Fitch: Computer Sciences Outlook Remains Stable

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NEW YORK--(BUSINESS WIRE)-- Fitch Ratings stated today that the Ratings Outlook for Computer Sciences Corp. (CSC) remains Stable. The Outlook reflects Fitch's view that CSC's underlying business fundamentals remain unchanged despite near-term operational and accounting issues that have adversely affected the company's financial performance in the first half of fiscal 2012.

Fitch's view is supported by the company's 16% growth in contract signings led by the Managed Services Sector (MSS) in the first half of fiscal 2012 within the context of a relatively stable pricing environment and government spending pressures. Fitch believes the North American Public Sector (NPS) operating margin will remain in the upper single-digit range, despite modest revenue pressures, and MSS operating margin likely bottomed in the first quarter, leading to a sequential improvement of 300 basis points to 3.9% in the second quarter.

Despite near-term challenges in MSS, Fitch estimates CSC will still generate approximately $500 million of free cash flow (FCF; post-dividends) in fiscal 2012 (March 31). Fitch expects second half FCF to benefit from strong seasonality, sequential improvement in operating margin led by MSS and the timing of certain cash flows, including the $277 million contract settlement with the U.S. government. FCF materially below expectations could result in negative rating actions.

CSC's FCF of negative $645 million in the first half was adversely affected by a $270 million refund of an advance payment from the U.K.'s National Health Service (NHS) previously received on April 1, 2011, costs associated with the remediation of several MSS contracts faced with greater-than-expected implementation expenses and legal fees of nearly $50 million based on Fitch's estimates.

CSC's reported financial results for the second quarter were also negatively affected by several non-cash items, including goodwill impairment ($2.7 billion), the contract settlement with the U.S. government ($269 million) and adjustments associated with estimate at completion (EAC) accounting, all of which will not recur.

EAC accounting requires all of the previously recognized profits for a contract to be reversed in the current quarter when contract profitability deteriorates below prior expectations. Therefore, CSC's operating margin could recover quickly to the extent that the duration and amount of previously recognized profits reversed in the second quarter were material. EAC adjustments are clearly not a positive, but the accounting treatment can exaggerate the financial impact in a given quarter.

A portion of the U.S. government settlement in the second fiscal quarter reduced Department of Defense (DoD) revenue in the NPS segment by $42 million. Fitch adjusts for this one-time charge, implying DoD and NPS revenue declined approximately 6% and 2%, respectively, compared with 10% and 5% on an as reported basis.

The decline in adjusted NPS revenue is in-line with Fitch's expectations for low-single digit annual declines in government revenue over the next several years. Fitch expects this revenue pressure to be offset by growth in CSC's commercial sector, which accounts for 64% of the company's total revenue.

Fitch estimates CSC's valuation on an enterprise value (EV) to EBITDA basis has declined 20% to 3 times (x) compared with 3.7x at Dec. 31, 2010 due to a nearly 49% decline in the company's stock price. However, the company is less attractive on FCF-based valuation metrics given CSC's relatively high capital intensity and greater volatility in FCF recently, well in excess of seasonal norms. Fitch estimates an EV to FCF of approximately 10x using a normalized FCF (pre-dividend) figure of $600 million.

CSC would likely require a significant equity control premium before the board of directors considers an acquisition offer given the company's depressed stock price and ability to rectify the items affecting the company's financial performance. In the event CSC is acquired, the change of control covenant included in two of the company's three outstanding note issues would likely be triggered.

The $300 million of 5% senior unsecured notes due 2013 do not carry a change of control covenant, while the $700 million of 5.5% notes due 2013 and the $1 billion of 6.5% notes due 2018 both carry a change of control triggering event covenant. The triggering event occurs when two of the three rating agencies downgrade the rating on the unsecured notes and assign the notes a non-investment grade rating within 60 days following the consummation of a change of control.

Fitch currently rates CSC as follows:

--Long-term Issuer Default Rating (IDR) at 'BBB+';

--Senior unsecured debt at 'BBB+';

--Bank credit facility at 'BBB+';

--Short-term IDR at 'F2';

--Commercial paper (CP) rating at 'F2'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

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

Applicable Criteria and Related Research:

Corporate Rating Methodology

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

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Fitch RatingsJohn M. Witt, CFA, +1-212-908-0673Senior DirectorFitch, Inc.33 Whitehall StreetNew York, NY 10004orJason Pompeii, +1-312-368-3210Senior DirectororMedia Relations:Brian Bertsch, +1-212-908-0549Email: [email protected]

Source: Fitch Ratings

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