TEXT-S&P cuts KPN rating to 'BBB', outlook is stable
Overview -- We think Dutch telecoms incumbent operator Koninklijke KPN N.V.'s 2012 EBITDA will be weaker than we had anticipated in mid-2011 because of intense competition in its domestic market. -- In addition, higher pension and operating lease adjustments have increased the divergence between reported and Standard & Poor's adjusted debt leverage metrics for KPN in full-year 2011. Consequently, we anticipate markedly and durably higher debt leverage than we previously forecast. -- We are lowering our long-term rating on KPN to 'BBB' from 'BBB+'. -- The stable outlook reflects our belief that KPN will sustain its strong business risk profile and improve its credit metrics after a likely deterioration this year. Standard & Poor's Ratings Services lowered its long-term corporate credit rating on Dutch telecom incumbent operator Koninklijke KPN N.V. (KPN) to 'BBB' from 'BBB+'. We affirmed our 'A-2' short term rating on KPN. The outlook is stable. Rationale The downgrade reflects our view that KPN's Standard & Poor's-adjusted credit measures will deteriorate more significantly and durably than we previously anticipated. We consider that KPN's revenues, operating margins, and free cash flow will remain under sustained pressure owing to a combination of factors: -- Falling domestic mobile revenues, and, in our view, the still uncertain timing and extent of the benefits of KPN's recent product restructuring; -- Fierce ongoing competition from cable operators; -- Costs for retention efforts, copper network upgrades, and accelerated deployment and marketing of fiber-to-the-home products; and -- Required fixed outlays to support fourth-generation (4G) mobile technology deployment and potential spectrum acquisitions. In addition, increased debt adjustments on the back of higher pension deficit and operating lease commitments at year-end 2011 have pushed up KPN's adjusted debt leverage more than we previously anticipated, translating into an estimated adjusted ratio of debt to EBITDA of more than 3.0x at end-December 2011. We think that KPN's unadjusted leverage ratio will likely stand in the high end of management's 2.0x-2.5x range in 2012-2013, compared with 2.2x at year-end 2011, and that this would translate into a fully adjusted ratio within a 3.0x-3.5x range. We have consequently revised our assessment of KPN's financial risk profile to "significant" from "intermediate." We now anticipate that KPN's 2012 EBITDA after restructuring costs will drop by mid-to-high single digits in 2012, after a 6% fall in 2011, compared with our previous estimate of a low-to-mid single digit decline in 2011, followed by stabilization in 2012. In our base-case scenario, we forecast that KPN's EBITDA will rebound somewhat from 2013 onward, on successful cost savings and 2012 commercial investments. After dividends, we think KPN will retain only modest absolute debt reduction capacity in 2013-2014, whereas absolute debt could increase slightly this year given our anticipation for potential outlays to acquire spectrum. The ratings incorporate our assessment of KPN's still strong business risk profile, based on its solid, albeit eroding, domestic market positions, large scale diversification benefits derived from its successfully managed operations in Belgium and Germany, and overall consistent generation of free cash flow. Liquidity The 'A-2' short-term rating reflects our view of KPN's adequate liquidity under our criteria. Under our criteria, we assess KPN's liquidity using debt maturities and undrawn facilities available over a next-six-month basis, given our opinion of its well-established and solid relationships with banks, and that it will continue to have very good access to capital markets in the future owing to its domicile in the Netherlands and absent any exposure to more risky emerging economies. We also consider that KPN has prudent financial management, including a well-spread debt maturity structure with about EUR1 billion to EUR1.5 billion of annual long-term debt maturities, and still robust generation of free cash flow (after the "tax recapture" outflows) in excess of EUR1.5 billion on average annually, by our estimates. We also note that KPN has discontinued share buybacks this year. Tempering these positive aspects are our anticipation that dividend payouts could leave only modest discretionary cash flow, and heavy postretirement obligations, whose fluctuations, net of dedicated assets, may require additional cash contributions at times. The ratio of sources to uses is comfortably above 1.2x at year-end 2011, using next-six-months debt maturities and undrawn facilities. Liquidity sources comprise a EUR2 billion committed line maturing in 2016, without any financial maintenance covenants, of which EUR1.6 billion was undrawn at year-end 2011; our anticipation of about EUR3.5 billion funds from operations (FFO) for full-year 2012; and about EUR1 billion in reported cash at year-end 2011. Liquidity uses include EUR0.6 billion of short-term debt within the next six months at year-end 2011, and in full-year 2012 about EUR2.0 billion-EUR2.2 billion in capital expenditures, EUR1.2 billion in dividends, and EUR40 million in additional pension contributions given that KPN's statutory coverage of its pension obligations was below the 105% minimum coverage required by the Dutch pension regulator. Outlook The stable outlook reflects our view that KPN's product repositioning in mobile, fiber, and upgraded copper, and its cost management will help it to sustain its strong business risk profile and comfortably position the group at its rating level. The outlook also factors in improvement in KPN's adjusted ratio of debt to EBITDA in 2013 and beyond, after possibly increasing to the high end of 3.0x-3.5x this year under our revised base-case forecast. We could consider upgrading KPN if it managed to deliver a pronounced turnaround in its EBITDA from 2013 onward, sustained its strong business risk profile, and significantly reduced debt deleverage, so that its fully adjusted debt-to-EBITDA ratio would fall to below 3.0x. The possibility of a further downgrade of KPN is remote at this stage but could occur if we weakened our assessment of its business risk profile, and its ratios of debt to EBITDA and FFO to debt were to deteriorate to respectively 3.5x and to below the mid-20% area. Any continued weakening in KPN's EBITDA in 2013 could cause these ratios to deteriorate and lead us to revise our business risk assessment. Related Criteria And Research -- Principles Of Credit Ratings, Feb. 16, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Business And Financial Risks In The Global Telecommunication, Cable, And Satellite Broadcast Industry, Jan. 27, 2009 Ratings List Downgraded; Ratings Affirmed To From Koninklijke KPN N.V. Corporate Credit Rating BBB/Stable/A-2 BBB+/Stable/A-2 Senior Unsecured BBB BBB+ Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column. 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