Reuters logo
TEXT-Fitch: Telephone and Data Systems outlook now negative
November 21, 2012 / 5:55 PM / in 5 years

TEXT-Fitch: Telephone and Data Systems outlook now negative

Nov 21 - Fitch Ratings has affirmed the 'BBB' Issuer Default Ratings (IDRs)
and long-term debt ratings of Telephone and Data Systems, Inc. (TDS) and
its subsidiary United States Cellular Corp. (USM). USM's ratings consider the
consolidated ratings at Telephone and Data Systems, Inc. (TDS). The Rating
Outlook on both entities is revised to Negative from Stable.

The affirmation reflects TDS' solid financial profile that has afforded the
company some flexibility to withstand operating challenges at its current rating
category. TDS has a good cash position, undrawn committed revolver lines, no
material maturities in the next 20 years and a significant level of other assets
that could be monetized.

The revision in Outlook reflects Fitch's longer-term concerns with the wireless
operations. Postpaid subscriber additions at USM have been under material
pressure for nearly three years. During 2012, the company reported postpaid net
losses that are materially worse than Fitch expectations. USM has begun to
improve traction with share gains and positive year-over-year postpaid gross
addition trends during the past couple of quarters. However, churn has increased
approximately 20 basis points as a result of the competitive intensity, lack of
iPhone, and economic environment.

USM has taken steps to address these operational shortfalls with the divestiture
of the Chicago and St. Louis markets, new branding campaign, targeted churn
initiatives and broader third-party distribution. The sale of the wireless
markets to Sprint Nextel will benefit the company's operating profile by
improving profitability and cash flows, reducing capital spending, and improving
past negative subscriber trends. As a result, the sale of these underperforming
markets should provide better transparency with USM's operations in its
remaining more mature markets where the company has achieved better penetration.

However, the sale of wireless assets also represents a retrenchment of its
strategic plans and USM's inability to compete against the national operators
despite being in the Chicago market for over 10 years. The competitive
environment will also only get more challenging in the future. Verizon Wireless
and AT&T Wireless have continued to strengthen their position against the rest
of the industry through spectrum acquisitions and increased subscriber
penetration to drive greater revenue and cash flow share. Verizon Wireless'
early advantage with 4G LTE coverage and new share data plans has resulted in
material share gains during 2012. T-Mobile and Sprint have also taken
significant steps to improve their competitive positions longer term.

USM's increased distribution through Walmart should help further improve USM's
gross addition trends as the company was more heavily reliant on distribution
through company-owned stores versus its national peers. Fitch believes USM could
pursue other initiatives to broaden its distribution mix although subscribers
acquired through third-party channels are typically less profitable, with higher
churn characteristics. Fitch also believes the lack of iPhone distribution
creates a material competitive disadvantage relative to the national operators.

USM also has exposure longer term to declines from ETC revenues, which is a
higher margin revenue source. USM had received in excess of $150 million of ETC
revenue at its peak. Going forward, ETC revenue subsidies received by USM are
subject to reform plans by the FCC, as payments are scheduled to be reduced 20%
annually. These reductions began in mid-2012.

Longer term, Fitch believes TDS' ability to grow revenues and cash flows while
competing effectively against much larger national operators is key to
maintaining its investment grade ratings. Fitch acknowledges the steps the
company has taken to improve its operating profile and profitability. However,
Fitch remains concerned with the company's scale and competitive position. A
failure by TDS to demonstrate the ability to sustain improved operating
performance across its wireless and wireline segments would lead to a negative
rating action.

TDS' has good financial flexibility because of its cash, committed credit lines
and other assets. At the end of third-quarter 2012, TDS' consolidated cash
balance was approximately $589 million. TDS also has $181 million of added
liquidity in longer-dated treasury or treasury-backed securities. TDS and USM
maintain approximately $700 million of undrawn revolver capacity, principally
through TDS' $400 million revolving credit facility and USM's $300 million
revolver, which both mature in December 2015. The principal covenant contained
within the facility is a consolidated leverage ratio of 3.0x, which allows the
company considerable flexibility.

Consolidated free cash flow (FCF) which had previously been at least $200
million the past three years was a deficit of $86 million for the last 12
months. This was due in part to capital spending that has peaked at over $1
billion as a result of USM's LTE expansion, growth related to wireline projects
and the new wireless billing system. Looking forward, Fitch expects FCF levels
in 2013 could be flat to moderately negative due to the continued high level of
capital investment, decommissioning costs related to the Chicago/St. Louis
markets and higher cash tax payments in 2013 as the benefit for bonus
depreciation reverses. TDS will benefit by avoiding the significant capital
investment that would have been required in the Chicago/St. Louis markets.

TDS does not have any significant maturities until after 2030. For the last 12
months, TDS' consolidated leverage of 1.4x and interest coverage of 11.0x were
strong for its rating category, as ratings remain constrained by subscriber
trends, competitive environment and lack of wireless scale.

TDS has other sizable assets that could be monetized, including USM's cellular
towers and a 5.5% minority interest in Verizon Wireless' Los Angeles
partnership, although a sale of the partnership interest could potentially
affect the ratings depending on the use of the proceeds. The cash generation
from these assets accounts for a material portion of its cash from operations at
approximately 10%.

TDS has been active with share repurchase programs at both TDS and USM in the
past. As of Sept. 30, 2012, TDS and USM had not repurchased any shares. TDS'
current share repurchase program expired in November 2012. Fitch expects TDS'
board will authorize a new share repurchase program. USM has authorized up to
1.3 million shares to be repurchased on an annual basis.

WHAT COULD TRIGGER A RATING ACTION

Negative: The ratings have a Negative Outlook. Future developments that may
individually or collectively lead to a negative rating action include:

--A further erosion in the operating performance of the wireless segment due to
negative postpaid subscriber trends associated with competitive pressure on
churn or gross additions. Fitch must see an improved performance in gross
addition and churn trends that can be sustained over this Outlook period as the
company has taken initial steps to improve this deficiency.
--TDS must demonstrate progress toward improved profitability across the
wireline and wireless operations that can be sustained for the longer term. A
failure to accomplish this would be a further concern.
--Negative growth trends in Wireless revenue if ARPU growth slows and/or
wireless net additions are negative thus further pressuring cash flows.
--Improvement in future FCF expectations beyond 2013.
--TDS undertakes more aggressive share repurchase activity, potentially from
shareholder pressure, thus weakening its liquidity position.

Positive: Fitch believes that competitive factors, current subscriber trends and
the company's relative position in the wireless industry would not likely allow
for a positive rating action at this time.

Additional information is available at 'www.fitchratings.com'.The ratings above
were solicited by, or on behalf of, the issuer, and therefore, Fitch has been
compensated for the provision of the ratings.

Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Rating Global Telecom Companies: Sector Credit Factors' (Aug. 9, 2012).

Applicable Criteria and Related Research:
Corporate Rating Methodology

0 : 0
  • narrow-browser-and-phone
  • medium-browser-and-portrait-tablet
  • landscape-tablet
  • medium-wide-browser
  • wide-browser-and-larger
  • medium-browser-and-landscape-tablet
  • medium-wide-browser-and-larger
  • above-phone
  • portrait-tablet-and-above
  • above-portrait-tablet
  • landscape-tablet-and-above
  • landscape-tablet-and-medium-wide-browser
  • portrait-tablet-and-below
  • landscape-tablet-and-below