Fitch Ratings has affirmed Seagate Technology plc's and its wholly-owned subsidiary, Seagate HDD Cayman's, Long-Term Issuer Default Ratings (IDR) at 'BB+'.

In addition, Fitch has affirmed Seagate HDD Cayman's senior unsecured rating at 'BB+'/'RR4'. The Rating Outlook is Negative.

The ratings and Outlook reflect Fitch's expectation that FCF and leverage metrics will remain pressured over the near-term due to the severity of the recent downturn, despite largely normalized inventory across Seagate's markets and recovering cloud demand, including artificial intelligence (AI) infrastructure. Fitch forecasts only modest near-term FCF and EBITDA leverage still in the mid-3x range even assuming it repays the $479 million of senior notes maturing in January 2025.

Key Rating Drivers

Capital Allocation Shift: Fitch expects Seagate to use FCF (CFO - Capex - Dividends) and a substantial portion of net proceeds from divestitures for debt reduction rather than share repurchases in order to accelerate the return of credit metrics to within Fitch's rating sensitivities. Nonetheless, Fitch does not forecast EBITDA leverage below our 3.0x negative rating sensitivity until fiscal 2026. Prioritizing the use of FCF for debt reduction is a departure from Seagate's prior financial policies, which include using at least 70% (but typically closer to 100%) of pre-dividend FCF for common dividends and stock buybacks.

Beyond Seagate's April 13, 2024 sale of intellectual property (IP), equipment and certain other assets related to its system-on-chip business to Broadcom for $600 million of cash consideration, Fitch does not expect significant divestitures through the rating horizon.

Improving Profitability Profile: Fitch expects the magnitude of the downturn to reset Seagate's baseline profitability below historical levels but cost reductions and a richer product sales mix to strengthen the company's profitability profile. Over the nearer-term, Fitch expects EBITDA margins approaching 20% and modest positive FCF. In the longer run, Fitch anticipates EBITDA margins will return to the low 20% and, in conjunction with moderating capital intensity, drive mid- to high-single digit FCF margins.

Meanwhile, Seagate has already achieved the $200 million of run-rate operating expense savings from the cost reduction initiatives aimed at footprint optimization that the company announced in fiscal 2023. Fitch expects cloud spending, including AI infrastructure investments, to drive an increase in higher gross profit margin mass capacity products as a percentage of consolidated revenue, which now represents more than 80% of consolidated revenue versus three quarters in fiscal 2022 and two-thirds in fiscal 2021.

Secular Demand: Fitch believes robust demand for storage across media types provides a path for modest positive organic long-term revenue growth. AI and 5G-enabled applications across computing environments will be a significant driver of demand. Fitch expects the significant majority of data creation will be cool/cold storage on lower cost hard-disk drive (HDD)-based capacity drives in the public cloud, driving the bulk of Seagate's long-term revenue growth, with surveillance penetration and other edge applications leading the remainder of top-line growth.

Constructive Industry Conditions: Fitch believes Seagate's nearly 50% capacity drive market share supports constructive supply conditions that should enable long-term profitable growth and solid FCF margins. Seagate's intensified capital spending in recent years and repurposing of existing capacity as legacy revenue declines should enable the company to manage capital spending at structurally lower levels through the forecast period, including lower near-term capacity additions.

Meaningful Technology Risk: Fitch believes storage technology and product risks remain meaningful, with regular areal density increases required to offset significant pricing pressure to sustain HDD's total cost of ownership (TCO) advantage over SSDs and keep pace with its chief competitor, Western Digital Corp. ('BB+'/Negative Watch). Energy assist-based drives promise to provide a roughly decadelong roadmap to drives of more than 50 terabytes, reducing Seagate's technology risk. At the same time, the breakdown of Moore's Law constrains SSD makers' ability to close the TCO gap.

Derivation Summary

The severity of the recent downturn has weakened Seagate's position relative to the 'BB+' rating and will constrain near-term FCF and credit metrics. Seagate's operating profile hinges upon its strong market positions in HDDs, significant barriers to entry from moderate investment intensity required for meaningful market participation and secular demand for storage solutions supporting higher-than global GDP long-term revenue growth. Our expectations for lower than historical FCF over the next few years in the face of upcoming debt maturities weakens Seagate's financial flexibility and financial structure factors.

Fitch views Seagate's operating profile as overall in line with that of HDD competitor, Western Digital, particularly pro forma for Western Digital's planned spinoff of its Flash Memory from the disk drive business. Together Seagate and Western Digital represent the vast majority of high capacity disk drives, markets benefitting from secular growth dynamics. Until separation, Western Digital's higher long-term growth prospects by virtue of its exposure to flash are offset by far greater cyclicality, given a less consolidated industry structure and more commodity-like nature of flash products. Investment intensity ends up being similar for Seagate and Western Digital mainly due to the latter's ability to source NAND flash while sharing investment intensity with its JV partner.

Fitch views Seagate's financial profile as roughly in-line with that of Western Digital, due to the latter's traditionally more conservative financial policies, including prioritization of FCF for debt reduction to achieve a then target EBITDA leverage metric and dividend suspension in support of that target. Meanwhile, Seagate has no publicly-articulated financial policies and historically prioritized share repurchases on top of an annual dividend that consumes roughly half of average annual FCF, putting its financial flexibility metrics in-line with the 'bb'-category.

Seagate's debt, excluding debt Fitch attributes to the company's unrated accounts receivable factoring arrangement, is unsecured and Fitch's Corporate Recovery Ratings and Instrument Ratings Criteria caps senior unsecured debt at 'RR4'/+0.

Key Assumptions

Strengthening FY24Q4 revenue to drive low teens negative revenue growth for full fiscal 2024, followed by robust revenue growth in fiscal 2025 from depressed levels;

Longer-term revenue growth in the low- to mid-single digits, driven by cloud spending, including on AI infrastructure;

EBITDA margins recover to approach 20% in fiscal 2025 expand through the out years;

Dividends remain roughly flat and capital spending is at the mid-point of 4%-6% long-term guidance;

Seagate uses FCF and a substantial portion of net proceeds from its system-on-chip business sale for debt reduction over the next couple of years;

Longer-term, Seagate resumes returning cash flow to shareholder through dividends and buybacks.

RATING SENSITIVITIES

Fitch could stabilize the Outlook for the 'BB+' ratings if we expect Seagate to sustain EBITDA leverage below 3.0x.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Public commitment to manage debt levels for total leverage sustained below 2.5x;

Expectations for annual FCF margins consistently in the mid to high single digits while growing revenue, structurally higher market share and diversifying end market and product exposure.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Expectations for annual FCF sustained below $500 million or FCF margins in the low single digits from persistently weaker than expected revenue trends or profit margins, indicating poor execution on its roadmap;

Expectations for total leverage sustained above 3.0x, from debt issuance to support debt-funded shareholder returns persistently in excess of FCF.

Liquidity and Debt Structure

Fitch views Seagate's liquidity as adequate and, as of March 29, 2024, consisted of $795 million of cash, cash equivalents and short-term investments, and an undrawn $1.5 billion senior unsecured revolving credit facility due Sept. 14, 2026. Fitch's expectations for a return to positive FCF in fiscal 2025 and average annual FCF of $250 million-$500 million through the forecast period also support liquidity. Over the nearer-term, $600 million of net proceeds from the systems-on-chip business sale to Broadcom, Inc. on April 13, 2024 supports the company's $479 million of 4.75% senior notes maturing Jan. 1, 2025.

Issuer Profile

Seagate Technology Plc (Seagate) is a leading provider of data storage technology, primarily HDDs but also other storage solutions that enable customers to manage exponentially growing data from end-point to cloud.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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