Fitch Affirms IBM's IDRs at 'A+/F1'; Outlook Stable

Wed Jun 19, 2013 3:28pm EDT

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(The following statement was released by the rating agency) NEW YORK, June 19 (Fitch) Fitch Ratings has affirmed the ratings of International Business Machines Corporation (IBM) as follows: --Long-term Issuer Default Rating (IDR) at 'A+'; --Senior unsecured revolving credit facility at 'A+'; --Senior unsecured debt at 'A+'; --Short-term IDR at 'F1'; --Commercial paper (CP) rating at 'F1'. Furthermore, Fitch has withdrawn all ratings for IBM International Group Capital LLC. The Rating Outlook is Stable. Fitch's action affects approximately $43 billion of debt, including IBM's undrawn $10 billion credit facility. KEY RATING DRIVERS The ratings and Outlook reflect IBM's: --Strong company profile primarily supported by i) significant revenue market share in information technology (IT) services (No.1), servers (No.1), enterprise software (No.1) and external storage (No.3); ii) solid recurring revenue (50%) from IT services, software and financing that mitigates revenue and profit volatility; and iii) highly diversified revenue base by offering, customer, industry and geography (65%+ revenue outside U.S.). --Exceptional financial flexibility due to i) robust internal liquidity with a significant cash position ($12 billion) and free cash flow (FCF) exceeding $11 billion since 2008; ii) solid external liquidity with an undrawn $10 billion revolving credit facility (RCF) due 2017 and ready access to capital markets; iii) strong credit protection metrics; and iv) roughly $28 billion of finance receivables (57% short-term and 60% considered investment grade). --Well-executed management strategy, including i) ability to identify early trends that present significant higher margin, long-term growth opportunities and reposition investment priorities, both organic and inorganic, to capitalize on these opportunities (i.e. analytics and growth markets); ii) consistent and sizable investments in R&D (6% of revenue) to develop innovative differentiated solutions that leverage IBM's entire portfolio of offerings and command higher profit margins (i.e. Smarter Planet); iii) core competency in identifying and integrating strategic acquisitions; and iv) established track record of consistently meeting or exceeding financial forecasts. Rating concerns center on: --Risk of core debt (non-financing) increases to achieve financial and/or business objectives, such as sizable debt-financed share repurchases and/or acquisitions, resulting in a material reduction of credit protection measures. Fitch notes IBM has significant incremental debt capacity without adversely affecting its current credit ratings. --Consistent, material increases in cash dividends long-term, which could pressure FCF and financial flexibility in the absence of commensurate growth in profitability. This could necessitate further increases in core debt to fund acquisitions and/or share repurchases. --IBM's increasing dependence on mainframe (System Z) refresh cycles to maintain profitability in the Systems and Technology Group (STG) due to IBM's underperforming storage business, weak industry demand for UNIX-based Power servers as more and increasingly diverse workloads are performed on low-cost x86 industry standard servers (ISS), and negative revenue mix shift as ISS are considerably less profitable than UNIX. Declining demand for UNIX-based Power systems also adversely affects the profitability of STG's microelectronics business, which designs and manufactures the Power microprocessors used in Power servers. The decline in UNIX server demand also carries negative longer-term revenue and margin ramifications for IBM's support services and financing businesses relating to Power servers. IBM's strategy to reverse the decline in Power server demand is to expand the Power platform to address the open-source Linux market. IBM first introduced PowerLinux solutions in April 2012 and currently offers three Power-based Linux systems, including the PureFlex System, a pre-integrated offering of compute, storage, networking, virtualization and management. As for ISS, Fitch believes IBM lacks the scale and purchasing leverage to profitably compete against Hewlett-Packard Company and Dell Inc. in this highly competitive market. --The long-term threat to highly profitable mainframe demand and associated operating system software (zOS) from ISS. KEY RATING SENSITIVITIES Fitch believes the company's lack of a strategic rationale to maintain a higher rating at the expense of financial flexibility required for acquisitions or shareholder-friendly activities limits further positive rating actions. The ratings may be downgraded in the event of: --A shift to more aggressive financial policies. IBM has strong financial flexibility and liquidity supported by nearly $12 billion of cash and equivalents as of March 31, 2013 and an undrawn $10 billion RCF expiring on Nov. 10, 2017. Liquidity is further supported by strong and consistent annual FCF (post-dividends) exceeding $11 billion since 2008. Fitch expects IBM's FCF to exceed $11 billion in 2013. This is primarily due to continued profit margin expansion, reflecting a more favorable revenue mix and continued cost discipline, offset by substantial incremental cash taxes. Also a factor is modest top-line growth led by Smarter Planet solutions, business analytics, growth markets and cloud computing. Fitch expects IBM to continue to use FCF for acquisitions, particularly in the software and services industries, aggressive share repurchases and dividend payments to shareholders. The underfunded status of IBM's worldwide defined benefit (DB) pension plans deteriorated to negative $14.4 billion (86% funded) at year-end 2012 from negative $10.4 billion (89% funded) in 2011. This is primarily due to lower discount rates in the U.S. and worldwide plans, which increased the present value of IBM's future pension liability (U.S. discount rate declined 60 basis points to 3.6%). Excluding unfunded nonqualified DB pension plans, the funded status of IBM's U.S. and worldwide plans at year-end 2012 was 98% and 94%, respectively. In 2013, IBM is required to make legally mandated contributions of $700 million to its international DB plans. This compares with approximately $600 million actually contributed in 2012. The amount of the 2013 pension contribution is very manageable given the amount and consistency of IBM's cash flow. Fitch believes IBM has more than ample liquidity to satisfy its longer-term legally mandated pension funding requirements (estimated at approximately $4 billion through 2017). This estimate could increase due to more frequent re-measurement of funded status in certain non-U.S. countries and the performance of financial markets. Total debt was $33.4 billion as of March 31, 2013, and consisted of $8.7 billion of short-term debt (including $1.8 billion of CP) and $24.7 billion of long-term debt. Fitch estimates $25.2 billion (76%) of total debt is attributable to IBM's global financing business with the remaining debt attributable to core (non-financing) operations. For the purpose of financial evaluation, Fitch analyzes IBM's core business and financing activities separately, since they are capitalized differently and have dissimilar cash flow characteristics. IBM Global Finance (IGF) accounted for nearly 9% of IBM's pre-tax earnings in 2012. This, however, represents the largest component of IBM's balance sheet, constituting approximately 23% of total assets and 24% of total liabilities as of March 31, 2013. IBM has $3.0 billion of long-term debt maturing in the remainder of 2013 followed by $3.8 billion of maturities in 2014. Fitch believes IBM will refinance the vast majority of the upcoming debt maturities in order to maintain a targeted debt/equity ratio of approximately 7x for the financing business and maintain a permanent amount of core debt in the capital structure. Total leverage and interest coverage as of March 31, 2013 were relatively unchanged at 1.3x and 26.5x, respectively. Core leverage and interest coverage remained flat at 0.3x and 55x, respectively. The main purpose of IGF is to facilitate clients' acquisition of IBM systems, software and services by providing financial and capital management solutions. IGF has a solid long-term operating record, provides strategic advantages to IBM in terms of attracting and retaining customers by delivering total solutions. IBM also generates an annuity-like revenue stream associated with multi-year leases. IGF's primary focus on IBM's products and clients mitigates some risks associated with financing via a deep knowledge of its client base and clear insight into the solutions being financed. Asset quality metrics have remained relatively solid as a result of the relatively conservative underwriting culture and strong risk management capabilities. IGF's capitalization remains solid for the rating category and leverage levels continue to hover near management's target of 7x. Contact: Primary Analyst John M. Witt, CFA Senior Director +1-212-908-0673 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Jason Pompeii Senior Director +1-312-368-3210 Committee Chairperson Jamie Rizzo, CFA Managing Director +1-212-908-0548 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com. Additional information is available at 'www.fitchratings.com'. Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug. 8, 2012). Applicable Criteria and Related Research: Corporate Rating Methodology here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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