Fitch Ratings has assigned a 'BBB-' Issuer Default Rating (IDR) to
Harris Corporation (HRS). Fitch has also assigned an 'F3' short-term IDR
and an 'F3' rating to the company's commercial paper program; 'BBB-'
ratings to the senior unsecured $1 billion credit facility and senior
unsecured indebtedness; and 'BBB- EXP' ratings to the $1.3 billion term
loans announced on March 19, 2015. The Rating Outlook is Stable. A
complete list of ratings is provided at the end of this release.
The ratings incorporate the expectation that HRS' announced acquisition
of Exelis Inc. (XLS) will be completed on the expected terms. On Feb. 6,
2015, HRS announced the acquisition of XLS in a cash and stock
transaction valued at $23.75 per share, or an approximately $4.75
billion enterprise value, to be financed through 70% cash and 30%
equity. The agreement has been unanimously approved by the Boards of
Directors of both companies. The deal is subject to the approval of XLS'
shareholders. Under the terms of the transaction, XLS shareholders will
receive $16.625 in cash and 0.1025 a share of HRS common stock, based on
HRS' closing price as of Feb. 5, 2015, for each share of XLS common
stock. Upon closing, HRS shareholders will own approximately 85% of the
combined company, and XLS shareholders will own approximately 15%.
Fitch currently rates XLS 'BBB+/F2', with the ratings on Rating Watch
Negative as a result of the announced acquisition. HRS entered into a
$3.4 billion 364-day bridge loan agreement to backstop financing for the
acquisition on February 6, 2015. On March 16, 2015, HRS reduced the
bridge loan from $3.4 billion to $2.1 billion concurrently with entering
into a $1.3 billion term loan agreement securing commitments of a three
year $650 million term loan and a five year $650 million term loan. This
term loan will be funded at the close of the acquisition. Fitch expects
HRS will issue additional senior unsecured indebtedness in the near
future in connection with the acquisition. Fitch's ratings are expected
to cover approximately $5.3 billion of debt upon the completion of the
XLS acquisition including assumed senior unsecured notes from XLS. The
transaction is expected to close in June 2015.
Fitch considers HRS' existing credit profile, excluding the XLS
acquisition, to be consistent with a strong 'BBB' category rating, and
the IDR would likely be upgraded as much as two notches if the
acquisition is not completed.
KEY RATING DRIVERS
HRS' ratings are supported by the company's competitive position in the
defense industry; technology capability; sizable international and
commercial sales; good product diversification; adequate liquidity; and
large backlog. The company has solid cash generation and strong
operating margins and is expected to realize significant cost savings
from the XLS acquisition. Additionally, HRS is a sole source provider
for many of XLS' products. The ratings are also supported by adequate
financial flexibility and Fitch's expectations that the company will
improve its credit metrics over the next three years largely driven by
voluntary and scheduled debt reductions.
Acquisition benefits are likely to include better scale and a more
balanced product portfolio. The company has identified more than $100
million of potential annual cost savings, though it will be partly
offset by higher interest expenses and one-time integration expenditures
in the range of $130 million to $150 million necessary to achieve the
Some of HRS' post-acquisition leverage metrics will be weak for the
ratings. Fitch estimates the company's leverage (debt to EBITDA) and
adjusted leverage (adjusted debt / EBITDAR) will be 3.1x and 3.3x,
respectively, a significant deterioration compared to 1.5x and 1.7x at
the end of fiscal 2014 (ended June 30, 2014). Fitch estimates HRS'
credit metrics will improve over the next two years driven by modest
revenue growth and voluntary debt repayment. The recently announced $1.3
billion term loans will be repayable without penalties and HRS targets
retiring approximately $1.8 billion in debt over the next three years to
bring its net debt leverage to 1.5x (which Fitch estimates is equivalent
to approximately 1.7x on a gross leverage basis) as communicated during
the announcement of the XLS acquisition. Fitch expects HRS' leverage and
adjusted leverage will decline to approximately 2.2x and 2.5x,
respectively, by the end of fiscal 2017. Funds from operations (FFO)
adjusted leverage is also expected to improve to approximately 3x during
the same time frame.
Despite HRS' elevated post-acquisition leverage, Fitch believes the
company will have an investment grade profile due to strong cash
generation, solid financial flexibility, strong margins and
technological advantages compared to some of its peers. Fitch notes HRS'
management is committed to maintaining investment grade ratings and has
publically stated its goal to de-lever rapidly. Fitch also notes that
many of the company's other credit metrics (profitability, diversity,
backlog, etc.) are indicative of a strong investment grade company.
The ratings are also supported by adequate financial flexibility. Fitch
expects the post-acquisition company's liquidity will be in the range of
$1.3 billion to $1.5 billion consisting of cash and nearly full
availability under its $1 billion RCF. Fitch expects HRS' liquidity will
remain steady over the next several years as Fitch anticipates the
company's cash balances will not increase due to rapid debt repayment.
Additionally, Fitch expects the company will generate approximately $600
million of annual free cash flow (FCF - Cash Flow from Operations less
CapEx and Dividends).
Fitch will focus on merger integration risks, but these risks are
mitigated by the significant experience of HRS' current management team
members in successfully integrating businesses, as it has participated
in numerous acquisitions. Additionally, Fitch views the friendly nature
of the acquisition as a positive in overcoming challenges associated
with an integration of this scale.
Other concerns include uncertainty surrounding HRS' ability to realize
identified synergies, XLS' large pension deficit (including a relatively
high percentage of Level III assets), and corresponding future pension
funding requirements. Fitch is also concerned with the accelerated
timetable for the acquisition. HRS expects to complete the acquisition
by June 2015 and the company will incur significant costs if the
acquisition does not proceed as planned. Additionally, Fitch is
concerned about HRS' future cash deployment strategies, but expects the
company's share repurchases will be moderate.
There is also likely to be some strategic uncertainty given the
possibility of future portfolio actions, but Fitch anticipates HRS will
not make sizable acquisitions until it completes XLS' integration and
reduces its leverage. The company's ratings will also be exposed to
shocks and downturns in U.S. military spending or shifts in spending
mix, although Fitch believes there is a good chance that spending is now
at or near a trough. Fitch also notes that despite the larger scale that
will result from the acquisition, HRS will remain smaller than many of
its key competitors.
HRS will assume XLS's sizable pension deficit of $1.9 billion (70%
funded) as of Dec. 31, 2014, up from $1.2 billion (78% funded) at the
end of 2013. The deterioration in the funded status of the pension plans
was primarily driven by a decrease in discount rates and new
mortality/actuarial assumptions. The domestic pension benefit obligation
was $6.8 billion at the end of 2014. Required cash contributions to the
company's plans were $133 million in 2014; however, the large pension
deficit and required contributions are mitigated by the expected
reimbursements from the U.S. government, which treats a part of pension
costs as allowable, and reimbursable costs under some contracts.
Fitch's key assumptions within its rating case for the issuer include:
--Low single-digit revenue growth.
--EBITDA margins at approximately 21% immediately following the merger,
with modest increases in the following years, reflecting Fitch's
conservative view of the realized merger synergies. Fitch excluded
synergies in its modeling resulting in slower than possible revenue and
--Debt repayment will be accelerated and driven by the company's cash
generation. Fitch notes HRS' leverage may be reduced faster if the
company realizes planned synergies, allocates less cash to share
repurchases and dividend increases, or divests assets.
--Dividend payout ratio will remain unchanged from HRS' pre-acquisition
--Share repurchases will be suspended in fiscal 2016, but will resume in
fiscal 2017. Fitch expects share repurchase amounts will depend on
internal cash generation and may not resume in fiscal 2017 if the
company's is not on target to achieving its 1.5x net leverage goal by
the end of fiscal 2018.
--Cash flow generation will be solid and the company will generate above
approximately $600 million FCF annually after giving effect to pension
contributions and dividends.
--The company will contribute approximately $160 million towards its
pension liabilities annually.
--Capital expenditures will fluctuate in the range of 2.25% to 2.75% of
Fitch does not expect to take positive rating actions until HRS reduces
its leverage and makes progress on the merger integration. Fitch will
consider upgrading HRS if the acquisition is not completed and HRS
continues operating with its existing capital structure. Any upgrade
would likely be limited to two notches.
Fitch may take a negative rating action if the post-acquisition
company's leverage and adjusted leverage remain above 2.5x and 2.75x for
a prolonged and sustained period of time. Fitch may also consider a
negative rating action if the company's FCF margin declines and remains
below 4%. Additionally, a negative rating action may be considered if
the merger results in unforeseen operating challenges and the company
fails to achieve expected financial results, or if the company engages
in sizable share repurchases or acquisitions prior to reducing leverage.
Fitch has assigned the following ratings to HRS:
--Senior unsecured revolving credit facility 'BBB-';
--Senior unsecured three- and five-year term loans 'BBB- EXP';
--Senior unsecured notes and debentures 'BBB-';
--Short-term IDR 'F3';
--Commercial paper 'F3'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent
and Subsidiary Linkage' (May 28, 2014);
--'2015 Outlook: Global Aerospace and Defense (Traffic and Order
Backlogs Trump Fuel)' (Dec. 17, 2014);
--'Fitch Places Exelis Inc. on Rating Watch Negative Following
Acquisition Announcement' (Feb. 9, 2015);
--'Aerospace and Defense: Ratings Navigator Companion' (Nov. 14, 2014).
Applicable Criteria and Related Research:
Aerospace and Defense: Ratings Navigator Companion
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage
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