... These Senior Notes Rated by Fitch Rates BBB- StorageNewsletter

Fitch Ratings has assigned a BBB- rating to Seagate HDD Cayman’s proposed issuance of $1 billion of senior unsecured notes due in 2023.

The notes will be guaranteed by Seagate Technology plc, the parent company of Seagate HDD. The Rating Outlook is Stable.

Fitch believes Seagate HDD’s debt issuance will have minimal effect on Seagate’s consolidated leverage (total debt/operating EBITDA) and strengthen interest coverage (operating EBITDA /interest expense) in the intermediate term as the vast majority of the net proceeds from the debt offering are anticipated to be used to repay existing debt bearing higher coupon rates.

The Ratings and Outlook reflect:

Expectations for relatively stable HDD drive pricing going forward due to a highly consolidated industry structure, as the top two companies, Seagate and Western Digital Corp., control 88% of the market; strong HDD growth in exabytes shipped (30%-40% annually) in excess of areal density growth largely driven by the cloud and usage of internet-enabled mobile devices; increasing shipment linearity and tightly managed capital expenditures across the supply chain that minimizes the risk of supply and demand imbalances.

The increasing linearity in HDD shipments reflects the declining correlation with PC demand due to strong growth in near-line enterprise HDD storage for use in cloud data centers. IDC estimates worldwide PC shipments declined 15% sequentially in the first quarter of 2013, yet the total addressable market for HDDs was nearly flat sequentially (-0.2%), according to WDC.

Positive profitability implications from a favorable mix shift towards higher capacity HDDs for cloud computing that require greater media and heads per drive, thereby absorbing a greater amount of fixed-cost investments than lower capacity PC drives. Seagate’s average drive capacity increased 60% year-over-year to 823GB in the quarter ended Dec. 28, 2012, despite acquiring Samsung’s predominantly notebook HDD business.

Solid liquidity and financial flexibility are supported by $1.9 billion in cash, the vast majority of which is readily accessible without adverse tax considerations, generally positive annual free cash flow (FCF), and an undrawn $500 million senior unsecured revolving credit facility due 2018.

Fitch believes Seagate’s FCF volatility will continue to moderate due to a more stable HDD pricing environment, lower demand volatility, favorable product mix shift and cautious approach to capital investments that increase HDD manufacturing capacity. Seagate has generated positive FCF for four consecutive years on a trailing 12-month basis.

Strong credit protection metrics and management’s commitment to conservative financial policies;
Broad product portfolio and significant scale in HDD industry;
The company’s vertically integrated model, which reduces per-unit manufacturing costs and facilitates new product time to market.

Fitch’s rating concerns consist of:

Long-term threat of technology substitution from NAND flash-based SSDs, including risk of consumers substituting traditional notebooks with HDDs for ultrabooks equipped with SSD or media tablets with flash-based storage.

The high relative cost of flash-based storage compared with HDDs continues to limit the amount of storage capacity on PCs and tablets, increasing demand for storage in the form of hybrid HDDs, cloud and external storage, areas where Seagate continues to be well positioned. Seagate’s Pulsar 800GB MLC SAS enterprise SSD currently retails for $6,599, or $8.25 per GB, nearly 12x the cost per gigabyte of HDD.

Fitch expects PC demand to recover in the second half of calendar 2013 due to normal seasonality and a plethora of new convertible notebook PCs that more closely align with user requirements, including lower price points enabled in part by lower cost hybrid solid state drives, and improved battery life supported by Intel’s upcoming, more efficient microprocessor, codenamed Haswell.

Substantial historical volatility in earnings and free cash flow due to the cyclicality of HDD demand and significant fixed costs;
Moderating, but still consistent declines in ASPs for HDDs due to low switching costs;
Event risk associated with implementation of aggressive shareholder-friendly activities, primarily debt-financed share repurchases;
Ability to sustain a time to market advantage critical to achieving market share gains and maintaining overall profitability, given formidable competition from WDC.

Rating Sensitives

Positive:

Future ratings upgrades are currently unlikely due to the long-term threat of technology substitution from SSD, where Seagate lacks a dominant product position relative to HDDs.

Negative:

If the cost per gigabyte differential between enterprise HDD and SSD narrows, resulting in greater than expected cannibalization of enterprise HDDs, and Seagate’s enterprise SSD products are uncompetitive;
If Seagate’s enterprise market share materially erodes due to more formidable competition from WDC;
If the company pursues more aggressive financial policies, such as sizable debt-financed share repurchases.
If ultrabooks with SSD materially cannibalize the traditional notebook market, SSHs fail to achieve significant penetration in the ultrabook market and growth in near-line enterprise and external HDDs is insufficient to offset the decline in exabytes shipped to the notebook HDDs.

FCF (post dividends) was nearly $2.8 billion in the latest 12 months ended March 29, 2013 compared with $1.1 billion in the corresponding year ago period due to supply shortages from the Thailand flood that inflated ASPs. Fitch forecasts at least $1.9 billion of FCF annually through fiscal 2015 ended June 29.

Financial covenants in the credit agreement consist of a minimum fixed-charge coverage of 1.5x and a maximum net leverage ratio of 1.5x. In addition, the facility requires minimum liquidity of $700 million.

Leverage (total debt/operating EBITDA) decreased to 0.7x as of March 29, 2013 from 0.9x in the year-ago period. Fitch anticipates Seagate’s leverage will remain below 1x.

Interest coverage (operating EBITDA/gross interest expense) increased to 16.1x in the Lended March 29, 2013 compared with 12.6x last year. Fitch anticipates interest coverage will remain above 17x through fiscal 2015.

Total debt as of March 29, 2013 was
approximately $2.5 billion and consisted of: