S&P Downgrades CDK Global (CDK) to 'BB+'; Outlook Stable
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At the same time, we assigned a 'BB+' issue rating and '3' recovery rating to the company's $350 million senior unsecured term loan. The '3' recovery rating indicates our expectation for meaningful recovery (50%-70%; upper end of the range) in the event of a default.
We also lowered our ratings on the company's unsecured notes, term loan, and revolver to 'BB+' from 'BBB-' and assigned a recovery rating of '3' (upper end of the 50%-70% range).
"The rating actions reflect our revised view of CDK's financial policy," said S&P Global Ratings credit analyst Kenneth Fleming.
We believe that the loan issuance will enable the company to increase shareholder returns above its stated target of 70 to 80% of free operating cash flow over the coming year. In our current base case for CDK's fiscal year ending June 30, 2017, we have modeled $650 million in dividends and buybacks which includes $80 million to pay the annual dividend, $350 million to complete the $1 billion return, and an incremental $220 million in share buyback. The incremental $220 million represents the company's entire discretionary cash flow for 2017. However, we note that absent a stated
buyback goal for 2017, the actual returns in the coming year could be meaningfully higher through the use of cash on the balance sheet, use of the revolver, or additional debt issuance. CDK has faced mounting pressure from activist investors to improve margins and increase shareholder returns since its spin-off from ADP in 2014. In June 2016, CDK accelerated its $1 billion shareholder return to one year from two years. Because of this uncertainty and the fact that leverage is almost a full turn above our threshold of 2x for a 'BBB-' rating, we have revised our assessment of our financial policy modifier to negative from neutral.
The stable outlook reflects CDK's market leadership position in the auto dealer IT market, the company's improving EBITDA margins under its current restructuring program, and our expectation that its recurring revenue model will result in solid free cash flow generation over the next year.
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