Oct 1 (The following statement was released by the rating agency)
Fitch Ratings has affirmed Deutsche Telekom's (DT) Long-term Issuer Default Rating (IDR) at 'BBB+' with a Stable Outlook. Fitch has also affirmed DT's senior unsecured rating at 'BBB+' and Short-term IDR at 'F2' This includes the debt issued by Deutsche Telekom International Finance B.V. and guaranteed by DT.
DT is an established incumbent operator in Germany. It faces only modest competitive pressures domestically on the back of sustainably strong market positions and a benign economic environment leading to stable cash flow generation. These strengths are diluted by notably more weakness in its European franchise suffering from austerity across the region, and multiple challenges in the US market. High leverage relative to the current 'BBB+' rating provides little financial flexibility within the rating.
KEY RATING DRIVERS
Strong Incumbent Position
As an incumbent operator, DT benefits from strong domestic positions. The company holds reasonably large retail market shares in key segments which have been largely sustained. DT is also a key infrastructure provider which entitles it to substantial wholesale revenues. The incumbent's accelerated capex into fibre upgrades/vectoring and LTE improves its competitive positions with positive implications for the top line.
Pressures Across Europe
Nearly all of DT's European countries of operations experience an impact of austerity and economic jitters to a varying degree which translates into weak financial performance. DT has been able to generally withstand competitive pressures performing on a par with or better than its peers. However, this was not enough to reverse negative financial performance trends. At least moderate pressures are likely to continue over the medium-term.
US Operating Turnaround, Challenges
After a merger with MetroPCS, DT's T-Mobile USA emerged as a stronger and larger market player with a spectrum portfolio sufficient to catch up with larger players in terms of LTE coverage. However, challenges are multiple. The merits of the company's 'un-carrier' business model that implies low average revenue per user but also low subscriber acquisition/retention cost per customer remains largely untested in this market. The company's operating turnaround in Q213 had a pronounced negative impact on the company's EBITDA generation. A migration of MetroPCS's CDMA customers to the UMTS/LTE network entails a risk of churn increases or uncontrolled handset subsidies and subscriber retention costs.
High Leverage, Depressed FCF
DT's leverage is high for its rating level, and is projected to be close to Fitch's downgrade trigger of 3.5x in funds from operations (FFO) adjusted net leverage at end-2013. Fitch expects that the company would deleverage from that level in 2014 - a failure to do so would likely indicate the management's higher debt tolerance than currently expected by the agency. Fitch believes the company retains a deleveraging capacity based on its positive free cash flow generation. However, cash flows will be depressed by high network investments over the next three to four years. The company is facing high capex in the US in 2013, but also in Germany in 2014-2016, and is exposed to spectrum auctions across Europe in 2013-2014. Dividend cuts can only partially offset high investments and EBITDA pressures.
A negative rating action could be driven by a rise in leverage to above 3.5x FFO adjusted net leverage without a clear path to deleveraging. Pressure on free cash flow driven by EBITDA margin erosion, higher capex and shareholder distributions, or significant underperformance in the core domestic market and at other key subsidiaries may also be negative for ratings. A commitment to a lower leverage target and stabilisation of operating performance across the entire franchise may be rating-positive.