Fitch Places Dell's Ratings on Watch Positive on EMC Acquisition

OREANDA-NEWS. Fitch Ratings has placed the ratings for Dell Inc. (Dell) and its direct wholly-owned subsidiary, Dell International LLC (Dell International), on Rating Watch Positive. The actions follow the announcement that Dell will acquire EMC Corporation (EMC) for a total consideration of $67 billion. Fitch's actions affect $14.8 billion of total debt. A full list of current ratings follows at the end of this release.

KEY RATING DRIVERS

Dell and EMC signed a definitive agreement under which Dell, together with its owners, will acquire EMC, a leading storage and virtualization provider, for a total consideration of $67 billion. The acquisition will result in the world's largest integrated information technology (IT) provider by revenues and will strengthen Dell's storage and virtualization offerings, providing higher profit margin growth opportunities.

The deal also strengthens Dell's free cash flow (FCF) profile, providing sufficient capacity to achieve targeted core leverage, which excludes debt and profitability associated with the Dell Financial Services, below 3 times (x) in the 12-18 months following the transaction's close. Fitch expects to resolve the Watch Positive upon receiving greater certainty around the ultimate capital structure following the deal and subsequent debt reduction roadmap.

Dell will pay EMC shareholders roughly $33.15 per share in a combination of cash and a tracking stock linked to a portion of EMC's economic interest in the VMware business, which will remain an independent publicly traded company. The deal is subject to customary conditions, including receipt of required regulatory and EMC stockholder approvals, and is expected to close mid- to late-2016.

Dell will fund the acquisition with a mixture new common equity from owners, Michael S. Dell, MSD Partners, Silver Lake and Temasek, the tracking stock issuance, new debt financing and available cash. In connection with the transaction, Dell will repay substantially all existing secured debt (other than debt supporting Dell Financial Services) at the closing of the transaction.

Dell's ratings and Outlook reflect:

--Adequate financial flexibility supported by Dell's significant cash balance, the majority of which is overseas, and a largely undrawn $2 billion asset-based revolving credit facility, partially offset by a significant and increased working capital deficit that could weigh on liquidity if revenue materially declines.
--Fitch's belief that Dell remains committed to using FCF primarily for debt reduction, consistent with the company's objective of returning ratings to investment grade.
--Significant scale, which provides procurement efficiencies for memory, hard disk drives and other components utilized across the hardware business, specifically PCs, servers and storage.

Ratings concerns center on:

--The majority of Dell's revenue remains transactional and derived from Client Solutions predominantly in the commercial market, although the EMC acquisition should reduce the mix of transactional sales.
--Consumer PC demand remains weak, and Fitch believes meaningful improvement is unlikely given continued substitution in this space.
--Aggressive industry pricing environment for PCs and servers, particularly for the hyperscale server market, although Fitch expects Dell and other leading PC providers to continue gaining share from smaller rivals.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Dell include:
--Flat organic constant currency revenue growth through the intermediate term;
--Dell and EMC each achieve targeted cost savings under existing restructuring plans, driving modest operating profit margin expansion;
--Dell issues roughly $45 billion of incremental debt to fund the transaction;
--Dell will use annual FCF, which Fitch estimates will exceed $4 billion following the combination, for debt reduction through the intermediate term.

RATING SENSITIVITIES

Positive rating actions could occur if Fitch expects:
--Dell is on track to sustain core leverage between 2.5x-3x from use of FCF for debt reduction; or
--Positive organic revenue through the cycle, supporting the company's strategy as an integrated IT provider.

Negative rating actions could occur if Fitch expects:
--Pre-dividend FCF margin remains below 2% for a sustained period;
--Core leverage exceeds 3.5x for a sustained period from significant revenue declines.

FULL LIST OF RATING ACTIONS

Fitch has placed the following ratings for Dell on Watch Positive:

Dell Inc.
--Long-term Issuer Default Rating (IDR) 'BB';
--Senior unsecured debt 'BB/RR4'.

Dell International LLC
--Long-term IDR 'BB';
--Senior secured first lien ABL facility 'BBB-/RR1';
--Senior secured first lien term loans to 'BBB-/RR1';
--Senior secured notes to 'BBB-/RR1'.