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Fitch Places Sky's 'BBB+' on Rating Watch Negative; Guides to Potential 2-Notch Downgrade
July 29, 2014 / 10:36 AM / 3 years ago

Fitch Places Sky's 'BBB+' on Rating Watch Negative; Guides to Potential 2-Notch Downgrade

(The following statement was released by the rating agency) LONDON, July 29 (Fitch) Fitch Ratings has placed British Sky Broadcasting plc's (Sky) Long term Issuer Default Rating (IDR) and senior unsecured rating of 'BBB+' on Rating Watch Negative (RWN) following the announcement of Sky's proposed acquisition of 100% of Sky Italia and a 57.4% stake in Sky Deutschland from Twenty-First Century Fox. The most likely outcome of the RWN will be a two-notch downgrade to 'BBB-', with its resolution subject to closing of the deal, which remains subject to regulatory clearance and shareholder approvals. Management's commitment to an investment grade rating and track record of delivering targeted metrics is an important factor. The potential exists for financial metrics that might appear challenging at the investment grade level, given the required offer to Sky Deutschland minorities. However, this is not our base case, while Fitch believes mitigating action would be available and be taken by management in this event. KEY RATING DRIVERS Announced Transaction, Leverage and Downgrade Impact The transaction, including cash consideration of GBP4.9bn is expected to increase net debt / EBITDA from approximately 0.8x (YE14; based on unaudited results) to 2.9x. Fitch guides that, subject to the take-up of the tender to Sky Deutschland minorities, the transaction is likely to lead to a two-notch downgrade of Sky's ratings, given the expected deleveraging that management has guided to over the next two years. Unadjusted (net debt/EBITDA) leverage of 2.9x (assuming no or minimal Sky Deutschland tender take-up) implies funds from operations (FFO) net adjusted leverage of around 3.3x - verses a broad threshold of 3.0x to sustain the ratings at 'BBB-'. Management's guidance of deleveraging (on an unadjusted basis) of between 0.5x-0.7x by June 2016 should bring the FFO metric back to an investment grade threshold. Commitment to Investment Grade Rating Fitch considers Sky's management has a good track record in delivering results, both operational and financially. Similarly, the execution and integration of past acquisitions has been good; with financial policies managed to allow a healthy level of headroom within targeted rating levels. Fitch acknowledges the commitment that management has made to maintaining its investment grade rating and that mitigating action is likely if leverage metrics might otherwise be pressured by a high take-up of the Sky Deutschland minorities tender. Funding for the transaction(s) including, a successfully completed secondary share placement raising approximately GBP1.4bn, the cancellation of the share buyback programme, along with disposals and asset contributions (ie. the recent disposal of the ITV stake and contribution of its National Geographic stake as part of the deal consideration), underline management's commitment to contain the impact of the transaction on Sky's financial metrics. Sky Deutschland Minorities Tender The risk of a sizeable take-up of the tender by Sky Deutschland's minorities is not considered high given the absence of an acquisition premium. Take-up of the tender could theoretically push metrics to a level that might be considered stretched for an investment grade rating (a 100% take-up by minorities could potentially push initial net debt/EBITDA leverage to 4.0x), However, this is not our base case assumption, and Fitch believes mitigating action would be available to management in the event take-up was higher than expected. Medium-Term Strategic Move In Fitch's view, the transaction(s) are about expanding Sky's addressable audience. Management has a proven track record of delivering a high quality pay-TV business in the UK and Ireland. However, the maturity and competition of these markets may temper further growth, with management regarding the untapped potential in Germany and Italy, as significant. The acquired businesses are nonetheless significantly lower margin and the deal expected to be accretive only in year 3. The agency recognises that management are taking a medium term strategic view, with the challenge being to convince audiences in these countries to embrace pay-TV in the way that British audiences do. 2014 Performance Sky reported FY14 results on 25 July, confirming 7% revenue growth to GBP7.6bn and EBITDA down 1% to GBP1,667m (margin 21.9%). With 2014 a year of investment amid rising competition in the UK pay-TV and multi-play markets, Sky continues to perform well. Nonetheless, in Fitch's view, its pay-TV audience is mature and the competitive environment intensifying; factors which we believe underpin the proposed acquisition(s). Management has proven adept at expanding its product offering, maintaining strong KPIs and ensuring the company's position as the market leader in pay-TV. Operational performance/execution is regarded as strong, although the announced deal underlines management's willingness to accept a stretched capital structure in order to develop medium-term goals. RATING SENSITIVITIES Negative Post-closing FFO net leverage sustainably above 3.0x would be likely to lead to a downgrade from 'BBB-'; acknowledging that an 18-24 month timeframe will be allowed before sustainable leverage is achieved. Fitch's rating case assumption is that this metric will fall to between 2.5x - 3.0x within two years post-closing. Operationally, adverse changes to industry dynamics including price erosion, increasing content costs and capital intensity and increasing regulatory pressure, leading to significant downward pressure on EBITDA and free cash flow, would pressure ratings. Positive Failure of the proposed Sky Deutschland/Italia acquisitions to close, an outcome which is considered unlikely, and subject to the strength of ongoing performance, would likely lead to an affirmation of the ratings at 'BBB+'. Contact: Principal Analyst Jonathan Levy Analyst +44 20 3530 1701 Supervisory Analyst Stuart Reid Senior Director +44 20 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Damien Chew Senior Director +44 20 3530 1424 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available at www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable criteria, Corporate Rating Methodology dated 28 May 2014, is available at www.fitchratings.com. Applicable Criteria and Related Research: Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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