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Rating Action:

Moody's affirms A2 unsecured rating of General Dynamics, stable outlook upon agreement to acquire IT service provider CSRA Inc.

Global Credit Research - 12 Feb 2018

New York, February 12, 2018 -- Moody's Investors Service ("Moody's") affirmed its debt ratings of General Dynamics Corporation (GD), senior unsecured at A2, senior unsecured shelf at (P)A2 and short-term rating at P-1, following the announcement earlier today that GD will acquire IT service provider, CSRA, Inc. The rating outlook on General Dynamics is stable. The ratings and outlook of CSRA, Inc. are unaffected by this rating action.

GD has agreed to acquire CSRA for $9.6 billion, including the assumption of CSRA's debt of $2.8 billion, in an all cash transaction, valued at 11.6x CSRA's estimated calendar 2018 EBITDA. Moody's expects that General Dynamics will repay CSRA's debt on or soon after the closing, which GD expects to occur in the first half of 2018. GD will fund the transaction with a mix of cash on hand and new debt.

RATINGS RATIONALE

"The ratings affirmation reflects Moody's expectation that General Dynamics will use its free cash flow to prioritize repayment of the acquisition debt to sequentially strengthen and restore debt metrics to pre-transaction levels within about two years," said Moody's Senior Credit Officer, Jonathan Root. Moody's anticipates that GD will hold at least $3 billion of cash on hand and will generate at least $2 billion of annual free cash flow in upcoming years, which provides ample ability for GD to timely repay the acquisition debt. However, this will require a significant reduction in share repurchases, which were almost $1.6 billion in 2017. Moody's estimates that CSRA will contribute incremental free cash flow of at least $250 million per year, further enhancing liquidity and the ability to repay transaction debt.

Moody's believes GD's Information Technology (GDIT) segment will strengthen by merging with CSRA. Sharing best practices and leveraging respective strengths across a larger combined organization should enhance GDIT's efficiency and profitability as it competes in the market for outsourced IT services. CSRA's go-to-market business model, best in class business development, strategic alliances with technology providers and low-cost, shared delivery centers are attractive to GDIT. Combining these elements with GDIT's enterprise IT skill sets should enhance the value the combined company can provide to customers. We believe the expanded scale and scope of services will help GDIT more effectively compete across US government departments, both military and civilian, as these organizations sustain and modernize their IT infrastructures in upcoming years. Increasing federal expenditures coupled with needs to modernize IT infrastructure should bode well for demand in this sector in upcoming years. GDIT achieved an 11.4% operating margin in 2017; CSRA reported an operating margin of 10.5% for the first nine months of its fiscal year which ends March 31, 2018. Government efficiency initiatives and competition could pressure margins in the sector; however, having larger scope of services and scale can help to manage such pressure.

Maintaining strong competitive positions in its selected product areas -- navy vessels, land tactical equipment and Gulfstream general aviation aircraft -- provide GD a strong foundation. The company has also maintained a strong balance sheet with Debt to EBITDA of below 2x since 2013. Being a prime contractor to the DoD stabilizes GD's operating results from a steady flow of contracts. About 60% of revenue flows from the US government; 26% from Gulfstream business jets and aviation services, the balance from non-US government and US and non-US commercial customers including for information systems and services.

Timely repayment of acquisition-related debt, US defense outlays, demand for Gulfstream private jets, sound execution across its businesses and share repurchases relative to free cash flow will remain the key factors in GD's long-term credit profile. Backlog has a shorter tenor than those of larger industry peers, Boeing and Lockheed Martin. However, with GD Systems & Information Technology currently representing 29% of consolidated revenue, the Indefinite Demand, Indefinite Quantity (ID/IQ) terms of the majority of this segment's business restrains backlog since contracts for these services are not typically multi-year, but task orders (purchase orders) flow year after year. GDIT's share of total revenue will increase to about 26% following the merger, from about 15% in 2017.

The stable outlook reflects Moody's expectation that GD will strengthen debt credit metrics sequentially starting in 2018 as it applies the majority of free cash flow to the repayment of the transaction debt. Expectations of ongoing steady performance across the company's segments with potential for modest growth in earnings given upcoming deliveries of Gulfstream's new design G500 and G600 models in 2018 and anticipated increases in US and global defense spending also support the stable outlook.

GD's ratings could be downgraded if it makes other acquisitions, whether debt-funded or that reduce the free cash flow deployed to debt repayment, before repaying a majority of the about $9 billion of debt it will incur for the CSRA transaction. Lack of demonstrated progress in sequentially reducing Debt to EBITDA following the CSRA acquisition could also lead to a downgrade, such as if Moody's does not expect Debt to EBITDA to approach 2.6x by the end of 2019 and low 2x level by early 2020. Achieving these levels will dictate that share repurchases would need to decline by 60% or more compared to the $1.6 billion repurchased in 2017. A decline in DoD backlog due to unexpected cancellations of existing programs or fewer future awards that lowers Defense (Combat Systems and Marine Systems) total backlog to about $30 billion from October 1, 2017 backlog of about $42.5 billion and or a sustained decline in demand for Gulfstream's large jets that lowers Aerospace margins below 15% from the 17.2% in 2017 or lowers backlog to below $8 billion from the almost $12 billion on October 1, 2017 could also pressure the ratings. Annual free cash flow sustained below $2 billion, cash sustained below $3 billion, operating margin below 11%, EBITA to average assets below 11%, or retained cash flow to debt sustained below 25% could also lead to a downgrade. There will be limited upwards rating pressure before credit metrics are restored to pre-CSRA acquisition levels. For example sustained metrics such as operating margin that exceeds 14%, Retained cash flow to debt of more than 40%, Debt to EBITDA below 1.5x, and EBITA to average assets higher than 15% could support a ratings upgrade.

General Dynamics Corporation is a leading US prime defense contractor and manufacturer of Gulfstream business jets. Headquartered in Falls Church, Virginia, the company operates under four segments: Aerospace, Combat Systems, Information Systems & Technology, and Marine Systems. The company reported almost $31 billion of revenue in 2017. The market capitalization was $63.3 billion on February 9, 2018.

Through its subsidiaries, CSRA Inc., headquartered in Falls Church, VA, delivers information technology mission and operations-related services across the United States federal government. Revenues for the LTM ended December 29, 2017 were approximately $5.0 billion.

The following rating actions were taken:

Outlook Actions:

..Issuer: General Dynamics Corporation

....Outlook, Remains Stable

Affirmations:

..Issuer: General Dynamics Corporation

....Senior Unsecured Commercial Paper, Affirmed P-1

....Senior Unsecured Regular Bond/Debenture, Affirmed A2

....Senior Unsecured Shelf, Affirmed (P)A2

The principal methodology used in these ratings was Global Aerospace and Defense Industry published in April 2014. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Jonathan Root
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Robert Jankowitz
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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