Information technology (IT) is one of the most consistently watched industries in the U.S., and has become one of the largest. Despite S&P Global Ratings revising its IT spending forecast down due to the COVID-19 pandemic, companies within the technology sector have remained resilient.

Investment-grade debt issuers entered 2020 with stronger balance sheets and are providing services and products that are even more relevant due to COVID-19-related shutdowns. The majority of rating actions were on speculative-grade issuers, mainly driven by capital structures leveraged with limited room within their rating categories.

As of Sept. 14, 2020, we've assigned outlooks that are not stable to 39 of the roughly 200 rated U.S. technology companies. Our mix of these non-stable outlooks leans negative, as ratings on 32 credits have negative outlooks (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 three companies in the U.S. technology sector are on CreditWatch (Table 1).

Chart 1

Marcoeconomic Risks Due To COVID-19 Drive Negative Outlooks

About half of these negative outlooks are driven by macroeconomic weakness tied to COVID-19. These companies' business models are challenged by the overall macroeconomic softness in 2020. About 30% are assigned to companies whose business have either faced long-term operating challenges or sell products exposed to weaker end markets (e.g., oil and gas). The remaining 20% of companies face liquidity risk, have completed large acquisitions, are executing share buybacks that impair their financial metrics, or are going through a turnaround (Chart 2).

Chart 2

U.S. Technology Companies On CreditWatch

Ratings on these technology companies are on CreditWatch:

Table 1

• On July 13, 2020, S&P Global Ratings placed all of its ratings on Analog Devices Inc. on CreditWatch with positive implications following the announced acquisition of Maxim Integrated Products Inc. We expect to resolve the CreditWatch upon close of the transaction, after conducting a detailed review of post-close business strategies, associated integration and restructuring charges, capital structure, and ongoing financial policy.
• On July 13, 2020, we also placed our ratings on Maxim on CreditWatch positive. We expect to resolve the CreditWatch upon close of the transaction, given our expectation for an improved business profile and our belief that management's financial policies will support leverage of 1.5x.
• On Aug. 7, 2020, we placed all of its ratings on Avnet Inc. on CreditWatch negative, due to weaker than expected operating performance. We plan to resolve the CreditWatch after evaluating the company's competitive position, including its profitability, cost structure flexibility, and positioning with the tech distribution industry, and also our updated forecast for the company's EBITDA, cash flow and leverage. We could lower the rating by one notch if we come to believe Avnet's competitive position has weakened or if we expect leverage to remain above 3x for a prolonged period.

U.S. Hardware And Semiconductor Companies

We anticipate a full recovery should take about two years for hardware and semiconductor issuers. Hardware and semiconductor customers are cautious about making major capital purchases, and we don't expect credit metrics for issuers in this subsector to return to pre-COVID-19 levels until the end of 2021. Speculative-grade issuers were subject to the majority of rating actions mostly due to liquidity concerns and our expectations for weaker operating performance over the next 12 months.

These companies in this segment of the IT industry (Table 2) are candidates for rating changes:

Table 2

• We revised our outlook on TE Connectivity Ltd. to negative from stable to reflect our expectation for weak global growth and automotive sales, which will drive total revenue declines of 12%-15% in fiscal 2020, leading to S&P Global Ratings-adjusted leverage rising to the low-2x area by the end of the fiscal year. We could lower the rating if we believe end-market exposure will likely increase business volatility over time or if business performance does not recover as expected within 12-24 months, leading to margin pressures and S&P Global Ratings-adjusted leverage above 1.75x. We could also lower the rating if the company adopts a more aggressive shareholder return initiative or acquisition growth strategy such that leverage remains above that level.
• On Feb. 20, 2020, we revised our outlook on Corning Inc. to negative from stable, reflecting potentially greater volatility in its display business and uncertainty in optical operational performance in 2020 that could moderate profitability and raise leverage. We could lower the rating if Corning's display and optical volumes do not rebound as expected and near-term industry volatility is higher than expected, without tempering its share buybacks, leading to leverage sustained above low-2x, or if free operating cash flow (FOCF) to debt remains weak and we don't believe it would approach 20% over time. We would also consider a lower rating if Corning pursues opportunistic acquisitions, leading to credit metrics breaching those thresholds.
• Our negative outlook on Pitney Bowes Inc. is based on our view that Pitney's reliance on small and midsize businesses (SMBs) for over 80% of EBITDA leaves it highly exposed to a COVID-19-related economic downturn. We could lower our ratings on Pitney Bowes if a weakening U.S. economy and increasing bankruptcies and spending cuts at SMBs accelerate revenue declines in the firm's Sending Technology segment. Because this segment generates the vast majority of Pitney Bowes' EBITDA and free cash flow, such a decline would have an outsize impact on leverage and cash generation, and could lead to leverage rising over 3.5x on a sustained basis, which we would support a downgrade.
• On March 30, 2020, we revised our outlook on Dell Technologies Inc. to negative from stable, which reflects our view that weak macroeconomic conditions will decrease enterprise IT spending in fiscal 2021. We could lower our rating if Dell's performance deteriorates beyond our base case, likely as a result of a prolonged macroeconomic downturn, with the combination of revenue declines and lower profitability raising leverage to 4x on a sustained basis. We could also lower our ratings if the company pursues shareholder-friendly activities or debt-financed acquisitions that also sustain leverage above 4x. Finally, any strategic evaluation of VMware Inc. that results in a weaker competitive position or credit metrics could lead to a downgrade.
• On Feb. 21, 2020, we raised our rating on Santa Clara, Calif.-based semiconductor firm Advanced Micro Devices Inc. (AMD) to 'BB' with a positive outlook after repayment of $965 million of debt in 2019, reducing adjusted leverage under 1x. The outlook is positive, based on our view that AMD's strong product pipeline will enable further central processing unit share gains and support continued positive free cash flow through 2020. We would look to continued revenue and free cash flow growth along with expanded EBITDA margins as primary factors for a further upgrade to 'BB+'. Further market share gains against Intel Corp. and sustained share against Nvidia Corp., as well as leverage remaining at or below current levels and a continued commitment to a conservative financial policy would also support a upgrade.
• On April 22, 2020, we revised our outlook on Plantronics Inc. (Poly) to negative from stable to reflect our expectation of significant operating headwinds over the next 12 months because of reduced demand from a global macroeconomic recession and possible extended supply chain disruptions from COVID-19 containment measures. We could lower the rating over the next 12 months if Poly cannot manage near-term business uncertainties and improve margins, or a deeper or more prolonged global recession than anticipated affects demand for endpoints. In this scenario, revenues could decline at least in the mid-single-digit percent area, EBITDA margins decrease below 15%, and FOCF to debt remains below 7% on a sustained basis. We could also downgrade Poly if its liquidity position weakens significantly, which could be due to weaker FOCF generation and an inability to address tightening covenant headroom, reducing availability of the revolving credit facility.
• Our negative outlook on CommScope Holding Co. Inc. reflects our view that macroeconomic weakness related to COVID-19 may delay carrier capital spending, particularly on 5G infrastructure, which could lead EBITDA to stagnate and leave leverage in the high-7x area for a prolonged period. We could lower the rating if the company maintains leverage above the mid-7x area or FOCF to debt in the low-single-digit percents. This could occur if cable operator spending in 2020 remains low, possibly due to macroeconomic weakness, and wireless network operators delay 5G investments into 2021.
• On April 2, 2020, we lowered our rating on Elo Touch Solutions Inc. to 'B' with a negative outlook, reflecting our view that deteriorating macroeconomic conditions will lead to revenue declines at Elo. This would leave leverage near 5x and negative cash flow after debt amortization, with potential for further deterioration in credit metrics should scale and timing of the pandemic exceed our expectations. We could lower the rating if impacts from the pandemic contribute to significantly lower product implementations by customers and revenue growth below our base-case expectation, or funded debt rises (through draws on the revolving credit facility), lifting leverage over the mid-5x area, or total liquidity declines to less than $25 million area.
• On March 31, 2020, we lowered our rating on Crackle Intermediate Corp. (dba SnapAV) to 'B-' with a negative outlook, reflecting our uncertainty about how severely the coming macroeconomic downturn will affect SnapAV's operating performance given its products' discretionary nature, particularly because leverage is already high at around 9x. We could downgrade SnapAV over the next 12 months if FOCF falls to around break-even or if total liquidity falls below $30 million, likely the result of a prolonged macroeconomic downturn that lasts into the second half of 2020 or beyond. At that point, we would question the sustainability of the capital structure.
• On July 2, 2020, we lowered our rating on Electronics for Imaging Inc. (EFI) to 'CCC+' with a negative outlook, reflecting our view that COVID-19 impact will significantly constrain revenue and FOCF generation that will affect total liquidity. We expect EFI would require more favorable market conditions to meet its financial obligations over a multiyear period. We could lower our rating on EFI if, in a COVID-19 macroeconomic environment, it sustains weak customer demand such that we expect unadjusted FOCF deficits or less than 1x EBITDA to cash interest coverage in 2021. We could lower the rating if total liquidity falls below $50 million, which incorporates a cushion to cash needed to run the business. We believe either of these conditions increase risk of a payment default or debt restructuring within the subsequent 12 months. We could also lower the rating if EFI engages in a term loan acceleration, exchange or restructuring, or distressed debt repurchase.
• Our negative outlook on Eastman Kodak Co. reflects our view that the company's capital structure is unsustainable due to heightened refinancing risk, particularly with respect to its convertible notes and preferred stock, both due in November 2021. We could lower the rating to 'CCC' if it becomes clear Kodak would not refinance to meet its 2021 debt obligations, increasing default risk within 12 months.
• On April 3, 2020, we lowered our rating on Natel Engineering Company Inc. (NEO Tech) to 'CCC+' with a negative outlook, reflecting our view that macroeconomic weakness related to the coronavirus elevates the risk of acceleration of the term loan due to a financial covenant breach, a debt exchange or restructuring, or a distressed repurchase of debt at a discount. We could downgrade NEO Tech if we came to believe a term loan acceleration, exchange or restructuring, or distressed debt repurchase were more likely than not to occur within the next 12 months, due to a severe impact on operating performance from a weakening macroeconomic environment.
• On Aug. 23, 2020, we lowered our rating on Riverbed Parent Inc. to 'CCC+' with a negative outlook, reflecting a potential further downgrade if we believe the company cannot address its debt obligations consistent with the original terms. We could lower our rating on Riverbed if its operating performance and credit metrics continue to deteriorate beyond our forecast or if its liquidity becomes impaired such that we envision a potential covenant violation or distressed debt exchange in the next 12 months.

U.S. Software And IT Services Providers

Although we expect IT spending to contract 4% in 2020, we expect most software issuers' credit metrics to be relatively unaffected by COVID-19. Certain software issuers with higher exposure to SMBs or vulnerable end markets have been hurt. Nonetheless, we expect their credit metrics to recover to pre-COVID-19 levels by mid-2021.

We believe these companies in the software and services segment of the IT industry are candidates for rating changes:

Table 3

• Our negative outlook on International Business Machines Corp. (IBM) reflects our expectation that the adjusted EBITDA base will be lower in 2020, reflecting weak enterprise IT spending, but to increase in 2021 from pent-up demand for products and services and continued profitability improvement from mix shifts to higher-value offerings. We would lower our issuer credit rating on IBM if the company significantly underperforms our base-case scenario, the result of a deeper and longer global economic recession than anticipated, such that we do not believe leverage will remain below 2.5x on a sustained basis. We could also lower the rating if IBM takes a more aggressive stance in its financial policy or engages in higher-than-expected shareholder returns (dividends or share repurchases) such that leverage exceeds our 2.5x downgrade threshold over the next two years.
• On June 19, 2020, we lowered our rating on Oracle Corp. to 'A' with a negative outlook, reflecting our view that given the lack of clear financial policy guidance from management, the current pace of share repurchases would continue to weaken credit metrics through fiscal 2022, and that we could lower the rating again. We could do so if adjusted leverage exceeds 2.5x over the next two years, which would likely be the case in fiscal 2022 if share buybacks persist at $5 billion per quarter. A debt-funded acquisition that pushes leverage over the same level would also cause a downgrade.
• Our negative outlook on VMware mirrors the negative outlook on Dell given the companies' close ties. We could lower our ratings on VMware if we lower our rating on Dell. We could also lower the rating if VMware shifts its financial policy and no longer commits to maintaining an investment-grade credit profile. This could result if the company engages in material shareholder returns or large-scale acquisitions such that leverage exceeds 3x (versus 1x as of May 1, 2020). Additionally, we could lower the rating if we no longer view VMware as an insulated subsidiary of Dell, its credit profile weakened with the relationship no longer at arm's length.
• Our positive outlook on Nuance Communications Inc. reflects the 1-in-3 chance we will raise our ratings over the next 12 months if it continues to demonstrate its commitment to a more conservative financial policy, which in our view will allow it to sustain S&P Global Ratings-adjusted debt to EBITDA of less than 4x through acquisitions and shareholder returns. We could revise our outlook on Nuance to stable if we believe it can sustain leverage of more than 4x. This could occur if it deviates from its current financial policy targets, undertakes an aggressive growth strategy or debt-funded share repurchases, or less likely significant operating underperformance relative to our base case due to increased competitive pressures, customer losses, a less-profitable product, or unexpected missteps with its organic growth plans or restructuring initiatives.
• Our negative outlook on GreenSky Holdings LLC reflects challenges including those related to sustaining bank funding relationships and expanding funding to support new loan growth. We are also considering COVID-19-related disruptions to loan growth and ongoing declines in profitability due to changes in loan economics. EBITDA margins have declined over the last few years as the finance charge reversal expense has risen. We could lower the rating if GreenSky loses bank partnerships and cannot secure additional funding, or if it faces increased competition or adverse changes in the consumer-lending environment that materially affect its business model. We could also consider a downgrade if annual FOCF meaningfully declines.
• Our negative outlook on Datto Inc. reflects the possibility we could lower our ratings over the next 12 months if a prolonged economic downturn significantly weakens the company's credit metrics or hinders its ability to generate positive cash flows. We could lower our rating if we expect leverage to increase above 7x or free cash flow generation to remain negative. We believe this would likely occur if customer cancelations significantly increase, new bookings activity is limited, or it cannot curtail operating expenses.
• Our negative outlook on EVO Payments International LLC reflects the risk that sluggish consumer spending from gradual easing on social distancing across the globe could continue to pressure the company's operational performance over the next 12 months, keeping leverage elevated before a significant recovery. We could lower the rating if a delayed recovery in consumer spending causes EVO's financial performance to deteriorate further, such that leverage remains above 7.5x over the coming year. We could also lower the rating if debt-financed acquisitions or shareholder returns keep leverage above 7.5x.
• On July 13, 2020, we raised our rating on Unisys Corp. to 'B' with a positive outlook, reflecting our assessment of its improved credit measures, along with our belief its prospects to sustain leverage below 5x are favorable. We could raise our ratings on Unisys if we come to believe the company could comfortably sustain leverage below 5x and an FOCF–to-debt ratio above the mid-single-digit percent area over the next 12 months.
• On Aug. 3, 2020, we assigned our 'B-' rating to cloud-based solutions provider LogMeIn Inc. with a positive outlook, reflecting our expectation that the company's cost-optimization efforts will materially improve EBITDA margins and reduce leverage toward the low-7x area by the end of 2021. We could raise our ratings over the next year if we expect leverage is on a path to decline and will sustain below 7.5x. In this scenario, we would expect LogMeIn to maintain organic revenue growth in the low- to mid-single-digit percent area and substantially improve profitability and free cash from cost-reduction initiatives.
• Our negative outlook on Aspen Jersey Topco LLC reflects our belief macroeconomic weakness related to the pandemic will likely depress demand for Aptos products, which could lead to significantly weaker revenue and profitability than we previously expected. As a result, we see a growing risk of Aptos sustaining significantly weaker credit metrics including negative free cash flow over the next 12 months. We could lower the rating if prolonged business disruptions or a continued decline in earnings increase leverage toward the 10x area or if FOCF turns negative with limited prospects for improvement.
• On April 10, 2020, we lowered our rating on First American Payment Systems L.P. to 'B-' with a negative outlook, reflecting our view that uncertain market conditions could lead to persistent negative free cash flows and a deteriorating liquidity position such that we view the company's capital structure unsustainable in the coming year. We could lower the rating over the next year if the current market environment worsens beyond our expectations such that liquidity is not sufficient over the next 12 months. This would likely be the result of a prolonged macroeconomic downturn that lasts into the second half of 2020 or beyond. At that point, we would question the sustainability of the capital structure.
• The negative outlook on Procera I L.P. (now branded as Sandvine) reflects our view that its dependence on large deals and ongoing transition to a newer hardware and software platform could weaken financial metrics over the near term. We could lower the rating to 'CCC+' if the company faces sustained revenue declines and free cash flow turns negative. This could happen as a result of delayed telco contracts due to the COVID-19 pandemic. We could also consider a downgrade if total liquidity falls under $40 million, or if we view the covenant cushion as less than adequate.
• We base our negative outlook on Project Silverback Holding Corp. (dba Sparta Systems) on broader macroeconomic factors caused by the COVID-19 pandemic, which if prolonged and in excess of our current stress scenario could impair its ability to generate sufficient liquidity to meet debt obligations. We could lower the rating if the current macroeconomic environment weakens operating performance, increased competition leading to significant attrition rates of its larger clients, or the transition to software-as-a-service substantially weakens revenue and cash generation versus our base-case expectation (such that free cash flow becomes materially negative and overall liquidity weakens), and we come to view the capital structure as unsustainable.
• On March 25, 2020, we revised our outlook on QBS Parent Inc. to negative to reflect the challenges from the macroeconomy and oil and gas end markets that we believe QBS will face over the next 12 months, weakening operating results relative to our previous expectations. We could lower our rating on QBS if we believe it cannot generate positive FOCF in the next 12 months, or if it faces weaker demand, sales, and profitability than we expect. This could result from end-market turmoil or sustained low commodity prices. We could also lower the rating if the company has less-than-adequate liquidity or if the capital structure is unsustainable.
• We base our negative outlook on Solera Parent Holding LLC reflecting our expectation for a material and potentially unrecoverable decline in Solera's transaction-based revenue over the next 12 months due to weaker economic growth stemming from the efforts to contain the coronavirus outbreak. We could lower our rating on Solera if FOCF generation turns negative or liquidity weakens due to worse-than-expected operational performance or steeper-than-anticipated decline in its transaction-based revenue. The company's elevated adjusted leverage and weakening FOCF would likely lead us to believe its capital structure is unsustainable. This scenario could occur due to protracted economic weakness related to the pandemic or key customer losses or business disruptions related to management's global restructuring efforts.
• The negative outlook on Starfish Holdco LLC (dba Syncsort) reflects our expectation it will have large one-time restructuring costs and a decline in revenue from the COVID-19 impact that will prompt negative unadjusted FOCF in 2020. We could downgrade Syncsort if we come to believe a debt exchange, restructuring, or distressed debt repurchase would occur. We could also downgrade Syncsort if we believe the macroeconomic impact from COVID-19 has fundamentally changed the business such that revenue lost in 2020 will not come back, sustaining leverage above 10x and negative unadjusted FOCF in 2021.
• On May 19, 2020, we revised our outlook on Sungard AS New Holdings LLC to negative from stable, reflecting our view the company faces material risk stemming from its plans to stabilize its revenue base. The magnitude of the company's revenue declines have led to multiple cost-restructuring initiatives, which have weighed down its near-term earnings and cash flow. We expect Sungard to generate negative FOCF over the next 12 months, but anticipateit will maintain sufficient liquidity. We could lower our ratings on Sungard if we expect free cash flow generation to remain persistently negative after 2020 because of continued revenue declines and further restructuring actions. This would lead us to believe that its capital structure is unsustainable.
• The negative outlook on Veritas Holdings Ltd. highlights our view that macroeconomic weakness could accelerate revenue declines, reverse recent EBITDA margin gains, and pressure liquidity if the company cannot sustain positive free cash flow generation over the next 12 months. We could lower our rating on Veritas if revenue decline accelerates to over 10% year over year in fiscal 2021 without significant and commensurate margin improvement, free cash flow turns negative for the year and is likely to remain negative through fiscal 2022, or cash flow is sufficiently negative to lead us to revise our adequate liquidity assessment.
• On April 15, 2020, we lowered our rating on Priority Holdings LLC to 'CCC+' with a negative outlook, reflecting our assessment that the company is vulnerable and dependent on favorable business, financial, and economic conditions to meet its financial commitments. If the operating environment persists, we see a higher risk of a low-liquidity event, including but not limited to a covenant breach, over the near term. We could lower our rating if we believe such an event or the likelihood of a distressed debt exchange or restructuring increases within 12 months.
• On March 20, 2020, we lowered our rating on SuperMoose Newco Inc. (now CentralSquare) to 'CCC+' with a negative outlook, reflecting our view that further weakening operating performance as a result of a prolonged macroeconomic slump could erode liquidity, and that the company will require more favorable market conditions to meet financial obligations over a multiyear period. We could lower our rating on CentralSquare if, in a weak macroeconomic environment, the company underperforms our forecast, we expect FOCF deficits to be more than $10 million, or total liquidity falls below $20 million. We believe either of these conditions increase risk of a payment default or debt restructuring within the following 12 months. We could also lower the rating if EBITDA falls such that the company can no longer satisfy the leverage covenant under its revolving credit facility.
• On April 7, 2020, we lowered our rating on Transact Holdings Inc. to 'CCC+' with a negative outlook, reflecting our assessment that the company is vulnerable and dependent upon favorable business, financial, and economic conditions to meet its financial commitments. The issuer's financial commitments appear unsustainable in the long term, although it may not face a near-term (within 12 months) credit or payment crisis. We could lower our issuer credit rating if we believe Transact would face a low-liquidity event, including but not limited to a covenant breach, or the likelihood of a distressed debt exchange or restructuring increases within 12 months.
• The negative outlook on Curvature Inc. reflects our view that there could be a greater risk of a distressed debt restructuring in the next 12 months if Curvature's efficiency improvements do not generate sufficient FOCF to sustainably support long-term debt servicing from 2021, or a global recession results in significant negative FOCF that materially drains near-term liquidity. We could lower the rating within the next 12 months if Curvature's cost and working capital efficiency initiatives do not mitigate significant negative FOCF after debt service or expectations of less than $20 million of total cash and revolver availability. This would lead us to believe there is heightened risk of a debt restructuring within six months. In the near term, this could be driven by significant declines in hardware sales and domestic maintenance revenues, despite a recent realignment of its sales function, as a result of the weaker macroeconomic environment.
• On April 2, 2020, we raised our rating on Optiv Inc. to 'CCC' from 'SD' with a negative outlook following distressed debt exchange to reflect our view that the company may struggle to revive performance, reduce leverage, and drive positive free cash flow in 2020 during projected GDP contraction, increasing the risk of continued weak financial metrics and additional distressed exchanges. We would consider a downgrade if we view Optiv as vulnerable to nonpayment within the next 12 months, either through a distressed exchange, reorganization of the capital structure, or a missed interest payment. This could happen if the company generates sustained negative free cash flow due to stiffer-than-expected competition and further deterioration of the macro and IT spending environment.

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 companies due to the impact of COVID-19, companies with business models that have long-term challenges, as well as higher leverage at certain companies resulting from acquisitions and share buybacks. Compared to a year ago, the count of companies on negative outlooks has increased 50%. Nonetheless, the technology sector has been one of the best performers within the entire corporate ratings universe. For close to 80% of U.S. tech companies we rate, the outlooks are stable, which indicates our expectation for consistent credit dynamics in 2020 and 2021.

Related Research

• Industry Top Trends Update, July 16, 2020
• As Global IT Spending Falls, Tech Ratings Pressure Rises, April 29, 2020
• An Outlook On U.S. Technology Companies That Are Candidates For A Downgrade Or Upgrade In 2019, Jan. 28, 2019