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Rating Action:

Moody's downgrades Hewlett-Packard Company to Baa2; outlook stable

14 Aug 2015

New York, August 14, 2015 -- Moody's Investors Service ("Moody's") downgraded the senior unsecured rating of Hewlett-Packard Company ("HP") to Baa2 from Baa1 and confirmed the Prime-2 short term rating. This completes a review initiated on October 6, 2014 when HP announced its intent to separate its Enterprise businesses from the company's personal computer and printing operations through a tax free spin-off to shareholders. Subject to customary regulatory filings, HP expects the separation will be completed by the end of fiscal year ending October 2015. Following the spinoff, HP will be renamed Hewlett-Packard Inc. ("HPI"). This rating action incorporates Moody's expectation that there is a high likelihood that the separation occurs and thus looks through to the credit profile of HPI. The outlook is stable.

Ratings downgraded for Hewlett-Packard Company:

Senior unsecured rating to Baa2 from Baa1

Senior unsecured MTN program to (P)Baa2 from (P)Baa1

Senior unsecured shelf registration to (P)Baa2 from (P)Baa1

Subordinated shelf registration to (P)Baa3 from (P)Baa2

Preferred stock shelf registration to (P)Ba1 from (P)Baa3

Preferred Non-cumulative stock shelf registration to (P)Ba1 from (P)Baa3

Ratings downgraded for Electronic Data Systems Corporation (guaranteed by Hewlett-Packard Company)

Senior unsecured rating to Baa2 from Baa1

Ratings confirmed for Hewlett Packard Company:

Prime-2 short term rating

"HP's Baa2 rating reflects the anticipated spin-off the Enterprise business and the remaining company's strong to leading market positions in printing and personal computers, countered by the secular growth challenges in both segments that will persist for the foreseeable future," stated Richard Lane, Moody's Senior Vice President. Lane added that "despite the growth challenges, annual EBITDA of about $4.5 billion, providing good flexibility to invest in adjacent markets such as 3D printing, although scaling operations in these new markets will take several years to be a material contributor."

RATINGS RATIONALE

The Baa2 senior unsecured rating is supported by strong to leading market positions in printing and personal computers, very high brand awareness, significant scale, and global presence. The rating also reflects the company's significant scale, with projected 2015 revenue of around $53 billion and adjusted EBITDA approximating $4.5 billion annually. Combined with very modest capital expenditure requirements, the company will convert a high percentage of profitability into free cash flow, projected to be around $2 billion annually. Adjusted gross debt to EBITDA is projected at approximately 2x.

Despite these strengths, ongoing secular demand challenges in both the printing and PC markets will persist for the foreseeable future, resulting in continued challenges to grow revenue. Additionally, while management has executed well and selectively targeted more profitable market segments of printing and PC's, competitive pricing in these slow-to-no-growth markets could intensify, pressuring adjusted EBITDA margins that Moody's estimates at 9%. These challenges underscore the importance of entering into adjacent markets and new form factors with an emphasis on cost efficiency in order to support the businesses longer term.

The capital intensity is low with capital expenditures less than 1.5% of revenue. Accordingly, cash flow conversion is very efficient as the company converts about 70% of EBITDA to cash from operations less capital expenditures (Moody's adjusted). In addition, the liquidity profile will be very strong as HPI is expected to complete the spin-off with around $4 billion of cash and equivalents and generate about $2 billion in free cash flow ("FCF") over the intermediate term. The majority of cash and FCF will be overseas, but the company will have relatively efficient access to this cash with only modest tax implications should the company bring cash back to the US. Given our expectations of limited growth prospects and a modest acquisition profile, however, the company may be pressured by shareholders to allocate more cash than currently anticipated to dividends or share repurchases.

HP has a leading market position in the global printing market with over $22 billion of annual revenue and $4.1 billion of annual operating profit with an operating margin in excess of 18%, up from 13% three years ago. The operating margin expansion is largely attributable to effective cost reductions, improved mix, and targeting markets more selectively. However, printing revenues have declined each quarter for the last three years, while the profitable supplies revenue has decline in all but one quarter. The market will remain challenged to grow and pricing could become more aggressive. As HP moves into adjacent markets such as 3D printing, we believe there are execution risks, but that the company is well positioned to pursue the opportunity given its broad customer base and strong brand name. But there will not be a meaningful contribution to total revenue from these new markets for several years, however, as it will take time to scale these new businesses.

The rating also reflects the company's very strong position in the PC market with nearly $34 billion of annual revenues and $1.2 billion of annual operating profit. HP's strong to leading market position (depending on geography), unit growth as well as operating profit margin stability in the face of a declining PC market points to solid execution. The overall PC market will continue its slow decline, however, HP and other top players (Lenovo and Dell) will continue to take share as smaller competitors who lack scale will recede.

HPI will maintain a very strong liquidity profile, exiting the spin transaction with approximately $4 billion of cash and equivalents. The majority of cash balances and free cash flow will be offshore, but the company will have good access to this cash with only modest tax implications should the company bring cash back to the US. HPI will have additional liquidity in the form of sizable revolving credit facility that would be used as a backstop to a comparably sized commercial paper program.

The company has indicated that HPI's common dividend post spinoff will be more than half of the existing $1.2 billion Hewlett-Packard Company common dividend. Moody's anticipates that share repurchases will be will well within the scope of the company's free cash flow.

The stable outlook reflects Moody's expectation that HPI revenue will be flat with EBITDA in the range of $4.5 billion to $5.0 billion over the next two years. Moody's expects acquisition activity and capital allocation will be disciplined, thereby maintaining a modestly leveraged and liquid balance sheet.

The rating could be upgraded if HPI is positioned to sustain revenue growth while maintaining or expanding profit margins. Additionally, sustaining EBITDA margins above 10%, adjusted debt to EBITDA less than 1.75x, and free cash flow to adjusted debt in excess of 20% while maintaining conservative financial policies and robust liquidity could be supportive of an upgrade over time.

The rating could be downgraded if HPI (i) encounters material difficulties related to the separation, (ii) fails to position itself for growth by fiscal 2017 or fails to maintain EBITDA margins above 7%, or (iii) adopts a more aggressive capital structure such that adjusted debt to EBITDA is sustained above 2.75x or free cash flow to adjusted debt is sustained at less than 15%.

Hewlett-Packard Inc., headquartered in Palo Alto, California, with $57 billion in revenue for the fiscal year ended October 2014, is a market leading provider of laser and inkjet printers and personal computers.

The principal methodology used in these ratings was Global Technology Hardware published in October 2010. Please see the Credit Policy 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 rating action on the support provider and in relation to each particular 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 rating action, and whose ratings may change as a result of this 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.

The following information supplements Disclosure 10 ("Information Relating to Conflicts of Interest as required by Paragraph (a)(1)(ii)(J) of SEC Rule 17g-7") in the regulatory disclosures made at the ratings tab on the issuer/entity page on www.moodys.com for each credit rating:

Moody's was not paid for services other than determining a credit rating in the most recently ended fiscal year by the person(s) that paid Moody's to determine this credit rating.

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.

Richard J. Lane
Senior Vice President
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Lenny J. Ajzenman
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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

Moody's downgrades Hewlett-Packard Company to Baa2; outlook stable
No Related Data.
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