OREANDA-NEWS. Fitch Ratings expects to assign the following initial ratings with a Stable Outlook to Computer Sciences Government Services, Inc. (CSGov) upon completion of CSGov's spin-off from Computer Sciences Corp. (CSC):

--Issuer Default (IDR) 'BBB-'.

Fitch anticipates that CSGov's unsecured issue ratings will be consistent with the company's expected IDR once the capital structure is finalized. Fitch's actions will affect $3.5 billion of expected unsecured debt financing, including an undrawn $500 million RCF.

Computer Sciences Corp. (CSC) will separate its commercial and government businesses via a tax-free spin-off of CSGov. The company expects to complete the separation by October, 2015, pending regulatory approval. Concurrent with the separation, CSGov will pay a special dividend of $10.50 per share (approximately $1.5 billion) to CSC's shareholders.

CSC also entered into a definitive agreement to acquire SRA International, Inc. (SRA) upon completion of the CSGov spin-off. CSGov will pay a total consideration of $1.4 billion, including a $390 million cash payment to SRA owners led by Providence Equity Partners, and the assumption of $1 billion of net debt. CSGov will fund the special dividend and acquisition of SRA with $3.5 billion of committed unsecured debt financing, including a $500 million undrawn revolver.

SRA provides increased scale, scope, and a leading position in healthcare. The acquisition also provides complementary capabilities in cloud computing, cyber security, IT infrastructure, mobility, data analytics, and software and systems engineering. SRA will represent approximately 20% of CSGov's pro forma revenue. Targeted net synergies of $50 million should bring SRA's 12% EBITDA margin in line with CSGov's 15% EBITDA margin. Fitch also believes minimal customer overlap provides potential cross-selling opportunities.

Pro forma for the transactions and debt issuance, Fitch expects total leverage (total debt to operating EBITDA) of 3.5x (3.3x after expected net synergies) upon separation. Nonetheless, Fitch expects CSGov will use FCF for debt reduction resulting in total leverage below 3x over the next 12 - 18 months. Fitch expects more than $300 million of annual FCF over the intermediate term.

KEY RATING DRIVERS

Rating strengths include:

--Significant recurring revenue driven by a 90% win-rate on recompetes and nearly 80% of revenue coming from long-term services contracts. CSGov has maintained win rates of nearly 30% on new contract bids while increasing bid volumes 39% in FY 2015 from the previous year. This has been somewhat offset by smaller contracts.

--CSGov's double digit operating income margin is the highest among the top 10 government IT services companies due to scale, a higher mix of fixed price contracts, and cost discipline. Cost control under a fixed price contract allows higher profitability vs. a cost plus contract that requires cost savings be passed to the client. The higher mix of fixed price contracts also increases the downside risk to operating margins, given the inability to pass on higher than expected delivery costs to clients.

--SRA will give CSGov a strong competitive position and top market share in the rapidly growing U.S. government healthcare business (growing 20%).

Rating concerns include:

--Top line risk due to constrained U.S. government budgets and an uncertain political environment. CSGov's fiscal 2014 revenue declined 12% primarily due to government budget cuts under sequestration. Fitch projects CSGov's annual revenue growth will be 2% over the intermediate term which is roughly in line with the annual increases under sequestration for defense and non-defense discretionary spending. Fitch believes changes related to the sequestration, particularly for defense spending, would likely be to the upside.

--Concentration risk from CSGov's reliance on government contracts. The vast majority of CSGov's business comes from 12 large government agencies, and the top ten contracts represent nearly 50% of revenue. The lack of diversification is offset by long term contacts (average 3 to 5 years) and the stickiness of the IT services CSGov provides, particularly services related to security and intelligence. The SRA acquisition will provide some contract diversification given SRA's largest contract is 3% of revenue and top 10 contracts are less than 20% of SRA's revenue.

--CSGov's deleveraging plan could be derailed by execution missteps given most of the company's FCF will be needed for debt repayment.

KEY ASSUMPTIONS

--Organic revenue growth in the low single digits over the intermediate-term, which is roughly in line with the defense and discretionary spending increases scheduled under the sequester.
--Concurrent with the separation from CSC, CSGov will pay a $1.5 billion special dividend to CSC shareholders.
--CSGov will make debt reduction with FCF a priority following the acquisition of SRA.
--100 basis points of margin improvement by FY 2018 from synergies related to the SRA acquisition.
--No significant acquisitions until the company integrates SRA and achieves its total leverage target below 3x.
--Minimal cash balance of $300 million.
--Up to $50 million of annual dividends.

RATING SENSITIVITIES

Negative rating actions could occur if Fitch expects:
--CSGov will sustain total leverage above 3x due to lower than expected revenue growth from weaker than anticipated government spending or intensified contract pricing; or
--Lower than anticipated debt reduction due to structurally weaker than forecast FCF or more aggressive financial polices to fund dividends or share repurchases.

Positive rating actions could occur if Fitch expects:
--CSGov will sustain total leverage near 2x; or
--Post-dividend FCF margin exceeds 10% over a sustained period of time.

LIQUIDITY

Pro forma for the separation and SRA acquisition, CSGov's liquidity position will be solid supported by:
--$300 million of cash (all in U.S.);
--$500 million under an undrawn revolver; and
--$450 million committed A/R facility.

Fitch's expectation for more than $300 million of annual FCF also supports liquidity. CSGov will not be required to make material cash contributions to its pension plans over the intermediate-term given the aggregate excess funding balance of $320 million, supporting sufficient FCF for rapid debt reduction over the intermediate-term.

Fitch expects CSGov's pro forma total debt will consist of $3 billion of unsecured loans and notes.