Fitch Affirms Microsoft Corporation at 'AA+/F1+'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the ratings for Microsoft Corporation (Microsoft), including the 'AA+/F1+' long- and short-term Issuer Default Ratings (IDRs). The Rating Outlook is Stable. Fitch's actions affect $60.5 billion of total debt, including the indrawn $10 billion revolving credit facility (RCF). A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
The ratings and Outlook reflect:
Fitch's expectation operating performance will remain strong, driven by robust cloud services growth. Fitch expects Microsoft to remain a leading cloud services provider over the intermediate term, driven by a significant Windows operating system (OS) footprint and competitive advantage in the hybrid cloud. Overall, Fitch projects flat top line growth in fiscal 2016 and low single digit positive revenue growth over the intermediate term, despite continued revenue declines in the 'More Personal Computing' segment.
Fitch also expects cloud services growth to diversify Microsoft's significant revenue base and increases profitability while reducing the company's dependence on personal computers (PCs). While Microsoft's 'More Personal Computing' segment still represents more than 40% of revenues, it constitutes roughly a third of operating profit. Fitch expects significant incremental gross profit drop through will stem profit margin compression in 2016 and return operating EBITDA margin to above 40% over the intermediate term.
Fitch expects positive growth and strong profitability will result in more than $10 billion of annual free cash flow (FCF, calculated by Fitch after payment of dividends), which should continue through the intermediate term. Fitch expects Microsoft will use a substantial amount of FCF for share repurchases, including completing the current share repurchase program, under which $14 billion was available as of Dec. 31, 2015, by the end of calendar year 2016. Beyond the completion of the current authorization, Fitch projects shareholder returns roughly equal to annual FCF.
As a consequence, Fitch expects total leverage (total debt to operating EBITDA) to step up over the intermediate term from significant incremental debt issuance to support shareholder returns, given the vast majority of Microsoft's cash and more than half of FCF is outside the U.S. Fitch estimates total leverage for the latest 12 months (LTM) ended Dec. 31, 2015 was 1.3x and could approach 2x over the intermediate term. Fitch estimates supplemental net adjusted leverage, which nets debt against cash adjusted for valuation, tax liabilities upon repatriation and probably use for stock buybacks, will remain below 1x.
Fitch believes Microsoft's nearly ubiquitous OS provides substantial recurring revenues and cash flow, despite ongoing declines in PC shipments, which Fitch expects could decline in the high single digits in 2016. Nonetheless, Fitch believes Microsoft's scale and visibility of profitability are enabling investments in growing cloud services and connected devices, diversifying the company's operating profile
--Fitch expects Microsoft will experience flat organic top line growth in fiscal 2016 with strong Intelligent Cloud penetration offsetting continued negative PC growth. Phones will remain challenged but potentially offset by solid detachable (Surface Pro) adoption. Fitch believes currency will reduce the top line by 2%, resulting in -2% revenue growth for the year.
--Beyond fiscal 2016, Fitch believes the increasing Intelligent Cloud growth will shift mix and drive positive low single digit growth through the forecast period.
--Gross profit margins will be stable from shifting the mix away from PCs, despite modest competition-driven pressure on cloud businesses.
--Fitch believes operating margins will strengthen from R&D leverage in the business.
--Capital spending will remain elevated to support investments in Intelligent Cloud.
--Cash tax rate will be 25%.
--Annual dividend growth will be 10% and $14 billion of share repurchases in calendar 2016 (50% in fiscal 2016 and 50% in fiscal 2017), after which Microsoft uses 100% of FCF for stock buybacks.
--Microsoft will refinance maturing debt and likely issue incremental debt to fund shortfalls in domestic cash.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--The expectation for supplemental adjusted net leverage (total debt netted against adjusted cash and investments held outside the U.S.) above 1.5x from significant debt issuance to support shareholder returns.
--Material profit margin erosion related competitive pressures, including strong commercial adoption of the public cloud and/or open-sourced software materially reduces demand for key Microsoft products; penetration of alternative operating systems in the PC market or market share gains by Apple; or greater acceptance of cheaper software applications that compete with Microsoft Office.
Positive rating actions are unlikely in the absence of material diversification, driven by solid organic growth in non-PC businesses.
As of Dec. 31, 2015, Fitch believes liquidity was robust and supported by:
--$102.3 billion of cash and short-term investments, of which $6 billion was located in the U.S.;
--Two undrawn $5 billion revolving credit facilities (RCF), one expiring Nov. 1, 2016 and the other expiring Nov. 14, 2018, both of which backstop the company's commercial paper (CP) program.
Fitch's expectation of more than $10 billion of annual FCF also supports liquidity.
Total debt as of Dec. 31, 2015 was $50.6 billion, consisting of staggered debt maturities. Fitch believes debt maturities are manageable, given the company's strong liquidity and consistent free cash flow. However, Fitch expects Microsoft will refinance all debt maturities, given the company's bias toward using domestic cash for shareholder returns.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--Long-term IDR at 'AA+';
--Senior unsecured debt at 'AA+';
--Senior unsecured revolving credit facility at 'AA+';
--Short-term IDR at 'F1+';
--Commercial paper at 'F1+'.
The Rating Outlook is Stable.