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VMware, Inc. -- Moody's places VMware's ratings under review for downgrade following announcement of a special dividend

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Rating Action: Moody's places VMware's ratings under review for downgrade following announcement of a special dividendGlobal Credit Research - 15 Apr 2021$4.75 billion of rated debt affectedNew York, April 15, 2021 -- Moody's Investors Service ("Moody's") placed VMware, Inc.'s ("VMware") Baa2 senior unsecured rating under review for downgrade following the announcement that VMware will issue a special cash dividend of $11.5 billion to $12 billion in conjunction with Dell Technologies Inc.'s ("Dell") plans to distribute its approximately 81% ownership interest in VMware to its shareholders. The transactions are expected to close in the fourth quarter of 2021.On Review for Downgrade:..Issuer: VMware, Inc.....Senior Unsecured Regular Bond/Debenture, Placed on Review for Downgrade, currently Baa2 Outlook Actions: ..Issuer: VMware, Inc. ....Outlook, Changed To Rating Under Review From StableRATINGS RATIONALE / FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSVMware intends to finance the special dividend with incremental debt and $2.5 billion to $3.5 billion of cash on hand. Pro forma for the increase in debt, Moody's estimates that VMware's total debt to EBITDA (Moody's adjusted) will increase to around 5x (Moody's adjusted), and the ratio of cash and investments to total debt (Moody's adjusted) will be about 15% at fiscal year ending January 2022. At FYE '21, VMware's total debt to EBITDA was about 2x and cash and investments represented 73% of total adjusted debt. VMware expects to use its free cash flow primarily to reduce debt for two years after the special dividend transaction.The ratings are under review for downgrade to reflect the significant erosion in VMware's credit metrics after the special dividend. The ratings review will focus on: (i) VMware's cash balances and debt capital structure after the spin-off transaction; (ii) Moody's assessment of VMware's debt reduction plans after the special dividend; and, (iii) our understanding of risks in commercial agreements between Dell and VMware after their separation.Subject to the terms of the financing and capital structure upon the close of the transactions and Moody's expectation for the pace of deleveraging over the 12 to 24 months after the special dividend, the senior unsecured ratings could be downgraded by one notch to Baa3. VMware has large operating scale, strong profitability and high revenue-to-free cash flow conversion. Moody's expects VMware to generate $3.3 billion to $3.5 billion in annual free cash flow over the next 2-3 years. The company's growing proportion of recurring revenues under software maintenance and subscription and Software as a Service (SaaS) agreements, the high growth rates in its subscription and SaaS revenues, and the $11.3 billion of Remaining Performance Obligations provide high cash flow visibility over the next 12 to 18 months.Moody's expectation that the ratings downgrade could be limited to one notch primarily reflects its view that VMWare's total debt to EBITDA could decline to 3.5x or lower by FY '24 if the company applies a meaningful share of its free cash flow after the dividend recapitalization toward debt reduction. Moody's further expects VMware to generate free cash flow of over 25% of its adjusted debt and maintain cash balances of over 15% of total adjusted debt over this period.VMware's credit profile additionally reflects its large installed base, a broad portfolio of infrastructure software technologies, and its market leadership in the server virtualization category. Moody's expects VMware's offerings that enable its customers to modernize applications and Information Technology (IT) infrastructure and manage IT assets across on-premise and public cloud environments will support revenue growth in the high single digits over the next 2 to 3 years. VMware's ongoing transition from perpetual licenses to subscription software sales will depress its reported revenues, profitability and operating cash flow over this period, but the transition will strengthen its credit profile as the more predictable subscription sales will account for a growing share of revenues. These supporting factors balance VMware's elevated financial risk profile and high business risks from intense competition across its product lines, the high proportion of its revenues that are derived from the mature server virtualization software segment and the declining on-premise traditional data center category, and rapidly evolving infrastructure technologies.Governance considerations are a key driver of this rating action. VMware paid a special dividend of $11 billion in FY '19 to support strategic goals of its shareholders and the planned dividend to accelerate Dell's deleveraging will again meaningfully erode VMware's credit metrics. The spin-off transaction is not expected to change the composition of VMware's Board of Directors. When compared to an overwhelming majority of the investment-grade rated technology companies that have highly diversified shareholding, VMware will still have a concentrated ownership. Affiliates of Michael Dell and Silver Lake Partners will collectively own over 50% of the common stock of VMware and Moody's believes they will continue to have an outsized influence in the key strategic and financial decisions of VMware.At the same time, Moody's believes that changes in corporate structure and certain governance practices and agreements relating to Mr. Michael Dell and Silver Lake Partners after the spin-off transaction are credit positive. VMware will no longer be a subsidiary of Dell and it will have a single class of common stock with equal voting power for all stockholders. Subject to the maintenance of certain minimum ownership thresholds, Mr. Michael Dell and Silver Lake Partners will have the right to nominate a total of 3 directors, and both will agree to vote in favor of all director candidates nominated by the Compensation and Corporate Governance committee, which consists of 4 independent directors. New standstill agreements will limit Mr. Dell and Silver Lake Partners from increasing their respective ownership interests by more than 1% of the outstanding shares after the spin-off transaction, while these agreements are in force. In addition, standstill agreements would limit Mr. Dell and Silver Lake Partners from taking actions that have the effect of controlling or changing the Board or management of VMware, or causing any material change in the capitalization, share repurchase practices, capital allocation practices or dividend policy of VMware. These limitations will be contingent upon maintenance of ownership interests above 7.5% and certain other conditions.Both Dell and VMware have benefited from a closer integration in multiple aspects of their businesses and both companies believe that the arm's length commercial agreements will preserve business and operational benefits. Moody's believes that the effectiveness of these agreements is uncertain and will only be proved over time.VMware, Inc. is a leading provider of infrastructure software to government and enterprise customers. Dell Technologies Inc. indirectly owns approximately 81% common equity interest in VMware.The principal methodology used in these ratings was Software Industry published in August 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1130740. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.At least one ESG consideration was material to the credit rating action(s) announced and described above.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Raj Joshi VP - Senior Credit Officer Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. 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