TEXT-Fitch assigns KPN's hybrid securities expected 'BB(EXP)' rating
(The following statement was released by the rating agency)
Feb 28 - Fitch Ratings has assigned Royal KPN N.V.'s (KPN, 'BBB-'/Stable) proposed reset subordinated perpetual and long-dated capital securities an expected rating of 'BB(EXP)'. The final rating is contingent on the receipt of final documents conforming materially to the preliminary documentation.
KPN intends to raise EUR2bn in hybrid securities in EUR and GBP tranches over time. The upcoming hybrid securities are proposed to be deeply subordinated and to rank senior only to KPN's ordinary shares, while coupon payments can be deferred at the option of the issuer. As a result of these features, the 'BB(EXP)' rating assigned to the proposed securities is two notches below KPN's 'BBB' Long-term Issuer Default Rating (IDR), which reflects the securities' increased loss severity and heightened risk of non-performance relative to the senior obligations. This approach is in accordance with Fitch's criteria, "Treatment and Notching of Hybrid in Nonfinancial Corporate and REIT Credit Analysis" dated 13 December 2012 at www.fitchratings.com.
Subject to KPN's AGM on 10 April 2013 approving the company's EUR3bn rights issue, the proposed securities qualify for 50% equity credit as they meet Fitch's criteria with regards to subordination, effective maturity of at least five years, full discretion to defer coupons for at least five years and limited events of default. If the rights issue is not completed, KPN may redeem the securities or there will be a 5% coupon step-up six months after the securities have been issued.
KPN has a call option to redeem the notes on the first call date not before 2018, and there will be a coupon step-up of 25bps not before 10 years after issue and a further incremental step-up of 75 bps 20 years after the first call date . KPN will also have the option to redeem the notes prior to the first call date for accounting, tax, rating agency or change of control reasons.
The proposed EUR securities have no maturity date while the GBP securities are expected to have a 60 year maturity. However, the issues will no longer be subject to replacement language disclosing the company's intent to redeem the instrument from 20 years after the first call date with the proceeds of a similar instrument or with equity. Hence this date is viewed as the securities' effective maturity date. The instrument's equity credit would switch to zero five years prior to this date (i.e. 15 years after the first call date).
There is no look-back provision in the securities' documentation, which gives the issuer full discretion to defer ongoing coupon payments on these securities. Deferrals of coupon payments are cumulative. The company will be obliged to make a mandatory settlement of deferred interest payments under certain circumstances, including a declaration or payment of a dividend.
KEY RATING DRIVERS
KPN's plans to strengthen its balance sheet show that the company is committed to maintaining its investment grade profile. However, Q412 results show that the company continues to operate in a challenging environment. Fitch does not expect KPN's operating free cash flow to recover significantly in 2013 and 2014.
- Muted Cash Flow Generation
Fitch expects KPN's 2013 underlying EBITDA to be significantly lower than in 2012. Fitch expects capex to remain around 2012 levels as KPN continues to upgrade its networks to maintain its leading position in the Netherlands and to boost growth in Germany. Improvements in operating free cash flow over the next few years will depend on how successful KPN is in stabilising its domestic position and taking market share in Germany.
- Mobile New Entrant Threat
KPN has managed to obtain a good spectrum in the auction, which should help underpin the company's longer-term competitive position in the Dutch mobile market. However, Tele2 plans to launch the fourth mobile network in the Netherlands after purchasing attractive 800MHz spectrum in the auction to complement its previously acquired 2.6GHz spectrum. This new entrant is likely to be intent on gaining market share, which could lead to increased price competition.
- High Domestic Fixed-Line Competition
Competition also remains intense in the fixed-line segment, where Dutch cable TV operators are the main threat. Although KPN stabilised domestic residential broadband subscribers in Q312, profitability remains under pressure. In response to the cable threat, KPN is upgrading its network through Reggefiber, KPN's joint venture to rollout a fibre-to-the-home (FTTH) network in the Netherlands.
- Reggefiber liabilities
KPN could own 100% of Reggefiber by 2017 (after the exercise of two options, subject to regulatory approval) which leads us to include all of the Reggefiber-related liabilities when assessing KPN's credit profile. These liabilities include the exercise of options to buy the 49% of Reggefiber that KPN does not own, and the shareholder loans and external financing incurred to support the FTTH network rollout. By end-2014, when KPN mighthave to fully consolidate Reggefiber, Fitch estimates these liabilities could amount to around EUR2bn, including the contingent liability from the last option exercisable as of 2017.
- Continued deterioration in KPN's domestic fixed and mobile operations
- An expectation that net debt/EBITDA (including Reggefiber-related liabilities) could exceed 3.5x on a sustained basis could lead to a downgrade
- Successful completion of the proposed EUR4bn rights issue would result in KPN's leverage falling below the key 3.0x threshold. To consider positive rating action, Fitch would also want to see clear evidence that there is a sustained improvement in KPN's domestic fixed and mobile operations.