Fitch Ratings has upgraded Dell Technologies, Inc. (Dell) and its subsidiaries, including their Long-Term Issuer Default Ratings (IDR) to 'BBB-' from 'BB+', on Dell's strengthened credit profile from ongoing debt reduction and solid operating momentum.
Fitch has also upgraded Dell subsidiaries' debt ratings by one notch, including the senior secured to 'BBB' from 'BBB-'/'RR1', senior unsecured to 'BBB-' from 'BB+'/ 'RR4' and legacy notes to 'BB+' from 'BB/'RR5'.
Fitch is maintaining the Rating Watch Positive (RWP) on the Long-Term IDRs and issue ratings and expects to upgrade the IDRs and senior unsecured debt upon Dell's spin-off of VMware, Inc. Fitch expects to affirm the senior secured debt at 'BBB' upon the spin-off, given our anticipation that Dell will achieve investment-grade ratings by at least two of the three credit rating agencies noted in its senior secured credit agreement, releasing the collateral supporting the secured debt. The legacy notes will remain structurally subordinated to the rest of the unsecured capital structure and be upgraded to 'BBB-' from 'BB+'.
The current ratings are consistent with Fitch's revised 'Corporates Recovery Ratings and Instrument Ratings Criteria,' dated 9 April 2021, and, therefore, Fitch has removed Dell from Under Criteria Observation (UCO).
Key Rating Drivers
Strengthened Credit Profile: Dell's credit profile has strengthened from the ongoing use of free cash flow (FCF) for debt reduction, enabled by solid operating performance. The company has reduced core debt by $5.5 billion so far in the current fiscal year ending Jan. 31, 2022, following at least $5 billion in each of the last two fiscal years, resulting in Fitch-estimated core leverage below our 3.0x positive rating sensitivity. Together with operating momentum, supported by solid demand for personal computers (PC), peripherals and servers, core leverage should decrease to 2.5x at FYE22, even were the spin-off not to occur.
Debt Reduction Irrespective of Spin-off: Assuming the spin-off is consummated, Fitch expects Dell to continue using FCF, on top of $9.3 billion-$9.7 billion of net proceeds from the VMware dividend, for debt reduction until it achieves its 1.5x-2.0x long-term core leverage target. This equates to a slightly higher target range at Fitch, given our lower debt-to-equity ratio assumption for the captive-financing business. Upon achieving its target, Fitch expects Dell will maintain solid liquidity and use FCF for bolt-on acquisitions and share repurchases.
Solid PC Business Momentum: Fitch expects Dell to continue outperforming the personal computer (PC) market through share consolidation on top of stronger and more resilient-than-previously expected market growth. Dell's computing solutions group (CSG) segment is poised for another year of double-digit growth from still solid consumer PC demand and recovering commercial markets. Scale-driven market consolidation by the top three PC makers, Dell among them, should continue fueling growth for this business, despite long-held risks of PC market maturation.
Challenging Infrastructure Spending Dynamics: Fitch expects challenging infrastructure spending dynamics will constrain growth for Dell's infrastructure solutions group (ISG) segment, although Fitch forecasts spending will recover in 2HFY22, after significant demand constraints in FY21 due to pandemic-driven lockdowns. While Fitch is forecasting low single-digit growth for ISG in FY22, demand for infrastructure spending will remain volatile and constrained to low single-digit average growth by customer hybrid infrastructure-optimization trends.
Standalone Profitability Profile: Fitch expects Dell's post-spin-off profit margins will moderate in FY22 from peak levels achieved in recent years, due in large part to normalization of cost actions taken during the pandemic and continued momentum in lower-margin consumer PCs. The resumption of ISG and commercial PC growth should drive modest profit-margin expansion beginning in FY23, although Fitch forecasts core EBITDA margins will remain near 9% versus nearly 10% in FY20-FY21 and FCF margins adjusted for DFS receivables change in the low- to mid-single digits.
Pro-forma for the spin-off, Dell's credit profile will be in line with the anticipated 'BBB' rating with the company's strong financial structure and flexibility, diversification and scale-based competitive advantage offsetting mature growth dynamics and comparatively low profitability. Fitch believes Dell's business profile is well positioned versus that of IT hardware provider peers, including Hewlett Packard Enterprise Company (HPE, BBB+/Negative) and HP, Inc. (BBB+/Stable), given the scale and diversification of its installed base.
Dell's pro-forma financial structure will be in line with that of HPE, with Dell's slightly stronger and more consistent cash flow profile offset by HPE's higher profit margins, due to Dell's nearly two-thirds mix of PC and peripherals sales. Dell's operating profile is as firmly positioned as HP, Inc.'s, which has a comparable PC business even as it faces secular challenges in its printing business. However, HP, Inc.'s financial profile is stronger with stronger FCF margins and a more conservative financial structure.
The spin-off will eliminate the rating linkage between VMware and Dell. Until the transaction closes, the current ratings reflect Fitch's belief that Dell's linkage with 80.6%-owned VMware is moderate under Fitch's Parent-Subsidiary Linkage (PSL) Criteria and, therefore, equalizes the companies' Long-Term IDRs. VMware is an unrestricted subsidiary in Dell's credit agreements and indentures and provide for no upstream guarantees, cross-default provisions or management or treasury-team overlap.
Dell's revenue grows by nearly 10% in FY22, followed by a mid-single-digit decline in FY23, reflecting VMware's full-year separation.
On a standalone basis, Dell's revenue grows by low single digits through FY21-FY25, from ongoing market-share gains in CSG and a gradually improving infrastructure-spending environment as PC demand moderates.
Profitability moderates in FY22 and gradually expands with a shift in ISG mix and normalizing input costs.
Dell uses the majority of cash flow for debt reduction until it achieves target core leverage, and mainly for stock buybacks and, potentially, a dividend thereafter.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
On a consolidated basis (no spin-off), expectations for core leverage sustained at or below 2.5x and, on a post-spin-off standalone basis, expectations for core leverage at or below 2.0x and adjusted pre-dividend FCF to core debt sustained near 30%.
Consistent organic revenue growth from profitable market-share gains in CSG and ISG segments.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
On a consolidated basis (no spin-off), expectations for core leverage sustained above 3.0x and, on a post-spin-off standalone basis, expectations for core leverage sustained above 2.5x and adjusted pre-dividend FCF to core debt sustained near 20%.
Decline in organic revenue from sustained market-share losses in CSG and ISG segments.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Adequate Liquidity: Fitch believes Dell's liquidity should remain adequate and, as of July 30, 2021, was supported by $5.8 billion of cash and cash equivalents ($11.7 billion including VMware) and an undrawn $4.5 billion of 1st-lien senior secured revolving credit facility (RCF) expiring on September 2023 ($5.5 billion including VMware's undrawn $1 billion senior unsecured RCF due September 2022). Fitch's forecast of $3.5 billion-$4.5 billion of adjusted FCF also supports liquidity, excluding VMware's FCF at spin-off close.
Dell is a leading global diversified technology infrastructure provider, with a comprehensive portfolio of IT hardware, software and service solutions spanning both traditional and emerging, multi-cloud technologies.
Summary of Financial Adjustments
Fitch applies a maximum allowable debt-to-equity ratio of 3:1 to Dell's financing receivables to allocate a portion of total debt to DFS, which Fitch excludes from measuring core debt. Fitch similarly excludes DFS profitability from total EBITDA to calculate core EBITDA, as well as the change in financing receivables from FFO in calculating adjusted FCF.
Sources of Information
Moderate PSL: We believe the PSL between Dell and its 80.6% owned subsidiary, VMware, is moderate. In Fitch's opinion, VMware's indentures or independent-related party committee do not constrain Dell's ability to access VMware's cash. As a result, Fitch equalizes Dell's and VMware's ratings. Fitch's PSL Criteria govern the derivation of VMware's ratings, given Dell's 80.6% economic and 97% voting interests in VMware and consolidation of VMware's financial statements. Post-spin-off, the PSL will no longer apply to Dell and VMware.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
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