Information technology (IT) is one of the most consistently watched industries in the U.S. The companies can be subject to swift changes in fortune from technological advancements, shifts in consumer or business preferences, mergers and acquisitions (M&A), or simply poor performance.

We identified 35 of the roughly more than 200 rated U.S. technology companies to which we've assigned outlooks that are not stable. Our mix of these non-stable outlooks leans negative, as 23 have negative outlooks (see Chart 1).

A negative (or positive) outlook represents at least a one-third chance of a rating change over the next 12 months (following a rating action) for speculative-grade issuers, or the next 24 months for investment-grade issuers. A CreditWatch placement represents at least a 50% chance of a rating change (either higher or lower) over the following 90 days, and is usually related to an event. However, these are just guidelines. We try to resolve these outlooks as soon as we receive necessary information. The ratings on four companies in the IT sector are on CreditWatch (see Table 1).

Not all rating actions are preceded by a non-stable outlook. We may upgrade or downgrade a company with a stable outlook if there is a sudden change in the capital structure, such as a debt-financed acquisition, or a rapid change in operating performance (usually negative). However, if credit metrics change gradually, we expect to transition between ratings with a positive or negative outlook.

Chart 1

Performance Drives Non-Stable Outlooks

About two-thirds of the non-stable outlooks in the group of companies discussed here were driven by stronger- or weaker-than-expected operating performance. About a third of these non-stable outlooks were precipitated by acquisitions, buyouts, or divestitures. (See Chart 2 for a breakdown.)

Chart 2

U.S. Technology Companies On CreditWatch

The following technology companies are on CreditWatch:

Table 1

• On Oct. 29, 2018, S&P Global Ratings placed all of its ratings on Raleigh, N.C.-based Red Hat Inc., including the 'BBB+' issuer credit rating, on CreditWatch with positive implications following International Business Machines Corp.'s announcement that it agreed to acquire Red Hat in an all-cash transaction worth $34 billion. We expect to resolve the CreditWatch upon close of the transaction, when we would equalize our rating on Red Hat with the 'A' rating on IBM.
• On Nov. 13, 2018, we placed our ratings on Rochester, N.Y.-based Eastman Kodak Co., including the 'CCC' issuer credit rating, on CreditWatch with positive implications. We will resolve the CreditWatch upon close of the sale of its flexographic packaging division to Montagu Private Equity LLP. We will likely raise our rating on the company, although it is unlikely that it will be more than two notches.
• Integrated Device Technology (IDT), a semiconductor and solutions provider, announced last year it will be acquired by Renesas Electronics Corp. for $6.7 billion. We placed our 'BB-' rating on IDT on CreditWatch with positive implications on Sept. 11, 2018. The CreditWatch placement is based on the announcement that as part of this transaction, all outstanding debt at IDT, including its senior secured debt and convertible debt, will be repaid. We plan to resolve the CreditWatch once the transaction closes, likely in calendar 2019, and then withdraw our issuer credit rating on IDT.
• On Jan. 16, 2019, we placed all of our ratings on First Data Corp., including our 'BB-' issuer credit rating, on CreditWatch with positive implications. The CreditWatch placement follows Fiserv Inc.'s announcement that it intends to acquire First Data in an all-stock transaction. Fiserv also expects to issue new debt to refinance all of First Data's outstanding debt. The transaction is expected to close during the second half of the second quarter, pending shareholder and regulatory approvals.

U.S. Hardware And Semiconductor Companies

There are 17 companies in this segment of the IT industry (see Table 2) that are candidates for rating changes.

Table 2

• We revised our outlook on U.S. semiconductor manufacturer Intel Corp. to positive on Feb. 9, 2017, to reflect our expectations about its leading scale, good product diversification, and operating growth. While Intel remains a market leader in PC and server computing markets, it has also diversified to data center, memory, and Internet of Things (IoT) semiconductor product markets with strong growth. We could raise our rating over the 12 months if the company continues to achieve strong diversification in markets other than PC microprocessors, generates organic operating growth, and maintains adjusted leverage under 1x with only temporary increases for acquisitions.
• On July 30, 2018, we lowered our rating on semiconductor manufacturer Qualcomm Inc. to 'A-' and revised our outlook to negative after it terminated its acquisition of NXP Semiconductors N.V. and announced its intention to repurchase up to $30 billion in stock by the end of fiscal 2019. Qualcomm terminated the deal because of delays from China's State Administration for Market Regulation. We viewed this acquisition as critical for its long-term success given the headwinds facing its smartphone business. These headwinds are magnified as smartphone industry growth slows and original equipment manufacturers (OEMs) look to improve margins in a highly competitive environment. We expect Qualcomm's adjusted leverage to exceed 2x over the near term as the company depletes much of its cash balances for share repurchases, and to remain above 2x if operating performance does not improve. We could lower the rating if adjusted leverage stays above 2x over the next two years following the share repurchase completion due to additional regulatory challenges, business disruptions caused by customer attrition, or a debt-funded acquisition.
• Motorola Solutions Inc., a communications equipment manufacturer, announced it would acquire Avigilon Corp., and we revised our outlook to negative on Feb. 1, 2018. The outlook revision is based on our expectation that leverage will increase to the high-3x area, high for the rating. While we believe that Motorola has good prospects to reduce leverage through free operating cash flow (FOCF), the company demonstrated a willingness to finance acquisitions and shareholder returns with new debt. Over the next 12-18 months, we could downgrade the company if operating weakness or continuation of aggressive financial policy keep EBITDA above the low-3x area. This could occur if the company performs below our base-case expectations for revenue growth of more than 4% and stable gross margin about 50% in 2019.
• Telecommunications equipment and components provider CommScope Holding Co. Inc. announced that it will acquire ARRIS International PLC for $7.4 billion, including the repayment of ARRIS debt. The negative outlook reflects higher leverage than similarly rated peers and the risk that a macroeconomic downturn could preclude the company from reducing leverage below 5x in 2020 as we expect. We could lower the rating if leverage remains above 5x on a sustained basis, which would likely be due to a weakening macroeconomic environment in which the company's large telecommunications customers push out investment spending and force price concessions.
• For the quarter ended June 30, 2018, electronics manufacturing services (EMS) provider Benchmark Electronics Inc. reported that EBITDA fell by more than $6 million year-over-year despite revenues increasing 7%, and we expect a similar pattern next quarter. We revised our outlook on Aug. 27, 2018, to negative to capture Benchmark's weakening profitability as well as declining FOCF on increased capital expenditures (capex). The EBITDA decline is largely due to lower-margin revenue mix, medical customer transitions, investments in engineering and solutions, and new program ramps. We could lower the rating if the company sustains leverage above 3x or FOCF to debt below 10%, or does not generate capex-related revenue growth. This could occur from weakness in its very strong testing and instrumentation segment, U.S.-imposed tariffs on goods made in China, or key customer attrition.
• On Sept. 20, 2018, we raised our rating to 'B+' and revised our outlook to positive on semiconductor firm Advanced Micro Devices Inc. (AMD) based on its improving profitability and market share. Our positive outlook reflects its significant share gains in the consumer central processing unit (CPU) market, demand growth in the graphics processing units (GPUs) market, and re-entry into the server CPU market. We expect the company to reduce leverage to under 2x over the next 12 months if it continues to improve profitability. We would look to leverage declining further and remaining under 2x as a primary criteria for an upgrade, along with further market share gains against Intel, sustained share against Nvidia Corp., ongoing revenue growth, and expanded EBITDA margins as factors in a potential upgrade. Evidence that AMD sustainably reduced the performance gap between its products and those of its main competitors, and has a product pipeline that can credibly sustain an improved competitive position, would also support a further upgrade.
• We revised our outlook on Artesyn Embedded Technologies Inc., a designer and manufacturer of power conversion and embedded computing solutions, to negative on Aug. 30, 2018, to reflect its weakened liquidity and negative free cash flows. While we expect working capital outflows to reverse following the fourth fiscal quarter, we anticipate net negative free cash flow for the year. Artesyn's shift toward its rapidly growing consumer segment led to higher cash usage due to significant investment in capex and inventory. This segment growth improved overall revenue trajectory, though at the expense of greater seasonality and customer concentration. We would consider a downgrade if free cash flow over the next 12 months remains negative or liquidity gets constrained by customer attrition from increased competition.
• We raised our rating on Nvidia, a semiconductor and GPUs provider, on Sept. 20, 2017, to 'BBB+' and revised the outlook to positive based on sustainable competitive advantages and rapidly expanding end markets. Our positive outlook reflects our belief in Nvidia's technological lead against rival AMD, significant accelerated revenue growth, high-30% adjusted EBITDA margins, and expanded use of its GPU technology. We expect Nvidia's net cash position due to cash balance to remain over $5 billion due to its ability to command a significant price premium on its high-end gaming GPUs and its technological leadership in enabling deep learning workloads that created partnerships with companies such as Amazon Web Services and Mercedes Benz. We could upgrade Nvidia over the next 24 months if it diversifies its end-market exposure through continued strong growth in data-center, deep learning, and automotive applications for its technology. We could also look to continued conservative financial policy and a sustained net cash position as conditions for a higher rating.
• On Nov. 15, 2018, we revised the outlook on Round Rock, Texas-based Dell Technologies Inc. to negative from stable. The negative outlook reflects our view that pro forma leverage will be high, in the mid-4x area as of the quarter ended Aug. 3, 2018, following Dell's proposed $5 billion incremental debt issuance related to the tracking stock conversion to Class C common stock. We expect revenue will remain strong in the second half of fiscal 2019 (ending February 2019) and revenue growth to be in the low- to mid-single-digit percentages in fiscal 2020. Importantly, we expect EBITDA margin to improve slightly, benefitting from improved mix shift due to better storage sales performance. As such, we anticipate leverage to decline to 4x or below by the end of fiscal second quarter 2020 (August 2019). We could lower our rating if we believe leverage will remain more than 4x post-fiscal second quarter 2020 (August 2019). This could be the result of lower-than-expected revenue growth from material share losses to competitors in its PC or external storage systems business, or its VMware Inc. business becomes more challenged than anticipated. It could also be the result of a more aggressive financial policy resulting from debt-financed acquisitions or shareholder returns that would delay expected leverage reduction.
• On Nov. 15, 2018, we revised the outlook on Palo Alto, Calif.-based VMware to negative from stable. The negative rating outlook reflects the company's close ties to Dell's group credit profile and the revision of our outlook on Dell to negative. We expect VMware's strong revenue, FOCF generation, investment in growth will continue, and a commitment to an investment-grade credit profile. We anticipate VMware's revenue growth to be at least 10% over the next two years, with particular strength in revenue growth from emerging product, maintenance, and services. We could lower the issuer credit rating on VMware if we lower our rating on Dell. We could also lower the rating if the company shifts it financial policy such that it is no longer committed to maintaining an investment-grade credit profile. This could result if the company engages in material share repurchases or large-scale acquisitions such that leverage exceeds 3x. Additionally, we could lower the rating if we no longer view VMware to be an insulated subsidiary of Dell, such that its credit profile could be weakened if the relationship is no longer at arm's length.
• On Oct. 29, 2018, we lowered the issuer credit and issue-level ratings on Armonk, N.Y.-based IBM to 'A' from 'A+' and revised the outlook to negative. The negative outlook reflects our expectation for the company's leverage to rise to about 2.4x at transaction close near the end of 2019. We expect overall revenue growth in the low-single-digit percentage area and adjusted EBITDA to improve slightly from above 25% currently, leading to leverage declining gradually to about 2x by 2021. The company is suspending its share repurchases in the two years post-transaction close and pursuing a balanced debt repayment and acquisition strategy. We would lower our issuer credit rating on IBM if the company significantly underperforms our base-case scenario, which could be caused by major acquisition integration issues, leading to deteriorated credit metrics, or if it pursues additional large-scale acquisitions such that we do not believe pro forma leverage will remain below 2.5x on a sustained basis. We could also lower the rating if the company takes a more aggressive stance on its financial policy or engages in higher than expected shareholder returns (dividends or share repurchases) such that leverage could exceed our 2.5x downgrade threshold over the next two years.
• Plantronics Inc., a headset and communication service provider, agreed to acquire Polycom Inc., a voice, video, and content collaboration solutions provider, for approximately $2 billion. We revised our outlook to negative on May 14, 2018. While the negative outlook reflects pro forma adjusted leverage in the high-3x area upon close of the acquisition, we expect the company to decrease leverage to the high 2x- to near 3x area over the next 12 months due to realized cost synergies and achieved modest organic growth. We could lower the rating on Plantronics if integration challenges, lower profitability, unrealized cost synergies, or additional debt-funded acquisitions result in adjusted leverage sustained above 3x within 12 months of the close of the acquisition.
• On April 10, 2018, we lowered our rating on Lexmark International Inc. to 'B-' and revised our outlook to negative. Lexmark has gone through multiple restructuring phases due to secular declines in the broader printing market, highly competitive industry conditions, and weakness in high-margin supplies sales due to a lower installed base, which led to significant negative free cash flow in 2017 and could lead to continued performance pressure. While trailing-12-months leverage is above 10x, we expect it to remain above 9x as of Dec. 31, 2018. We could lower our rating if we consider the capital structure to be unsustainable due to competitive pressures leading to operating declines, sustained liquidity below $100 million, failure to make progress on its revolver due in 2019 and the notes due in 2020, or covenant cushion to remain in the low-single–digit percentages.
• On Aug. 30, 2018, we lowered our rating on Diebold Nixdorf Inc., a global ATM, point-of-sale, and self-checkout terminal assembler and distributor, to 'B-' and revised the outlook to negative. The negative outlook reflects our expectations of weaker credit metrics over the next 12 months following the company's proposed term-loan A-1 debt issuance, which carries higher interest costs than its existing term loans. We expect adjusted leverage to rise above 10x in 2018 and to fall to the mid-7x area in 2019 due to cost savings and less costs to achieve the DN Now plan. We could lower the rating if lack of traction in its DN Now business or cost-savings plan, or deterioration in capital market conditions lead to operating performance weak enough that we believe there is significantly higher refinancing risk of its debt maturing in December 2020.
• On April 30, 2018, we revised our outlook to positive on memory packaging and specialty module manufacturer SMART Worldwide Holdings Inc. based on consistent revenue growth and improved profitability. Our positive outlook reflects our belief that SMART can outperform both the memory market and the broader semiconductor industry due to opportunities in Brazil and increasing demand for industrial semiconductor content. We forecast leverage to decline approximately 1x over the next 12 months due to continued EBITDA growth and debt repayment. We could raise the rating over the next 12 months if the company sustains its EBITDA margin improvement while maintaining leverage under 1.5x. To raise the rating, we would also require Silver Lake to reduce its ownership in SMART to under 40%.
• On May 4, 2018, we lowered our rating on Pitney Bowes Inc. to 'BB+' and revised the outlook to negative due to revenue declines and the acquisition of Newgistics, which elevated adjusted leverage to the high-3x area. Revenues from its most profitable segment, small and medium business solutions, declined due to the company's transition to e-commerce markets. While we expect improvement in margins over the long term as Pitney Bowes gains scale, we expect the firm's adjusted leverage to be around 3.3x on Dec. 31, 2018. We could consider a downgrade if the company cannot sustain organic revenue growth, improve margins in its digital commerce business, or if it adopts a more aggressive financial policy such as M&A or shareholder returns that keep leverage above mid-3x area over the next 12 months. We could also lower the rating if the company's covenant cushion falls below current levels.
• On Dec. 21, 2018, we revised the outlook on U.S. memory semiconductor producer Micron Technology Inc. to positive from stable. The positive outlook reflects our expectation that Micron will maintain cost competitiveness and good execution on subsequent process node transitions and a sizable liquidity position, despite a material reduction in capex to respond to tough memory market conditions. We also expect the company to generate free cash flow of at least $3 billion-$4 billion on a rolling-12-months basis while undergoing the industry cycle. We could raise the rating to investment grade if Micron can maintain EBITDA margins of at least 50%, total liquidity (cash and marketable securities plus revolver availability) of at least 30% of sales, and a net cash position over the coming year.

U.S. Software And IT Services Providers

These are the companies in the software and services segment of the IT industry that we believe are candidates for rating changes:

Table 3

• On Sept. 25, 2018, we revised our outlook on Oracle Corp. to negative, reflecting uncertainty around its financial policy and the potential for its credit metrics to weaken over time should it continue reducing cash through shareholder returns. We could lower our issuer credit rating on Oracle if the company's adjusted leverage exceeds 1.25x over the next two years as the company engages in large share repurchases. A debt-funded acquisition that pushes leverage over the same level would also cause a downgrade.
• We revised our outlook to negative on positioning technology and software provider Trimble Inc. on April 24, 2018, on plans to acquire enterprise resource planning (ERP) software provider Viewpoint Inc. for $1.2 billion. While pro forma adjusted leverage will rise to 3.6x at close, we expect Trimble to generate approximately $400 million free cash flow over the coming year, limit future acquisitions to moderate sizes, and devote excess free cash to debt repayment until leverage declines to the company's stated long-term target of 2.5x. We could consider a downgrade if the company's operating performance deteriorates due to integration risks or customer attrition, or it engages in additional material, debt-financed acquisitions, or share repurchases, such that leverage is sustained above 3x over the next two years.
• Ithacalux S.à r.l., a parent of data integration software provider Informatica LLC, delivered strong operating performance and cash flow in the first half of 2018, trends we think could continue in 2019. On Sept. 19, 2018, we revised our outlook to positive to reflect our view that leverage could fall to the low-8x area by the end of 2018 and around 7x in 2019 on continued double-digit percentage revenue growth and margin expansion. We think fourth-quarter seasonality should return to near historic levels in 2018 and beyond, as we expect the shift to subscription pricing to be less dramatic than it was in 2017. We could raise the rating if over the next 12 months the company sustains leverage less than 8x. That would likely occur if the company generates pre-leveraged buyout (LBO) growth rates while maintaining or expanding profitability.
• On May 22, 2018, we revised the outlook on U.K.-based infrastructure software provider Micro Focus International PLC to negative. The negative outlook reflects the possibility of a downgrade within 12 months if we do not see revenue declines moderate, specifically if high-single-digit percentage revenue declines continue through 2019 or there is a delay in the normalization of working capital outflows beyond October 2018. We could further consider a downgrade if in 2019 we no longer expect leverage to improve to about 3.5x or funds from operations to debt to about 20%, while FOCF to debt also remains below 15%. This would be driven by lower-than-expected EBITDA margins due to significant delays in cost savings from the integration of Hewlett Packard Enterprise Co.'s software business (HPES) or greater implementation costs.
• On Sept. 27, 2018, we revised the outlook on Washington, D.C.-based Blackboard Inc. to negative from stable. At the same time, we affirmed the 'CCC+' issuer credit rating. The negative outlook reflects the company's high leverage and continued weak FOCF generation, increasing the possibility that the company may face a liquidity shortfall requiring covenant relief or attempt a debt restructuring that we view as distressed over the next 12 months. We expect revenues to decline in 2019 and for sustained negative FOCF over the next few years. We believe the company depends on favorable business and financial conditions to meet its financial commitments longer term, rendering its capital structure unsustainable. We could lower our issuer credit rating on the company if we believe it would face a specific liquidity event, including covenant breach, or the likelihood of a distressed debt exchange or debt restructuring increases within 12 months.
• On April 10, 2018, we assigned our 'B-' issuer credit rating and positive outlook to Chicago-based Ensono L.P. The positive outlook reflects the potential for a higher rating over the next 12-18 months if the company successfully integrates Wipro's hosted data center services business (DCS) and good operating performance results in leverage improving below 6.5x on a sustained basis. We could raise the rating if healthy sales growth, stable churn, synergy realization, and higher EBITDA margins result in leverage improving below 6.5x on a sustained basis. An upgrade would also require our confidence that the competitive environment will remain supportive of growth prospects and stable pricing.
• On Sept. 21, 2018, we revised the outlook on San Antonio, Texas-based Rackspace Hosting Inc. to negative from stable. The negative outlook reflects the possibility that leverage could remain elevated at 6.5x if further execution missteps hamper its ability to stabilize performance, realize identified cost synergies, and improve FOCF. We could lower the rating over the next year if ongoing execution missteps cause operating performance to be weaker than we expect, including higher churn and pricing pressure, and synergies realization is delayed, preventing leverage from improving below 6.5x and causing FOCF to debt to remain sustainably below 5%. We could lower the rating if the company pursues additional debt-funded acquisitions that prevent leverage from improving below 6.5x on a sustained basis.
• On May 24, 2018, we raised our rating on Triple Point Group Holdings Inc. to 'CCC' from 'SD' (selective default) and revised our outlook to negative. Previously, the company reduced its debt via a debt exchange transaction that we viewed as distressed, so we lowered the rating to 'SD'. The rating change and outlook reflects Triple Point's weak liquidity caused by customer attrition from maintenance segment without enough subscription revenue growth to offset it, as well as constrained EBITDA margin. Due to its inability to generate consistent positive free cash flow the last two years, we expect free cash flow to remain below $3 million for 2018. We could lower the rating over the next 12 months if weak revenue performance and negative free cash flow result in insufficient liquidity to service its debt obligations. This could potentially lead to another distressed exchange if the company engages in a debt-restructuring plan.
• On Feb. 2, 2018, we upgraded payment processor Worldpay Inc. to 'BB+' and revised our outlook to negative. The negative outlook reflects Worldpay's (formerly Vantiv) sizable debt to fund the acquisition of Worldpay Group, resulting in pro forma adjusted leverage in the low-5x area as of March 31, 2018. We expect the company to use most of its free cash flow to deleverage to the low-4x area over the next 12 months. We could lower the rating if Worldpay is not on pace to reduce leverage to the low-4x area within 12 months of closing the acquisition due to low-single-digit percentage organic revenue growth or unrealized synergies.
• Seahawk Holdings Ltd., a systems, identity, and access management solutions provider, and financial sponsors Francisco Partners LLC and Evergreen Coast Capital announced that SonicWALL Inc. will be separated from Seahawk while Quest Software and One Identity will remain under Seahawk. We revised our outlook to negative on May 4, 2018. The negative outlook reflects that the reduced business diversity and the lack of EBITDA contribution from SonicWALL creates risk that leverage may remain over 7x for an extended period after the transaction closes. We could lower the rating if persistent revenue declines and lower-than-expected EBITDA margins lead to sustained leverage in the mid-7x area or if free cash flow is significantly below our expectations.
• IT operations management solution provider BMC Software Inc. agreed to be acquired by Kohlberg Kravis Roberts & Co. for $8.3 billion, and we revised our outlook to negative on June 18, 2018. We expect leverage to reach the mid- to high-8x area pro forma and to decline over the next 12 months. This includes the firm's proposed $300 million of pay-in-kind preferred equity, which we treat as a debt-like obligation to pay deemed repatriation taxes over an eight-year period, adding $120 million to adjusted debt. We could lower the rating if BMC sustains leverage over 8x due to growth below 3%, weak margin expansion, or significant debt-funded acquisition.

Closing Thoughts

We use outlooks and CreditWatch as mechanisms to signal upcoming changes to issuer ratings. Our non-stable outlooks have a negative bias, reflecting a combination of operating weakness at certain hardware providers, higher leverage resulting from acquisitions, and change in financial policies at certain companies. Nevertheless, for close to 85% of our companies the outlooks are stable, which indicates our expectation for consistent credit dynamics for U.S. tech companies in 2019.

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