Fitch Rates Hewlett-Packard's Senior Unsecured Note Offering 'A'; Outlook Negative

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has assigned an 'A' rating to Hewlett-Packard Company's (HP) proposed offering of senior unsecured notes maturing in 2014, 2016 and 2021. Net proceeds from the offering will be used for general corporate purposes.

The Rating Outlook is Negative reflecting HP's:

--Weaker-than-expected financial results in fiscal 2011 (Oct. 31) due to numerous internal and external challenges (macro economic, execution deficiencies, competitive pricing pressures, historical underinvestment, strong yen and excessive channel print supplies inventory), most of which are expected to continue in 2012.

--Deterioration in core (non-financing) and total credit metrics due to a significant and steady increase in total and core debt in the past two years, primarily to accelerate acquisition and share repurchase activities.

--Heightened acquisition risk and profitability pressures from material underinvestment in the services business and research and development (R&D) in prior years. Fitch believes return on investment in these areas will likely take several years, resulting in intermediate term profitability pressures and, potentially, acquisitions necessary to maintain the company's competitive position.

However, the near-term acquisition risk is mitigated by CEO Meg Whitman's intent to limit acquisition activity in fiscal 2012 to rebuild the balance sheet.

--Accelerated decline in high margin business critical systems (BCS) revenue, which declined 23% in the fiscal fourth quarter ended Oct. 31, 2011 following Oracle's decision to discontinue all software development for Intel's Itanium microprocessor. HP subsequently filed a lawsuit against Oracle on June 15, 2011, alleging that Oracle breached an agreement to support the Itanium processor.

Fitch also expects HP's technology services revenue and operating margin to be adversely affected in the longer-term as customers gradually migrate to UNIX servers offered by competitors (IBM and Oracle) or lower cost x86 servers with less profitable support contracts.

The ratings may be downgraded in the event HP:

--Resumes aggressive share repurchases materially exceeding those required to offset dilution from employee stock options as evidenced by a material decline in total basic shares outstanding;

--Fails to improve operational execution or execute its stated commitment to strengthen the balance sheet in fiscal 2012 through debt reduction;

--Pursues acquisitions with an aggregate cost exceeding $500 million - $1 billion in fiscal 2012 without moderating share repurchases. The amount of acceptable acquisition activity is ultimately contingent upon HP's free cash flow (FCF) and capital allocation strategy, which Fitch expects will emphasize near-term debt reduction; and/or

--Generates FCF (post-dividends) materially below Fitch's expectations. Despite near-term challenges, Fitch believes HP will still generate $6 billion - $6.5 billion of FCF (post-dividends) in fiscal 2012.

The ratings may be stabilized if HP:

--Allocates a significant portion of excess free cash flow (post-dividends) after share repurchases for anti-dilution purposes toward debt reduction, particularly in fiscal 2012. Fitch forecasts total debt reduction of $4 billion - $4.5 billion in fiscal 2012, assuming approximately $6.5 billion of FCF, $500 million for acquisitions and $1.5 billion of net share repurchases.

HP has ample opportunity for debt reduction with $8.1 billion of debt maturing in fiscal 2012, including $4 billion of CP and other short-term debt as of Oct. 31, 2011.

Fitch anticipates that a subsequent ratings downgrade or stabilization of the Outlook would most likely occur within

12 - 18 months.

Fitch notes HP generates a significant portion of FCF offshore, while cash payments for dividends and share repurchases require U.S.-based cash. Therefore, HP's cash location and ability to repatriate offshore cash in a tax efficient manner could affect the timing and amount of debt reduction, particularly on a quarterly basis.

The ratings are supported by HP's:

--Solid financial flexibility and liquidity provided by nearly $8 billion of cash (primarily offshore), consistent annual FCF ($7.3 billion in fiscal 2011) and $7.5 billion of undrawn committed credit facility capacity.

--Broad product portfolio with strong worldwide market share positions in servers (#1), PCs (#1) and IT services (#2). Market share figures based on 12 months ended Sept. 30, 2011;

--Significant recurring revenue primarily via printer supplies, outsourcing and technology services, and software maintenance (33% of total revenue);

--Extensive market coverage due to established multi-channel distribution model;

--Geographically diversified revenue base with approximately 66% of revenue derived from outside the U.S.; and

--Management's track record of significant debt reduction after the $14 billion acquisition of EDS in 2008, as well as a remaining need for HP Financial Services to maintain strong investment grade rating to maintain access to the tier 1 CP market.

HP previously demonstrated its willingness to commit to aggressive debt reduction after acquiring Electronic Data Systems Corp. (EDS) in August 2008 for $13 billion. Quarter-end core debt peaked at $13.4 billion in the quarter ended Jan. 31, 2009. In the following 12 months, HP terminated nearly all acquisition activity ($39 million) and curtailed share repurchases by 37% ($3.8 billion), compared with the year-ago period. The excess cash was utilized to reduce debt by 17%-21% per quarter, resulting in $6.4 billion, or 48%, cumulative debt reduction in one year.

Rating concerns include:

--Increasing competition in the industry standard server (ISS) market (x86) as products from relatively new entrants, specifically Cisco Systems (Cisco) in large enterprise and Lenovo Group (Lenovo) in small and medium business, begin to gain traction in the marketplace. Fitch believes Cisco and Lenovo account for only 4% - 5% total server shipments currently, but are rapidly growing.

The relatively new entrants likely contributed to intensifying pricing pressures, the decline in ESSN operating margin and a nearly four-point decline in HP's revenue share of the server market, albeit partially attributable to a difficult year-over-year comparison, in the 12 months ended Sept. 30, 2011 based on Gartner data.

Lenovo's x86 shipments increased 77%, well above market shipment growth of 7.2%, to nearly 47,000 units (2% share) in the third quarter, resulting in a number five ranking from IDC. Lenovo only entered the x86 server market in mid-2010 after licensing the x86 technology from IBM.

--Declining PC market share in the Asia Pacific (APAC) region, excluding Japan, primarily due to share losses in China, the largest and among the fastest growing PC markets worldwide, due to product recalls in calendar 2010. According to IDC, HP's PC shipments in APAC region declined 3% in the third quarter of 2011 whereas the overall market grew 13%.

--Weak consumer demand in mature markets, which Fitch attributes to a shift in consumer demand priorities toward tablets and smart phones, and overall economic uncertainty.

--The potential threat to HP's highly profitable printer supplies business from strong adoption of tablets or remanufactured/counterfeit cartridges.

--Risk of long-term hardware revenue and profitability pressures if customers aggressively adopt cloud computing and the market for cloud services is highly concentrated. In this scenario, cloud providers would have significant pricing leverage due to scale and/or could accelerate their utilization of unbranded custom-built servers.

In addition to its solid cash position and consistent FCF, HP's liquidity is further supported by two undrawn revolving credit facilities, which had aggregate capacity of $7.5 billion as of Oct. 2011, and multiple revolving trade receivables facilities with $299 million of available capacity as of April 30, 2011. HP's revolving credit facilities consist of a $4.5 billion credit facility expiring in Feb. 2015 and a $3 billion facility expiring in May 2012.

HP's credit facilities primarily serve as a backstop for the company's CP program, the capacity of which was increased to $16 billion from $10 billion in May 2008 to facilitate the acquisition of EDS. HP's aggregate credit facility capacity of $7.5 billion provides only 47% backup to the $16 billion CP program, well below the typical 100% backup required for an 'F1' CP rating.

Nonetheless, Fitch assigns an 'F1' rating to HP's CP based on the company's solid total liquidity package, consisting of a sizable cash position and strong free cash flow, and expectations that total CP outstanding will not materially exceed the total capacity of the credit facility backstop. CP issuance well in excess of the total facility backstop of $7.5 billion and/or a material decline in liquidity would likely result in negative rating actions.

Total debt was $30.6 billion as of Oct. 31, 2011, consisting of $3.2 billion of CP, $4.9 billion of other short-term debt, including current portion of long-term debt ($4.1 billion), and $22.6 billion of long-term debt. Fitch estimates $10.9 billion, or 36% of total debt, is attributable to HP's customer-financing business.

HP has significant near-term debt refinancing requirement with long-term (LT) debt maturities of $4.1 billion ($2.5B in 1Q12 and $1.6B in 3Q12) and $5.5 billion in calendar 2012 and 2013, respectively. Furthermore, HP has approximately $3 billion of outstanding CP, a portion of which HP may be required to refinance with LT debt following the loss of its Tier-1 rating by one agency.

HP's core (non-financing) leverage (core debt/core EBITDA) increased to 1.2x as of Oct. 31, 2011 from 0.7x in the prior year and core interest coverage (core EBITDA/ core interest expense) weakened, but remained strong at 71x compared with in excess of 100x in the year ago period. Total leverage increased to 1.8x at Oct. 31, 2011 from 1.2x in the prior year. Total interest coverage decreased to 31x in the latest 12 months ended Oct. 31, 2011 compared with approximately 44x in the year-ago period. Fitch forecasts total leverage and interest coverage of 1.6x and 17.6x, respectively, in fiscal 2012.

Fitch currently rates HP and subsidiaries as follows:

Hewlett-Packard Company

--Long-term Issuer Default Rating (IDR) 'A';

--Senior credit facilities 'A';

--Senior unsecured debt 'A';

--Short-term IDR 'F1';

--Commercial paper 'F1'.

EDS

--Long-term IDR 'A';

--Senior unsecured debt 'A'.

Hewlett-Packard International Bank PLC

--Short-term IDR 'F1';

--Commercial paper 'F1'.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 12, 2011).

--'Quantifying the Downside Risk to HP's Ratings' (Oct. 27, 2011).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

Quantifying the Downside Risk to HP's Ratings

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=654595

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