Fitch Affirms Computer Sciences IDR at 'BBB' on Announced Acquisitions

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the ratings of Computer Sciences Corp. (NYSE: CSC), including the Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook, on the announced acquisitions of Xchanging Plc. and UXC Limited. Fitch's actions affect $4.2 billion of debt, including the mostly undrawn $2.5 billion revolving credit facility. A full list of the current ratings follows at the end of this release.

The ratings and Outlook reflect Fitch's belief the acquisitions of Xchanging and UXC for $1 billion in aggregate are consistent with CSC's strategy of expanding next-generation offerings to offset declining legacy business. Nonetheless, CSC plans to use cash previously earmarked for debt reduction, resulting in higher than expected leverage through the near term and reducing headroom for operational shortfalls.

Fitch calculates CSC's pro forma debt to EBITDA after synergies will be approximately 1.7x vs the 1.1x post separation EBITDA that would have occurred with the previously anticipated $1 billion debt repayment.

CSC's proposed acquisition of Xchanging for $720 million of cash will offer CSC a newly modernized suite of commercial insurance platforms. The combined company will benefit from CSC's scope and scale. CSC also intends to leverage Xchanging's capabilities in other areas, such as wealth management outsourcing services and infrastructure and applications.

Fitch expects Xchanging will add over $600 million of annual revenue after the rationalization of some lower margin business. CSC expects to generate approximately 50 million pounds to 60 million pounds of ongoing annual cost synergies within 12 to 18 months following completion of the acquisition. The Xchanging acquisition is expected to close over the next six months pending receipt of regulatory approvals.

The Xchanging deal follows CSC's Nov. 24, 2015 announcement it entered into a binding agreement to acquire UXC, the largest IT services company in Australia, for $308 million in cash. UXC provides enterprise application capabilities, including Microsoft Dynamics, SAP, Oracle and ServiceNow implementations, significantly strengthening CSC's market position in Australia.

UXC should add approximately $500 million of annual revenue with operating EBITDA margin of roughly 6% before synergies, which is below CSC's 17% corporate wide EBITDA margin. The transaction is expected to be completed in the first calendar quarter of 2016 and is subject to regulatory and UXC shareholder approval.

KEY RATING DRIVERS

The ratings and Outlook reflect Fitch's belief that strong credit protection measures and solid liquidity provides CSC 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 the expectation that CSC will capitalize the Commercial business with a financial profile consistent with an investment grade rating.

In addition, the ratings and Outlook reflect Fitch's expectations that revenues from next generation solutions will begin to offset negative revenue growth for on-premise contracts by FY 2017, 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 of the government business, but Fitch anticipates CSC shifting its sales mix to more profitable and less capital intensive contracts. In conjunction with lower costs from substantial restructuring, Fitch expects CSC to generate $400 million of annual FCF through the intermediate term.

Rating strengths include Fitch's expectations for:

--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% - 60% from over 40% in fiscal 2015. Fitch believes the acquisitions will reduce CSC's EBITDA margins before cost synergies are achieved. Fitch expects CSC's operating EBITDA margin will exceed 17% 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 beginning in FY 2017;

--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.

RATING SENSITIVITIES

Fitch believes negative rating action could occur if:

--Debt to EBITDA remains above 2.0x for a sustained period;

--Debt financed acquisitions push debt to EBITDA above 2x without a credible deleveraging plan.

--Fitch expects CSC will not return to positive revenue growth by the end of FY 2017 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 ASSUMPTIONS

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

--CSC maintains debt to EIBTDA below 2.0x.

--An increasing mix of next generation solutions will drive positive organic revenue growth beginning in FY 2017.

--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 FCF.

--Shareholder returns will remain modest.

Fitch believes CSC's liquidity was strong as of Oct. 2, 2015 and was supported by:

--$1.8 billion of cash ($1.3 billion in U.S.);

--$2.3 billion of available borrowing capacity under a $2.5 billion revolving credit facility (RCF) due 2020;

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

--$240 million of available capacity under a committed leasing facility for capital expenditures on IT equipment and associated software.

Total debt was approximately $2.6 billion as of October 2, 2015, primarily consisting of:

--$379 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 the following ratings:

Computer Sciences Corp.

--Long-term IDR at 'BBB';

--Short-term IDR at 'F2';

--Senior unsecured debt at 'BBB';

--RCF at 'BBB'.

CSC Capital Funding Limited

--Commercial paper at 'F2'.

The Rating Outlook is Stable.

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

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=996624

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=996624

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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View source version on businesswire.com: http://www.businesswire.com/news/home/20151211005915/en/

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
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Senior Director
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or
Media Relations
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[email protected]

Source: Fitch Ratings

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