Fitch: Seagate Technologies' 'BBB-' IDR Unaffected by Acquisition of Dot Hill
Seagate's acquisition of external storage array-based systems and software provider, Dot Hill, will expand Seagate's storage systems offerings and should help accelerate growth for the company's original equipment manufacturer (OEM)-focused cloud storage systems and solutions business.. Dot Hill will add nearly \\$250 million of annual revenues, growing in the mid- to high-single digits, and almost \\$20 million of operating EBITDA.
Under the terms of the definitive agreement, a wholly owned subsidiary of Seagate will commence a tender offer for all of the outstanding shares of Dot Hill in an all-cash transaction valued at \\$9.75 per share, or a total of approximately \\$694 million. Excluding \\$49 million of cash at Dot Hill as of June 30, 2015, the deal values Dot Hill at \\$645 million, which is a 50% premium over the preceding three-month stock price average.
While Dot Hill's Board of Directors unanimously approved the acquisition, the tender offer is subject to customary closing conditions, including a minimum tender of a majority of outstanding Dot Hill shares and standard regulatory approvals. The deal, which Seagate will fund with available cash, is expected to close in the fourth calendar quarter of 2015.
KEY RATING DRIVERS
Seagate's ratings reflect:
--Fitch's expectation for a relatively stable HDD pricing environment going forward, despite weak PC unit demand, due to: 1) continued strong growth in data driven by the cloud and internet-enabled mobile devices; 2) consolidated industry structure with Seagate and Western Digital Technologies Inc. (WDC) controlling roughly 85% of the HDD market; 3) continued favorable HDD mix shift with higher capacity HDDs for cloud computing offsetting the decline in lower capacity drives for the PC industry; and 4) limited capacity growth as companies across the HDD supply chain, including Seagate, expand capacity cautiously within the context of macroeconomic uncertainty.
--Seagate's solid liquidity and financial flexibility are supported by \\$2.5 billion of cash, the vast majority of which is readily accessible without adverse tax considerations, an undrawn \\$700 million senior secured revolving credit facility due Jan. 15, 2020, Fitch's expectations for \\$800 million to \\$1 billion of annual free cash flow (FCF), and a staggered debt maturity schedule.
--Fitch believes Seagate's FCF will continue to benefit from: 1) a more stable HDD pricing environment; 2) lower anticipated demand volatility as secular growth in data and cloud computing reduce the historically strong correlation between cyclical PC demand, HDD shipments and profitability; 3) favorable product mix shift toward higher capacity, more profitable HDDs deployed in cloud computing.
--Strong credit protection metrics and management's commitment to conservative financial policies commensurate with an investment-grade rating.
--Broad product portfolio and significant scale in HDD industry.
--The company's vertically integrated model, which reduces per-unit manufacturing costs and facilitates time-to-market for new products.
Ratings concerns center on:
--Consistent declines in average selling prices for HDDs due to commoditization and low switching costs.
--Long-term threat of technology substitution from NAND flash-based SSDs. Fitch believes HDDs will co-exist alongside SSDs and tape storage in a multi-tiered enterprise data storage environment.
--Event risk associated with implementation of aggressive shareholder-friendly activities, primarily debt-financed share repurchases.
--Seagate's ability to sustain a time-to-market advantage critical to achieving market share gains and maintain overall profitability, given formidable competition from WDC.
--Flat near-term organic revenue growth due to weak demand in Europe and for PCs, offset by solid demand in enterprise from data center build-outs;
--Modest profit margin contraction with operating EBITDA margin remaining in the high teens through the intermediate term;
--Capital spending remains at 4%-5% of revenues, resulting in \\$800 million to \\$1 billion of normalized annual FCF;
--Share repurchases roughly approximating annual FCF, in the absence of acquisitions supporting the company's strategy to continue investing in next-generation storage technologies.
Future ratings upgrades are currently unlikely, given Fitch's expectations for continued PC market weakness and in the absence of increased diversification or sustainable technology-driven share gains.
Negative rating actions could occur if:
--Fitch expects FCF to remain below \\$250 million, likely if 1) substantial cost per GB difference between HDD and SSD unexpectedly narrows significantly, resulting in broader than expected cannibalization of HDD shipments, 2) ultrabooks with SSD materially cannibalize the traditional notebook market and solid state hybrids (SSH) fail to achieve significant penetration in the ultrabook market, or 3) strong growth in ultrabooks with SSD is not offset by incremental growth in near-line enterprise HDDs for the cloud market, external HDDs or personal clouds as users seek supplemental storage capacity to offset smaller capacity SSDs.
--Expectations for total leverage exceed 2.5x beyond the short term, driven by debt financed share repurchases or acquisitions.
Financial covenants in the credit agreement consist of minimum fixed-charge coverage of 1.5x and maximum net leverage ratio of 1.5x. In addition, the facility requires minimum liquidity of \\$500 million.
Fitch expects Seagate's leverage will remain near 1.5x through the intermediate term. Gross leverage (total debt/operating EBITDA) was a Fitch-estimated 1.6x as of July 3, 2015, up from 1.4x in the prior year. Interest coverage (operating EBITDA/gross interest expense) should remain above 10x and was a Fitch-estimated 12.3x for the fiscal year ended July 3, 2015, down from 14.3x in the prior year.
Total debt was \\$4.2 billion as of July 3, 2015 and consisted of:
--\\$800 million of 3.75% senior notes due November 2018;
--\\$120 million of 7% senior notes due November 2021;
--\\$1 billion of 4.75% senior notes due June 2023;
--\\$1 billion of 4.75% senior notes due January 2025;
--\\$700 million of 4.875% senior notes due June 2027;
--\\$500 million of 5.75% senior notes due December 2034.
FULL LIST OF RATING ACTIONS
Fitch currently rates the entities as follows:
--Long-term IDR at 'BBB-';
--Senior unsecured RCF at 'BBB-'.
HDD Cayman, wholly owned subsidiary of Seagate:
--Long-term IDR at 'BBB-';
--Senior unsecured RCF at 'BBB-';
--Senior unsecured debt at 'BBB-'.