lead to lower ratings.
Corporate Family Rating -- Assigned Ba1
Probability of Default Rating -- Assigned Ba1-PD
Speculative Grade Liquidity Rating -- Assigned SGL-1
Senior Unsecured Notes -- Downgraded to Ba1 (LGD4) from Baa3
Senior Unsecured Credit Facilities -- Downgraded to Ba1 (LGD4) from Baa3
Outlook -- Changed to Stable from Negative
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