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Fitch: Computer Sciences 'BBB' IDR Unaffected by Government Services and SRA Combination
[September 02, 2015]

Fitch: Computer Sciences 'BBB' IDR Unaffected by Government Services and SRA Combination


Fitch Ratings believes the ratings for Computer Sciences (News - Alert) Corp. (CSC or Commercial Business) are unaffected by the proposed combination of the Computer Sciences Government Services (CSGov) and SRA International (News - Alert) (SRA). A full list of the current ratings follows at the end of this release.

CSC announced that it has entered into a definitive agreement to combine CSGov with SRA once the CSGov spin-off is complete. Fitch does not believe the combination, which is expected to close in November 2015, will affect CSC's (News - Alert) RemainCo ratings since all incremental debt related to the CSCGov / SRA combination will be issued by CSCGov after the spin-off of CSCGov from CSC.

The combination provides increased scope and scale and provides complementary capabilities in cloud computing, cyber security, and IT infrastructure, mobility, data analytics, and software and systems engineering. Fitch expects some cross-selling opportunities since there is little customer overlap. Management is targeting $50 million of potential net synergies from the combination.

SRA's shareholders will be paid $390 million of cash and the transaction includes a $100 million termination fee. CSGov has committed financing totaling $3.5 billion, including a $500 million undrawn revolver. Proceeds generated from the financing are expected to be used to fund the $10.50 per share (approximately $1.5 billion) special dividend to CSC's shareholders and to refinance $1 billion of SRA's existing net debt.

The combined company will generate approximately $860 million of adjusted EBITDA before expected net synergies ($51 million) are achieved. CSCGov's leverage, pro forma for the anticipated spin-off and combination of SRA will approximate 3.5x (3.3x after expected net synergies). Fitch expects CSCGov will make leverage reduction a priority since the company previously stated that its capital structure would be consistent with investment grade ratings.

KEY RATING DRIVERS

The ratings and Outlook reflect Fitch's belief that, pro forma for the CSGov spin-off, strong credit protection measures and solid liquidity offset the weaker operating profile and provide the commercial business 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 a strong investment grade rating. This includes reducing debt with available cash to achieve gross leverage (gross debt-to-EBITDA) of 1.1x.

Fitch expects a roughly $1.5 billion distribution to CSC shareholders directly from CSGov concurrent with the separation.

The ratings and Outlook reflect Fitch's expectations that Commercial revenues from cloud-based solutions will offset negative revenue growth for on-premise contracts in the intermediate term, 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 but Fitch anticipates Commercial shifting its sales mix to more profitable and less capital intensive contracts. In conjunction with lower costs from substantial restructuring, Fitch expects $400 million of annual FCF through the intermediate term for the Commercial business.

CSC announced it will spin-off CSGov via a tax-free transaction, which the company expects to complete by October 2015, pending regulatory approval. The CSGov and SRA combination will be structured to preserve the tax-free transaction. Concurrent wit the separation, the CSGov will pay a $10.50 per share (approximately $1.5 billion) special dividend to RemainCo shareholders.



CSC expects to incur $75 million of expenses to facilitate the separation, given the businesses already runs independently. CSC plans to capitalize the standalone company with a financial profile consistent with an investment grade rating, including 1.1x gross leverage.

Rating strengths include Fitch's expectations for:


--Strong credit protection measures for the rating due to the management's commitment to capitalize the Commercial business with 1.1x gross leverage;

--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. As a result, Fitch expects operating EBITDA margin for Commercial will exceed 18% 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 in the intermediate term;

--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:

--CSC deviates from its planned capitalization targets of 1.1x gross leverage and 0.5x net leverage for the Commercial business due to lower than expected debt reduction;

--Fitch expects Commercial will not achieve positive revenue growth in the intermediate term 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:

--Commercial gross leverage will be 1.1x.

--Secular shifts away from traditional on-premise service offerings and pricing pressures result in low-single-digit negative organic revenue growth, despite strong growth rates from new service offerings and a more profitable sales mix.

--The $1.5 billion special dividend payment to shareholders concurrent with the separation will be funded by a dividend from CSGov.

--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 July 3, 2015 and was supported by:

--$2.2 billion of cash, approximately half of which is located outside the U.S.;

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

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

--$247 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 July 3, 2015, primarily consisting of:

--$350 million of 2.50% term notes due September 2015;

--$393 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 currently rates CSC as follows:

Computer Sciences Corp.

--Long-term Issuer Default Rating (IDR) 'BBB';

--Short-term IDR 'F2'.

--Senior unsecured debt 'BBB';

--RCF 'BBB'.

CSC Capital Funding Limited

--Commercial paper 'F2'.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com.

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