-- Credit measures for U.S. competitive local exchange carrier TW Telecom
have improved over the past year due to solid operating and financial
-- The company also paid down some of its senior secured debt in August.
-- We are revising our outlook on the company to positive from stable and
affirming our 'BB-' corporate credit rating.
-- We are also raising the issue rating on its senior notes to 'BB-' from
'B' and revising the recovery rating to '3' from '6'.
On Sept. 13, 2012, Standard & Poor's Ratings Services revised the outlook on
Littleton, Colo.-based competitive local exchange carrier (CLEC) TW Telecom
Inc. to positive from stable. At the same time, we affirmed our 'BB-'
corporate credit rating on the company.
We also raised the issue-level rating on TW Telecom's senior notes to 'BB-'
from 'B' and revised the recovery rating to '3' from '6'. The '3' recovery
rating indicates expectations for meaningful (50%-70%) recovery in the event
of payment default. The upgrade of the senior unsecured debt rating is based
on the August 2012 paydown of TW Telecom's senior secured debt, which improves
recovery prospects for unsecured debtholders.
The outlook revision reflects the company's improved credit measures over the
past year due to solid operating and financial results. During the first half
of 2012, total revenue and EBITDA increased 7.8% and 8.6%, respectively, year
over year, reflecting growth in data and Internet protocol (IP)-based
services. Additionally, the company repaid about $102 million of debt with
cash on hand, which resulted in operating lease-adjusted debt to EBITDA
declining to about 3.1x pro forma for the recent debt repayment, as of June
30, 2012, from 3.5x at year-end 2011. As such, we are revising our financial
risk profile to "significant" from "aggressive." We could raise the corporate
credit rating over the next year if the company reduces leverage below 3x on a
sustained basis while limiting annual capital spending to the $400 million
The ratings on TW Telecom reflect a "fair" business risk profile and
significant financial risk profile. Key business risk factors include intense
competitive pressures from larger and better capitalized incumbent telephone
companies, primarily Verizon Communications Inc. and AT&T Inc., in an industry
characterized by pricing pressure. Other business risk factors are the
company's high capital spending requirements and a long sales cycle associated
with selling to larger business customers. These factors somewhat overshadow
TW Telecom's well-established network with a significant footprint, a good
niche as a provider of telecommunications services to large- and
midsizeenterprise customers, some revenue stability from multiyear contracts,
and potential revenue growth from new products and services.
Our base-case scenario also incorporates some of the following assumptions:
-- We expect revenue to grow in the 6%-7% range in 2012 and 2013,
reflecting increased penetration of existing buildings, and upselling
customers to new IP-based products and services.
-- Also, we expect churn to remain at currently low levels, which will
contribute to revenue growth.
-- In addition, we expect the EBITDA margin to remain in the mid- to
high-30% area over the next couple of years.
-- We believe that leverage will be around 3x by year-end 2012 and the
high-2x area by the end of 2013.
-- We expect the company to generate at least $70 million of free
operating cash flow (FOCF) in 2012 and $75 million in 2013, which is still
modest relative to its debt burden.
TW Telecom faces significant competition from AT&T and Verizon nationally, as
well as from CenturyLink Inc. in certain markets. These incumbent
telecommunications providers are formidable competitors in the
large-enterprise market since they have more network capability and larger
footprints to serve this customer base, large sales forces, and existing
customers to whom they can sell more services. Although the incumbent cable-TV
providers are increasing their presence in the business market, these
operators are better suited to serving smaller business customers and
therefore, Standard & Poor's does not consider them a major competitive threat
to TW Telecom.
TW Telecom has been at the forefront of IP-based technologies, including metro
Ethernet and IP VPN services, an important component of its business strategy.
The company's customer base has been increasingly adopting metro Ethernet
services in particular, as these provide more flexible features and greater
route diversity than traditional private-line, frame relay, or asynchronous
transfer mode services. Moreover, TW Telecom's network investments have
enabled it to introduce new IP-based products and services, including dynamic
capacity, which allows its customers to scale capacity on demand. Still,
despite its differentiated services and technology, we believe TW Telecom
remains vulnerable to increased price competition longer term, especially as
other larger carriers increase capabilities to serve the metro Ethernet
market. Moreover, new bookings can take a while to translate into revenue as
the company's sales cycle for closing contracts can be long.
The company's solid financial performance is primarily due to growth in data
services, including its metro Ethernet and VPN products. Monthly revenue churn
declined to 0.9% in the second quarter of 2012 from 1.1% in the prior quarter
and is low relative to TW Telecom's peer group. While TW Telecom has reduced
its dependence on sales to other telecom carriers, this segment still
represents about 20% of its revenue base and is vulnerable to greater pricing
pressure, along with high churn, despite its good profit margins.
Because of the capital intensity of TW Telecom's business plan of building
fiber facilities on customer premises, achieving positive FOCF can be
challenging. During the first half of 2012, it generated about $50 million of
FOCF, in part helped by the timing of certain projects. We believe TW Telecom
has reasonable prospects to improve its FOCF as it increases penetration of
existing on-net buildings, although growth in FOCF also depends on the
company's expansion activities.
The EBITDA margin is solid at around 37%, and significantly better than that
of its peer group of CLECs because of its dense fiber-based network. Despite
our expectation for solid revenue growth, we do not anticipate any meaningful
margin expansion in the near term because of increased selling expense. Pro
forma for the recent debt repayment, leverage is moderate at about 3.1x as of
June 30, 2012 and we expect this measure to improve modestly from EBITDA
growth. The total leverage calculation includes the present value of operating
leases and minimum telecommunications purchase commitments, the latter of
which comprises the bulk of the present value calculation.
We are revising our liquidity assessment to "adequate" from "strong." TW
Telecom has $374 million of convertible debt that has a call and put option
starting in April 2013. We believe the company will need to repay the
obligation with a combination of existing cash, which will reduce its
liquidity but would still be sufficient for our adequate liquidity assessment,
and stock. If, however, it is able to refinance the convertible debenture with
new debt, we could revise the liquidity assessment back to strong.
Sources of liquidity consist of $430 million of cash and equivalents, pro
forma for the August 2012 debt repayment, full availability under the
company's $80 million senior secured revolving credit facility, and expected
funds from operations (FFO) of at least $425 million in 2012. We expect other
uses of cash to include capital expenditures of around $350 million and debt
amortization of about $5 million, as well as share repurchases.
Given that a large portion of capital expenditures are discretionary and tied
to business growth, the company has reasonable flexibility to reduce spending
if demand does not materialize. In line with our criteria, we expect sources
of liquidity to exceed uses by well over 1.2x over the next 12 months for net
sources to remain positive, even with a 15%-20% decline in EBITDA.
The revolving credit facility has a senior leverage, total leverage, and
interest coverage covenant. However, the covenants are only in effect if the
company draws on the revolver, which we do not expect to occur in the near
The rating outlook is positive and reflects our expectation that the company
will continue to grow revenue and EBITDA over the next year because of its
expanding product portfolio, long contract durations, and large and
diversified customer base. These factors should enable the company to reduce
leverage to below 3x by mid-2013 and, assuming annual capital spending in the
$400 million area, would result in a higher rating.
Conversely, we could revise the outlook to stable if business conditions
deteriorate, resulting in higher churn and pricing pressure, or if the company
pursued a more aggressive financial policy, which resulted in leverage in the
Related Criteria And Research
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Lower-Rated Issuers Face Some Liquidity Challenges, July 23, 2012
-- U.S. Telecom And Cable Companies, Strongest To Weakest, July 13, 2012
-- U.S. Telecom And Cable Ratings Should Be Stable Overall During Weak
Economic Recovery, July 13, 2012
-- A Matter of Policy: U.S. Telecom Companies Maintain High Dividend
Payouts, But For How Long?, May 30, 2012
-- A Matter of Policy: U.S. Cable And Satellite-TV Companies Ratchet Up
Shareholder Payouts, May 16, 2012
-- Top 10 Investor Questions: U.S. Telecom and Cable Industries, May 10,
-- Assessing The Four-Notch Rating Gap Between The Two U.S.
Direct-To-Home Satellite Video Operators, May 9, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
Ratings Placed On CreditWatch
TW Telecom Inc.
TW Telecom Holdings Inc.
Corporate Credit Rating BB-/Positive/-- BB-/Stable/--
Upgraded; Recovery Rating Revised
TW Telecom Holdings Inc.
Senior Unsecured BB- B
Recovery Rating 3 6
Ratings Affirmed; Recovery Ratings Unchanged
TW Telecom Inc.
Senior Unsecured B
Recovery Rating 6
TW Telecom Holdings Inc.
Senior Secured BB+
Recovery Rating 1