March 18 (The following statement was released by the rating agency)
Fitch Ratings has placed Vodafone Group Plc's 'A-' Long-term Issuer Default Rating (IDR) on Rating Watch Negative (RWN), following the announcement of its intentions to acquire 100% of the share capital of Grupo Corporativo Ono, S.A. (Ono) in an offer representing an enterprise value of EUR7.2bn for Ono. A full list of rating actions is below.
We will likely downgrade Vodafone's rating by one notch if it acquires Ono without taking other measures to reduce debt. Vodafone's leverage is currently low for a 'A-' rating with funds from operations (FFO) adjusted net leverage expected to be 1.2x at the end of March 2014. However, the planned acquisition of Ono, and expenditure on Project Spring over the next few years, could push this metric to above 2.5x within 18 months, which is the upper end of the leverage range for a 'A-' rating. The acquisition of Ono should significantly improve Vodafone's competitive position in Spain, which accounted for 6% of Vodafone's consolidated EBITDA in 1HFY14.
KEY RATING DRIVERS
Crystallisation of Acquisition Risk
The announced acquisition of Ono crystallises part of the acquisition risk for Vodafone's credit profile, which was part of the rationale for Fitch revising the Outlook on Vodafone's IDR to Negative on 4 March. Vodafone says it takes decisions on European fixed-line infrastructure on a country-by-country basis and that it could obtain this infrastructure by buying an existing operator, building its own or agreeing a wholesale deal with an incumbent. The Ono acquisition comes when Vodafone's headroom at the 'A-' level is likely to be significantly reduced over the next few years as a result of Project Spring. In addition to potential European fixed line acquisitions, there is also possible consolidation in the Indian market as well as other additional emerging market opportunities.
Project Spring Payoff
Vodafone's plan to spend an additional GBP7bn in capex over the next two years could allow it to build a network quality advantage over its competitors, which could increase market share and over time, improve cash flow generation.
Visibility of a return on this investment remains limited. However, Vodafone will need to be able to demonstrate to subscribers that a quality differential exists and the subscriber might have to be willing to pay a price premium for this network advantage, depending on Vodafone's competitors' reactions.
Increasing Emerging Market Exposure
Post-Verizon Wireless disposal, Europe's contribution to overall group cash flow is continuing to decline, while the importance of Vodafone's emerging market business continues to grow. This exposes the group to higher degrees of emerging market risk compared with historical levels. The two Indian tax cases and the uncertainty surrounding the 2013 Indian spectrum auctions highlight the unpredictability of these markets. The increasing exposure also exposes Vodafone to the threat of increased FX variability, although Fitch acknowledges the presence of offsetting local currency debt to help mitigate this risk.
Vodafone has experienced deterioration in organic service revenue growth in almost all of the company's main markets. While macro conditions and regulatory headwinds should begin to improve, there is still likely to be a continued drag on EBITDA over the coming few years and there is limited visibility over an inflection point in this trend.
- Expectation of FFO adjusted net leverage being sustained above 2.5x would lead to a downgrade.
- Sustained pressure on free cash flow (FCF) driven by weak EBITDA growth, higher capex and shareholder remuneration, or significant underperformance in key markets.
Positive (removal of RWN and affirmation at 'A-' with a Stable Outlook):
- FFO adjusted net leverage below 2.5x on a sustained basis together with healthy FCF generation.
- High single-digit pre-dividend FCF to sales is expected for a 'A-' rating.
- Evidence of successful monetisation of the Project Spring investments, leading to an improved competitive position for Vodafone in its European operations
FULL LIST OF RATING ACTIONS:
Long-term IDR: 'A-' placed on RWN
Senior unsecured: 'A-' placed on RWN
Short-term IDR: affirmed at 'F2'
Commercial Paper Programme: affirmed at 'F2'
For more details of our views on Vodafone's rating, see "Vodafone: What Investors Want to Know", dated 19 June 2013 at www.fitchratings.com, which looks at Vodafone's plans for its stake in Verizon Wireless and the competitive and economic challenges it faces in Europe.