Dell Technologies Inc

Transcription

1 Summary: Dell Technologies Inc Primary Credit Analyst: David T Tsui, CFA, CPA, New York (1) ; david.tsui@spglobal.com Secondary Contact: Tuan Duong, New York (212) ; tuan.duong@spglobal.com Table Of Contents Rationale Outlook Our Base-Case Scenario Business Risk Financial Risk Liquidity Recovery Analysis Related Criteria And Research MAY 17,

2 Summary: Dell Technologies Inc Business Risk: SATISFACTORY Vulnerable Excellent CORPORATE CREDIT RATING bb+ bb+ bb+ Financial Risk: SIGNIFICANT BB+/Stable/-- Highly leveraged Minimal Anchor Modifiers Group/Gov't Rationale Business Risk: Satisfactory Leader in the $2 trillion IT market with broad product portfolio in the PC, server, external storage system and virtualization software markets. Extensive sales force and channel partners covering enterprise, commercial, small- to medium-sized businesses and retail customers. Ongoing technology challenges, including migration of applications and infrastructure from on-premise data centers to the cloud. Integration of EMC acquisition, including sales force realignment. Financial Risk: Significant Significant funded debt outstanding of about $50 billion at fiscal year ended Feb. 3, Pro forma leverage in the low-4x area as of fiscal year ended Feb. 3, 2017 and declining to the mid- to high-3x area by the end of fiscal 2018 (including 80% of VMware EBITDA). Good free operating cash flow generation in excess of $4 billion in fiscal 2018 and about $7.5 billion in fiscal 2019 (in excess of $2 billion in fiscal 2018 and about $5 billion in fiscal 2019 excluding VMware). Cash and investment balance of about $15.3 billion as of Feb. 3, 2017 (including VMW cash and investment balance). MAY 17,

3 Outlook: Stable S&P Global Ratings' stable outlook on Dell Technologies Inc indicates our expectation that the company's organic revenue growth will be flat to low-single-digit percentage in fiscal year 2018 with expected revenue growth from its PC, server, VMware and other businesses to offset revenue decline in its external storage systems business. We also expect the company to be able to successfully integrate its acquisition of EMC, maintain market leadership in its product categories, and achieve identified cost savings, leading to leverage declining to the mid- to high-3x range by the end of fiscal Downside scenario We would lower our corporate credit rating on Dell if the company's revenue, profitability and FOCF generation underperform our base-case scenario, resulting in deterioration in credit metrics, including pro forma leverage exceeding 4x on a sustained basis. This could happen if the company's external storage systems business becomes more challenged than anticipated, as competitors gain market share resulting from disruptions arising from Dell's acquisition of EMC. In addition, although less likely, we could lower the ratings if the company's financial policy becomes more aggressive, with material debt-funded acquisitions or shareholder returns. Upside scenario Although unlikely over the next 12 months, we could raise our corporate credit rating on Dell by one notch to 'BBB-' if the company is able to execute its plan of achieving targeted cost savings and repaying debt, leading to leverage sustained below 3x. This could happen if the PC, server, external storage systems or virtualization software application markets strengthens or if Dell gains material market share in these areas such that leverage is reached the upside rating threshold. Additionally, we would also look for Dell's commitment to a financial policy that would preclude it from taking on incremental debt, for shareholder return, ownership exits, or acquisitions that would jeopardize its investment-grade ('BBB-' and above) debt ratings. Our Base-Case Scenario MAY 17,

4 Assumptions U.S. real GDP growth of 2.3% in 2017 and 2.4% in 2018; Eurozone real GDP growth of 1.6% in 2017 and 1.5% in 2018; Asia Pacific real GDP growth of 4.4% in 2017 and 4.5% in 2018; Global information technology (IT) spending growth in the low-single-digit percentage area in calendar year 2017; Revenue to be about $76 billion in fiscal 2018, representing flat to low-single-digit percentage organic revenue growth; Revenue growth to be in the low-single-digit percentage area as business environment in external storage systems improves and becomes less of a headwind to Dell's overall revenue growth; EBITDA margin, pro forma for cost savings from the business combination with EMC, to be between 13% and 14% in fiscal 2018 and 2019; Capital expenditures, including capitalized software development costs, of about $1.5 billion, or about 2% of revenues in fiscal 2018 and 2019; VMware to repurchase shares of about $1 billion annually; and Monetization of $1.5 billion receivables from VMware with proceeds to be used to repay $1.5 billion "Mirror Loan" outstanding. Key Metrics 2017A 2018E 2019E Adj. FOCF ($ bil.) Cash and investments ($ bil.) Pro forma leverage (x) Low-4 Mid- to high-3 Low-3 A Actual. E Estimate. Leverage calculation includes 80% of EBITDA contribution from VMware and pro forma cost savings from EMC acquisition. Business Risk: Satisfactory Our view of Dell's business risk profile reflects the company's diversified product portfolio and leading positions in PCs, servers, external storage systems, and virtualization software markets. The larger scale will also enhance Dell's position as a critical IT business partner with its customers and supply chain partners, allowing the combined company to compete more effectively against its competitors. The business combination would also improve Dell's customer mix to balance the company's strength in the small to midsize markets and EMC's strength in the larger enterprise markets. Furthermore, since the overall IT infrastructure environment increasingly embraces converged technologies, the business combination between Dell and EMC (and VMware) should help facilitate Dell's product offerings to keep pace with the technology evolution. We continue to view the overall integration risk to be moderate, since we expect modest product overlap and EMC's key business leaders to remain at Dell. However, Dell's plans to consolidate its and EMC's sales workforce could be disruptive, especially in today's challenging external storage systems market MAY 17,

5 environment with competition from existing large solutions providers as well as smaller providers that offer competitive transactional hardware. Dell's revenues were about $62 billion in fiscal year ended Feb. 3, 2017, which includes revenues from EMC since the merger transaction closed on Sept. 7, We expect Dell's revenue from its PC-related business to represent slightly less than half of total revenues in fiscal Highly competitive and cyclical market conditions characterize the PC market, with global PC market unit shipment declines in the low-single-digit percentage area in calendar year 2017, compared to a 6% decline in 2016, according to International Data Corp. (IDC). Despite the high cyclicality and weak PC market demand, Dell has been able to gain market share in a difficult market environment. We expect Dell's Client Solutions business segment revenue growth to be up in the low-single-digit percentage area in fiscal 2018, better than industry growth, as a result of share gains. Profit margin, however, could be pressured in fiscal 2018 on account of higher memory and display component costs. Revenue contributions from enterprise hardware products, such as storage, servers, and networking products, is expected to represent about 40% of Dell's total revenues in fiscal This business segment is exposed to average selling price declines as new and improved products are introduced, a high risk of technology obsolescence, and enterprise businesses' ongoing migration of their IT infrastructure from on-premise data centers to the cloud. We expect Dell's server and networking business to grow in the mid-single-digit percentage area while its storage business to experience a mid-single-digit percentage organic revenue decline, attributable to continued traditional and hybrid external storage systems revenue declines, especially in the high-end and mid-range external storage system sales. We anticipate revenue contributions from Dell's VMware and other business segments to represent about 10% of total revenues in fiscal VMware has a strong market position in the virtualization software market. Coupled with its hybrid cloud and software-as-a-service products, we expect VMware to experience a mid- to high-single-digit revenue growth in fiscal 2018, reflecting growth from license sales, software maintenance and also professional services. Dell's other businesses include: Pivotal, a provider of application and data infrastructure software connecting information between on-premise and cloud-based applications; RSA, a provider of advance-threat cybersecurity solutions; and SecureWorks, a provider of intelligence-driven information security solutions. These other businesses are in their high-growth phase albeit at a lower revenue base. We expect Dell's adjusted EBITDA margin to be between 13% and 14% in fiscal 2018, pro forma for cost savings from the business combination with EMC that we believe Dell would be able to achieve based on its track record of successfully managing its cost base appropriate for the company and business environment. This is slightly lower than the mid-teens percentage EBITDA margin projected in our prior forecast, primarily as a result of management's decision to increase investments for growth opportunities and also because of higher memory and glass component costs experienced since its fiscal fourth quarter We expect the margin pressure from higher component costs to lessen in fiscal 2018 as the year progresses and EBITDA margin to improve in fiscal Dell's founder Michael Dell continues to lead the combined company as chairman and CEO. Our assessment of Dell's management and governance reflects our positive view of the company's strategic planning process; its ability to track, adjust, and control execution of strategy; its standards for operational performance and management's experience; and its depth and breadth. The company's continued reliance on Michael Dell's position as controlling shareholder is an MAY 17,

6 offsetting factor. Financial Risk: Significant Our assessment of Dell's financial risk profile reflects the company's significant debt outstanding of about $50 billion as of Feb. 3, 2017, albeit down from about $57 billion at EMC transaction close in September 2016 as sales proceeds from the divestitures of Dell's IT services and software businesses and EMC's content management division were used to repay debt. Leverage, pro forma for cost savings from the business combination with EMC, is expected to be in the mid- to high-3x area at the end of fiscal 2018, higher than our prior forecast which is in the low- to mid-3x area, due to higher expected investments in growth areas and also the aforementioned margin pressure related to higher memory and glass component costs. Dell's FOCF generation, excluding VMware's FOCF, in fiscal 2018 is expected to be in excess of $2 billion, which we believe will be mostly used for debt repayment. In calculating the leverage ratio, we consider about 75% of Dell's cash and investments (excluding 100% of VMware's cash and investment) as surplus cash, after factoring costs such as the tax effects on the repatriation of foreign earnings and the tax on investment gains, and net the amount against debt. We believe Dell's management is committed to its capital allocation plan by applying most of its FOCF generation for debt repayment. The EMC acquisition in September 2016 follows Dell's leveraged buyout (LBO) by Michael Dell and Silver Lake Partners in October 2013 for approximately $25 billion. Dell was successful in its deleveraging plan since then, with leverage of about 2x as of the end of fiscal 2016, down from pro forma leverage in the 5x area at the time of the LBO transaction. Liquidity: Adequate We expect Dell's liquidity to be adequate to more than cover cash needs over the next 12 to 24 months. Our assessment of the company's liquidity profile incorporates the following expectations and assumptions: Sources will cover uses by more than 1.2x; Net sources of cash would be positive, even with a 15% drop in EBITDA; The company appears to have sound relationships with its banks; A generally satisfactory standing in the credit market; and Generally prudent risk management. MAY 17,

7 Principal Liquidity Sources Total cash and investment of $15.3 billion, consisting of $9.5 billion cash balance, $2 billion short-term investments and $3.8 billion long-term investments as of Feb. 3, 2017; About $2.7 billion available from its $3.2 billion revolving credit facility expiring Dec. 31, 2021; and FOCF in excess of $4 billion in fiscal 2018 and about $7.5 billion in fiscal 2019 (in excess of $2 billion in fiscal 2018 and about $5 billion in fiscal 2019 excluding VMware). Principal Liquidity Uses Capital expenditures, including capitalized software development costs, of about $1.5 billion in fiscal 2018 and 2019; $1.5 billion "Mirror Loan" due September 2017; $500 million unsecured notes due April 2018; $2.5 billion EMC unsecured notes due June 2018; and $600 million term loan A-1 facility and $1.8 billion term loan A-3 facility due December Covenants The company's term loan A-1, A-2, A-3 and revolving credit facility are subject to a first lien net leverage ratio covenant requirement. As of Feb. 3, 2017, the company was in compliance with the covenant requirement and we expect covenant headroom to remain adequate over the next 12 months. The company's senior secured notes (totaling $20 billion) issued on June 1, 2016 are subject to interest rate adjustments if the company's corporate credit rating is downgraded by either Moody's or S&P. Additionally, in the event of an "Investment Grade Event," defined by the bond indenture as the company's corporate credit ratings having been upgraded to investment grade ('BBB-' or higher, or the equivalent) by two of the three rating agencies, the guarantees and collateral securing the notes will be released. Recovery Analysis Key Analytical Factors Our simulated default scenario assumes a default in 2022 due to a worldwide economic recession and heightened competition, which result in significantly reduced spending in PCs, servers, external storage systems and virtualization software; and the company's inability to access the debt capital market for meeting debt maturities. We also assume that the company encounters serious operation missteps in the integration of its EMC acquisition. These factors ultimately would lead to lower revenue, profitability, and cash flow generation. We valued the company as a going-concern, applying a 5.5x EBITDA multiple to our estimated emergence EBITDA of about $5.6 billion to derive a gross enterprise value of $31 billion. We estimate administrative expenses of 5% reduce the gross enterprise value, resulting in a net enterprise value of about $29 billion. MAY 17,

8 Simulated Default Assumptions Simulated year of default: EBITDA at emergence: $5.6 billion. EBITDA multiple: 5.5x. Simplified Waterfall Net enterprise value (after 5% administrative costs): $29.1 billion. Valuation split (obligors/nonobligors): 66%/34%. Priority claims: $2 billion (VMW margin loan). Value available to first-lien debt claims (collateral/noncollateral): $23.6 billion/$3.5 billion Secured first-lien debt claims: $34.2 billion. -- Recovery expectations: 70%-90% (rounded estimate: 75%). Total value available to unsecured claims: $3.5 billion. Senior unsecured debt/pari passu unsecured claims: $3.4 billion/$10.6 billion. -- Recovery expectations: 10%-30% (rounded estimate: 20%). Structurally subordinated debt claims (Dell Inc. notes and EMC notes without guarantees): $8.1 billion. -- Recovery expectations: 0%-10% (rounded estimate: 0%). All debt amounts include six months of prepetition interest. The collateral value equals asset pledge from obligors after priority claims plus equity pledge from nonobligors after nonobligor debt. Related Criteria And Research Related Criteria Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017 Recovery Rating Criteria for Speculative-Grade Corporate Issuers, Dec. 7, 2016 Methodology: The Impact Of Captive Finance Operations On Nonfinancial Corporate Issuers, Dec. 14, 2015 Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 Corporate Methodology, Nov. 19, 2013 Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013 Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013 Group Rating Methodology, Nov. 19, 2013 Key Credit Factors For The Technology Software And Services Industry, Nov. 19, 2013 Key Credit Factors For The Technology Hardware And Semiconductors Industry, Nov. 19, MAY 17,

9 Methodology: Industry Risk, Nov. 19, 2013 Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 Use Of CreditWatch And Outlooks, Sept. 14, Corporate Criteria: Rating Each Issue, April 15, 2008 Business And Financial Risk Matrix Business Risk Profile Financial Risk Profile Minimal Modest Intermediate Significant Aggressive Highly leveraged Excellent aaa/aa+ aa a+/a a- bbb bbb-/bb+ Strong aa/aa- a+/a a-/bbb+ bbb bb+ bb Satisfactory a/a- bbb+ bbb/bbb- bbb-/bb+ bb b+ Fair bbb/bbb- bbb- bb+ bb bb- b Weak bb+ bb+ bb bb- b+ b/b- Vulnerable bb- bb- bb-/b+ b+ b b- MAY 17,

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