Fitch Ratings has downgraded the following ratings for Computer Sciences Corp. (NYSE: CSC):
--Long-term Issuer Default Rating (IDR) to 'BBB' from 'BBB+';
--Senior unsecured debt to 'BBB' from 'BBB+';
--Revolving credit facility (RCF) to 'BBB' from 'BBB+';
--Short-term IDR to 'F3' from 'F2';
--Commercial paper (CP) to 'F3' from 'F2'.
In addition, Fitch has removed CSC's ratings from Rating Watch Negative. The Rating Outlook is Negative.
Approximately $4.2 billion of debt is affected by Fitch's action, including CSC's undrawn $1.5 billion RCF.
CSC's ratings and Negative Outlook reflect:
--The significant shortfall in fiscal 2012 free cash flow (FCF) relative to Fitch's expectations, primarily due to greater than anticipated profitability pressures and unresolved contract renegotiations with the U.K.'s National Health Services (NHS). CSC reported FCF (post dividends) of $61 million, well below Fitch's FCF target of $500 million.
--The depth and breadth of CSC's underperforming contracts and risk associated with the remediation of these contracts. CSC has 40 contracts, 32 in the Managed Services Sector (MSS) and eight in the North American Public Sector (NPS), which are underperforming their original bid forecast model. These contracts represent approximately 20% of total revenue and generated an operating loss of $100 million - $200 million in fiscal 2012.
--Risk of incremental problem contracts and CSC's ability to win new contracts under a more stringent bid process.
--Risk of organizational disruption from the significant, albeit necessary, number of changes being implemented under new CEO Mike Lawrie.
--Uncertainty of U.S. federal IT spending, including risk of default associated with the next upcoming debt-ceiling debate and implementation of cost containment measures due to fiscal pressures.
--Sovereign debt challenges and weak economic environment in Europe (26% of CSC's revenue).
--Ongoing SEC investigation into accounting adjustments and related disclosures.
The ratings are supported by CSC's:
--Pressured, but historically consistent annual free cash flow (FCF) supported by substantial recurring revenue from long-term contracts (75%-80% of total revenue). Resolution of the problem contracts and anticipated cost reductions are likely to gradually improve FCF to historical norms.
--Target of $1 billion in profitability improvement in 12 to 18 months through cost savings and remediation of problem contracts. Cost savings will be derived from headcount reductions (approx. 2,000 announced to date), procurement savings and real estate consolidation.
Procurement savings will be realized by consolidating and limiting purchasing authority solely to individuals in the procurement office. In this manner, CSC expects to get tighter compliance with the company's global discount agreements with large vendors and therefore should theoretically be able to reduce its procurement costs. CSC's procurement budget is $7 billion.
--Diversified revenue mix with respect to service offerings and end markets served with commercial and government representing 64% and 36%, of total fiscal 2012 revenue, respectively. Furthermore, CSC addresses a broad range of industries within the commercial sector.
--Adequate total liquidity of $2.5 billion, consisting of an undrawn $1.5 billion RCF due March 2015 and approximately $1.1 billion of cash as of April 1, 2011.
--Significant market opportunities in cybersecurity, healthcare, cloud, application modernization, and datacenter transformation, particularly for the federal government.
A Positive rating action could occur if:
--CSC achieves its profitability improvement target of $1 billion in the next 12 - 18 months, resulting in a rebound in FCF.
A Negative rating action could occur in the event CSC:
--Profitability remains well below historical levels resulting in further deterioration of credit protection measures;
--Discloses additional material problem contracts;
--Experiences a significant decline in contract signings in a trailing 12 month period, which indicates a lack of competitiveness under the more stringent bid process.
--Confronts a material reduction in federal spending that causes NPS revenue to decline in excess of the forecasted mid-single digit rate and is not partially offset by commercial sector growth.
Fitch continues to view the appointment of Lawrie as CEO very favorably. Lawrie appears to have a strong grasp on the fundamental problems facing CSC and has stated that he is taking numerous actions to improve results, including:
--Reviewed all material outsourcing contracts to identify problem contracts;
--Restructured the contract bid process to minimize future problem contracts;
--Personal involvement in NHS discussions;
--Revised senior management compensation programs to be based on operating profit, free cash flow and revenue growth;
--Designed and confirmed a simplified operating model with the Board of Directors that will improve execution by providing greater clarity and accountability.
--Hired numerous new outside management, including Paul Saleh as CFO succeeding Mike Mancuso, who retires May 31.
CSC's liquidity was adequate as of March 30, 2012 supported by $1.1 billion of cash and equivalents and an undrawn $1.5 billion RCF expiring in March 2015. Financial covenants consist of minimum interest coverage and maximum leverage of 3x.
Furthermore, CSC could monetize its credit reporting business by exercising a put option prior to Aug. 1, 2013 that requires Equifax Inc. (Equifax) to purchase the business for cash within 180 days after the option exercise date. Although the purchase price will be determined by a third-party appraiser and is subject to negotiation, Equifax, based on an internal analysis, most recently estimated the fair value of the business to be $650 million - $750 million, as of Dec. 31, 2011.
Total debt was approximately $2.7 billion as of March 30, 2012, primarily consisting of:
--$700 million of 5.50% term notes due March 2013;
--$300 million of 5.00% term notes, due February 2013; and
--$1 billion of 6.50% term notes due March 2018.
The $300 million of 5% senior unsecured notes due 2013 do not carry a change of control covenant, while the $700 million of 5.5% notes due 2013 and the $1 billion of 6.5% notes due 2018 both carry a change of control triggering event covenant. The triggering event occurs when two of the three rating agencies downgrade the rating on the unsecured notes and assign the notes a non-investment grade rating within 60 days following the consummation of a change of control.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
John M. Witt, CFA, +1-212-908-0673
33 Whitehall Street
New York, NY 10004
Jason Pompeii, +1-312-368-3210
Jamie Rizzo, CFA, +1-212-908-0548
Brian Bertsch, +1-212-908-0549
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