August 28, 2014 / 1:05 PM / in 3 years

Fitch Revises BT Group's Outlook to Positive; Affirms at 'BBB'

(The following statement was released by the rating agency) LONDON, August 28 (Fitch) Fitch Ratings has revised BT Group plc's (BT) Outlook to Positive from Stable and affirmed the Long-term Issuer Default Rating (IDR) at 'BBB.' A full list of rating actions is available below. The revision in the Outlook reflects the extent to which BT has stabilised its revenues, its solid margins, improving leverage and solid cash flow generation. The company enjoys a good level of headroom at its current ratings and its metrics compare well with other investment-grade telecoms incumbents. The largely domestic nature of the company's cash flow, its nascent mobile strategy and the particularly competitive nature of the UK telecoms market are constraining factors. The evolution of the company's pay-TV strategy, continued costs efficiencies and competitor actions, will be key to a potential upgrade. The financial impact of the UEFA European football broadcast rights will not be felt until the financial year ending March 2016 and the impending UK Premiership rights renewal until FY17. We believe that visibility on the latter will, in particular, set the tone for potential content rights inflation over the medium-term. The roll-out of BT's mobile strategy and the potential risk of escalating commercial costs will also be a key consideration. KEY RATING DRIVERS Fibre Build and Content Strategy BT's fibre-to-the cabinet strategy is well advanced and has gained good traction among customers. The company has passed 20 million UK homes, equivalent to two thirds of UK premises and connected 2.3 million retail fibre customers. While cable technology currently has the potential to offer higher network speeds, BT's retail broadband customer growth rates, which are consistently running above 8%, are much stronger than the cable operator's and suggest this is not currently a competitive disadvantage. The company's content strategy is so far proving a success - centred around a popular and high quality portfolio of sports rights. TV customers stood at 1 million as of end-June 2014, up 21% year on year, while BT Consumer ARPUs show consistently strong trends (up 7.6% in 1Q FY15). Fitch will be monitoring customer response to any changes to the pricing of BT's pay-TV offering. Broadband Traction, Consumer Revenue Growth BT Sport - the centrepiece of the company's TV strategy remains free to broadband customers, which along with the company's investment in fibre, is driving solid broadband line growth. Against strong competition from Virgin Media (cable) and BskyB (the leading pay TV operator) BT has stabilised its leading broadband position at more than 33% of broadband lines, with quarterly line growth consistently running above 8%. BT Consumer revenues are growing at more than 7% (7.2% LTM June 2014), a feature which is unusual in most domestic incumbent businesses where the trends are typically negative. Content Rights Inflation, Premiership Auction The risk of material content rights inflation is real and will be tested when the Premiership rights are re-auctioned - potentially as early as end-2014. Last time BT paid GBP738m for 38 games (including 18 top picks) per season for three seasons running from 2013-2016. Management has stated they will be disciplined going into the auction, although Fitch believes the risk of significant cost escalation is material given the perceived importance of English football to UK pay-TV consumers. However, it should be noted that content accounted for less than 2% of BT's operating expense (before depreciation and amortisation) in FY14 compared with labour costs - its single largest cost - at 37%. Solid Metrics, Conservative Financial Approach BT has reduced net debt significantly through organic cash flow generation while cash flow trends are stable and improving. Reported net debt has been reduced by GBP2bn in the two years to FY14, standing at GBP7bn; management has indicated a desire to reduce this figure to below GBP6bn. Funds from operations (FFO) adjusted net leverage stood at 1.8x at FYE14, with Fitch's base case expecting further deleveraging over the next two to three years. Management has also expressed a commitment to regain a 'BBB+' rating, a statement that Fitch believes underpins BT's financial policies. The company generates a pre-dividend free cash flow margin of 10%, which is strong at the current rating level. Its revenues are stable, while cash flows are improving and more visible than at a number of its European peers. Rating Headroom Underpins Positive Outlook BT has headroom within its current ratings, which underpins the Positive Outlook. Its closest peers, TDC and Telefonica Deutschland (both BBB/Stable), are both significantly smaller and subject to far greater revenue pressures. Each of the peer group is predominantly reliant on domestic operations - which to some extent act as a constraint on their ratings. Key operational developments - including progress in mobile and the outcome of the upcoming Premiership rights renewal - will be an important consideration in any potential upgrade. RATING SENSITIVITIES Future developments that may, individually or collectively, lead to positive rating action include: -FFO-adjusted net leverage tangibly below 2.0x on a sustained basis -Sustained position in the highly competitive UK triple-play market supporting stable revenues, a sustained margin profile and solid free cash flow generation -Visibility on the cost implications of the mobile roll-out and significant content rights renewal; most notably the Premiership content renewal due end 2014 - mid 2015. Future developments that may, individually or collectively, lead to negative rating action include: -FFO-adjusted net leverage approaching 3.0x on a sustained basis -Deterioration in the key operating and financial metrics at BT's main operating subsidiaries, as could significant risk-taking in relation to the development of BT Consumer's pay-TV and mobile offerings FULL LIST OF RATING ACTIONS: BT Group plc Long-term IDR: affirmed at 'BBB'; Outlook revised to Positive from Stable Short-term IDR: affirmed at 'F2' British Telecommunications plc Long-term IDR: affirmed at 'BBB'; Outlook revised to Positive from Stable Short-term IDR: affirmed at 'F2' Senior unsecured rating: affirmed at 'BBB'. Commercial paper programme: affirmed at 'F2' 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 Nikolai Lukashevich Senior Director +7 495 956 9968 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available at 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 are available at 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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