(The following statement was released by the rating agency)
Oct 5 - Fitch Ratings has downgraded the ratings of Hewlett-Packard Company
(HP) and its wholly-owned subsidiary Electronic Data Systems LLC (EDS) as follows:
--Long-term Issuer Default Rating (IDR) to 'A-' from 'A'; --Short-term IDR to 'F2' from 'F1'; --Senior credit facilities to 'A-' from 'A'; --Senior unsecured debt to 'A-' from 'A'; --Commercial paper (CP) to 'F2' from 'F1'. Hewlett-Packard International Bank PLC --Short-term IDR to 'F2' from 'F1'; --CP to 'F2' from 'F1'.
--Long-term IDR to 'A-' from 'A'; --Senior unsecured debt to 'A-' from 'A'. The Rating Outlook is Stable. The downgrades reflect:
--HP's weaker-than-expected free cash flow (FCF) forecast of approximately $4 billion post dividends in fiscal 2013 compared with Fitch's expectations for $5 billion - $6 billion. The shortfall primarily reflects the loss of four major contracts in Enterprise Services (ES) and associated decline in revenue and profitability in fiscal 2013.
--Execution risks and longer than anticipated time frame required for HP to achieve a balance sheet reflective of an 'A' rated issuer.
--The increasing potential for incremental restructuring actions and associated cash payments to realign ES headcount with the lower forecasted revenue base.
The ratings and Stable Outlook are supported by HP's:
--Broad product portfolio with strong worldwide market share positions in servers (#1), PCs (#1) and IT services (#2);
--Significant recurring revenue (33% of total revenue) primarily via printer supplies, outsourcing and technology services, and software maintenance;
--Extensive market coverage due to established multi-channel distribution model;
--Geographically diversified revenue base with approximately 66% of revenue derived from outside the U.S.;
--Solid liquidity provided by nearly $9.5 billion of cash (primarily offshore), deteriorating, but consistent annual FCF and $7.5 billion of undrawn committed credit facility capacity;
Rating concerns include:
--Numerous internal and external challenges, consisting of, competitive pricing pressures, historical underinvestment, strong yen and excessive channel ink supplies inventory.
--Heightened acquisition risk and profitability pressures following material underinvestment in the services business and research and development (R&D) in prior years. Fitch believes return on investment in these areas will likely take several years, resulting in intermediate term profitability pressures and, potentially, acquisitions necessary to maintain the company's competitive position.
However, Fitch believes near-term acquisition risk is mitigated by CEO Meg Whitman's stated intent to rebuild the balance sheet and regain an 'A' rating.
--Increasing competition in the industry standard server (ISS) market (x86) as products from relatively new entrants, specifically Cisco Systems (Cisco) in large enterprise and Lenovo Group (Lenovo) in small and medium business, begin to gain traction in the marketplace. Fitch believes Cisco and Lenovo account for only 5% - 6% of total server shipments currently but are growing rapidly.
--Declining hardware market share in the Asia Pacific (APAC) region, excluding Japan, primarily due to share losses in China. Fitch believes HP's review of strategic alternatives for PSG, increasing competition from Dell, Lenovo and Cisco Systems, and weakness in BCS resulted in materially lower PC and server revenue in China.
--Continued decline in high margin business critical systems (BCS) revenue, which fell nearly 23% in the latest 12 months ended July 31, 2012, following Oracle's decision to discontinue all software development for Intel's Itanium microprocessor. Oracle reinstated software support for the Itanium processor after HP won its breach of contract lawsuit against Oracle. Nonetheless, Fitch believes BCS revenue will continue to decline due to a shrinking UNIX market and share losses to IBM.
HP's technology services revenue and operating margin has also be adversely affected as customers gradually migrate to UNIX servers offered by competitors (IBM and Oracle) or x86 servers with less profitable support contracts.
--Weak consumer demand in mature markets and potential long-term hardware revenue and profitability pressures if commercial customers aggressively adopt cloud computing and the market for cloud services is highly concentrated. In this scenario, cloud providers would have significant pricing leverage due to scale and/or could accelerate their utilization of unbranded custom-built servers.
In addition to its solid cash position and consistent FCF, HP's liquidity is further supported by two undrawn revolving credit facilities, which had aggregate capacity of $7.5 billion as of July 31, 2012, and multiple revolving trade receivables facilities with $1 billion of available capacity as of July 31, 2012. HP's revolving credit facilities consist of a $4.5 billion credit facility expiring in February 2015 and a $3 billion facility expiring in May 2017.
Total debt was $29.7 billion as of July 31, 2012, consisting of $5.7 billion of short-term debt, including current portion of long-term debt, and $24.1 billion of long-term debt. Fitch estimates approximately $11 billion, or 37% of total debt, is attributable to HP's customer-financing business.
HP's core (non-financing) leverage (core debt/core EBITDA) increased to 1.3x as of July 31, 2012 from 0.8x in the prior year and core interest coverage (core EBITDA/ core interest expense) declined to nearly 29x compared with in nearly 100x in the year ago period. Total leverage increased to 2x at July 31, 2012 from 1.4x in the prior year. Total interest coverage decreased to 18x in the latest 12 months ended July 31, 2012 compared with approximately 38x in the year-ago period. Fitch forecasts total leverage and interest coverage of 1.7x and approximately 15x, respectively, in fiscal 2013.
(Caryn Trokie, New York Ratings Unit)