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Rating Action:

Moody's downgrades IBM's senior unsecured rating to A2; outlook stable

09 Jul 2019

New York, July 09, 2019 -- Moody's Investors Service ("Moody's") downgraded International Business Machines Corporation's ("IBM") senior unsecured rating to A2 from A1 following receipt of regulatory approval for IBM to acquire Red Hat, Inc. ("Red Hat", unrated) for approximately $34 billion in an all cash transaction. IBM's Prime-1 commercial paper rating has been affirmed. This concludes a review initiated October 29, 2018. The outlook is stable.

While strategically positive, the acquisition of Red Hat will lead to "an increase in leverage and represent a departure from IBM's historical acquisition philosophy of making small, tuck-in acquisitions that limit integration risk," said Moody's Senior Vice President, Richard Lane. IBM intends to finance the deal with cash balances and debt financing such that Moody's estimates IBM's pro-forma gross adjusted debt to EBITDA will approximate 3x at closing, up from about 1.9x as of March 31, 2019.

Given IBM's public commitment to halt share repurchases through 2021 and direct the vast majority of its free cash flow (Moody's projects over $6 billion annually) to reduce leverage, IBM's gross adjusted debt to EBITDA could approach the low 2x level about two years from closing.

The stable outlook reflects Moody's expectations that IBM's revenue and profitability will modestly grow as the company progresses with its broad portfolio transition while integrating Red Hat and that liquidity will remain robust.

Affirmations:

..Issuer: International Business Machines Corporation

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

..Issuer: IBM International Group Capital LLC

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

..Issuer: IBM International Treasury Services Company

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

Downgrades:

..Issuer: International Business Machines Corporation

.... Issuer Rating, Downgraded to A2 from A1

....Senior Unsecured Shelf, Downgraded to (P)A2 from (P)A1

....Senior Unsecured Regular Bond/Debenture, Downgraded to A2 from A1

Outlook Actions:

..Issuer: International Business Machines Corporation

....Outlook, Changed To Stable From Rating Under Review

RATINGS RATIONALE

IBM's A2 rating reflects the company's strong business model, large scale, consistent free cash flow generation, customer and geographic diversity, as well as its strong liquidity. IBM has progressed in its multi-year transitioning of its broad portfolio towards becoming an enterprise class cloud services and solutions company, delivering higher value added products and services embodied within its broad strategic imperative businesses portfolio (data analytics, cloud, mobile, security, and social). Despite progress against a competitive landscape and uneven business conditions, IBM still remains challenged to achieve consistent revenue growth on a constant currency basis, with flat average quarterly revenue over the last six quarters.

The addition of Red Hat's $3.5 billion of revenue that is growing 15%, while small relative to IBM's $79 billion, will help overall growth but more importantly, will be strategically positive for IBM's long-term cloud strategy. The acquisition of Red Hat will accelerate IBM's ability to help enterprise clients transition to a multi-cloud, hybrid IT environment, given Red Hat's leading position in the Linux operating system and solid position in middleware and related emerging technology markets. At the same time, IBM will need to balance the neutral nature of Red Hat's approach to helping customers transition to a multi-cloud, hybrid cloud environment while achieving revenue synergies by cross-selling its products to Red Hat's existing customers.

IBM will fund the acquisition with balance sheet cash and debt (IBM raised $20 billion of debt in May) leading to gross adjusted debt to EBITDA of approximately 3.0x at closing. With over $6 billion of projected free cash flow after dividends, share repurchase suspension for 2.5 years post-closing, and plans to aggressively repay debt, Moody's expects leverage will approach the low 2x level two years from closing. Moody's expects the company's acquisition posture will remain opportunistic but modest in scope while dividends grow in line with earnings over the next few years. Integration risks are viewed as modest given Red Hat's relatively small size operationally, plans for Red Hat to operate independently to preserve the trusted open source heritage that is important to developers and customers, and the company's deep familiarity after having partnered together for many years. A likely bigger challenge will be to achieve the revenue synergies over time, while also steadily executing on IBM's ongoing portfolio mix shift.

IBM's liquidity profile is solid, historically maintaining a liquid balance sheet, consistent cash flow as well as solid alternate liquidity. IBM maintains a liquid balance sheet with $18 billion of cash and marketable securities as of March 2019. We anticipate IBM will maintain over $8 billion of cash balances going forward and project over $6 billion of free cash flow (after dividends) in 2019. The company also maintains a $15 billion commercial paper program ($3 billion outstanding at March 2019), that is fully backstopped by a $10.25 billion committed revolving credit facility that matures July 2023. IBM also has a $2.5 billion unused facility that matures July 2021 and a $2.5 billion unused facility that matures July 2019. The facilities have same day availability, do not require a re-representation of no material adverse change, and have one financial covenant under which there is ample cushion. Moody's expects the credit facilities to remain largely unutilized. This strong liquidity provides operational and financial flexibility and adds support to the rating.

The ratings could be upgraded if IBM demonstrates revenue growth in the low-to-mid single-digits and reduced competitive pressures throughout its broad operations. Additionally, EBITDA margins sustained above the mid 20% level coupled with continued financial conservatism, including adjusted gross debt to EBITDA sustained at less than 2.0 times, and the maintenance of strong liquidity could also contribute to upwards rating pressure. The ratings could be downgraded if IBM's revenue, profitability, or cash flow decline on a sustained basis, which scenario would imply unexpected headwinds to IBM's mix shift to higher value revenue streams. Furthermore, if management reverses its plans to steadily reduce debt or engages in material debt financed acquisitions over the next two years, or if the company recommences share buybacks before gross adjusted debt to EBITDA declines to the low 2x level, or if its strong liquidity profile weakens, the ratings could be pressured.

The principal methodology used in these ratings was Diversified Technology published in August 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

International Business Machines Corporation ("IBM") is one of the world's leading providers of hardware systems, software and technology related services, with $79 billion of revenue over the twelve months ended March 2019.

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.

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: 1 212 553 0376
Client Service: 1 212 553 1653

Lenny J. Ajzenman
Associate Managing Director
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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