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Fitch Maintains AT&T's 'A-' L-T IDR on Rating Watch Negative
October 20, 2017 / 1:59 PM / in a month

Fitch Maintains AT&T's 'A-' L-T IDR on Rating Watch Negative

(The following statement was released by the rating agency) CHICAGO, October 20 (Fitch) Fitch Ratings has maintained on Rating Watch Negative the 'A-' long-term Issuer Default Ratings (IDRs) and senior unsecured debt of AT&T Inc. (AT&T) (NYSE: T) and its subsidiaries. Fitch has also affirmed the company's short-term IDR and commercial paper ratings at 'F2'. A full list of rating actions follows at the end of this release. The ratings are on Negative Watch due to the pending Time Warner Inc. acquisition, which was announced Oct. 24, 2016 and is pending regulatory approval. KEY RATING DRIVERS Acquisition of Time Warner: Fitch believes AT&T's acquisition of Time Warner provides AT&T with a strong foothold in the evolving communications and media landscape. The acquisition, combined with AT&T's 2015 acquisition of DIRECTV, offers the potential to capitalize on emerging trends for mobile video and over-the-top (OTT) video delivery. Other benefits include the diversification of AT&T's revenue stream and additional financial flexibility owing to Time Warner's strong free cash flow (FCF). The Negative Watch for AT&T reflects the increase in leverage for AT&T, pro forma for the transaction. AT&T currently operates with gross leverage at the upper end of Fitch's expectations for the current 'A-' rating. At the end of 2018, approximately one year after the expected close of the transaction, Fitch estimates AT&T's gross leverage will be 2.8x, and then decline by approximately 0.3x in 2019. As currently proposed, the transaction would potentially lead to a one-notch downgrade for AT&T to 'BBB+'/Stable Outlook. However, the final rating would depend on Fitch's further analysis of the transaction, an assessment of AT&T's post-acquisition financial policies, and the effect of any additional conditions placed on the transaction by the regulatory approval process. Deleveraging Expected: On the announcement of the Time Warner transaction, AT&T affirmed its commitment to delever to a net leverage target of 1.8x four years after the close of the transaction as FCF are used to reduce debt. In addition to the incremental FCF from Time Warner in 2018 and beyond, Fitch's base case for AT&T on a stand-alone basis incorporates moderate revenue and EBITDA growth, with additional benefits to EBITDA stemming from the remaining cost synergies from DirecTV and cost reduction initiatives. In addition, Fitch expects a slight reduction in capital intensity over time via AT&T's network initiatives, and the lower capital intensity of Time Warner's operations. Core Telecom Leverage: As of June 30, 2017, AT&T's gross core telecom leverage was 2.7x. Gross debt includes a portion of the cash financing for the Time Warner acquisition and as a result net core telecom leverage was 2.2x. To determine core telecom leverage, Fitch has applied a 5:1 debt to equity ratio to the company's handset receivables, after adding back off balance sheet securitizations. Unlimited Wireless Plan Effects: Competition has caused all the major operators to offer unlimited wireless data services, which in turn has tempered wireless service revenue growth as the ability to monetize growth in data usage has stalled. In the near term the impact on revenues is negative as heavy users or "optimizers" trade down into unlimited plans and the company loses overage revenues and revenues from those on large packages. Over time, lower usage customers may mitigate the effect as their usage growth drives them into higher usage plans or into unlimited plans. Fitch believes unlimited plans will lead to reduced profitability and increased investment in the industry. FirstNet: AT&T won a bid to build and manage a nationwide broadband network dedicated to first responders. Under the agreement, AT&T will receive 20 MHz of low band spectrum and $6.5 billion in success-based payments. AT&T expects to spend $40 billion over the 25-year life of the contract to build, deploy, operate and maintain the network. As of Oct. 17, 27 of 56 states and other entities have opted into the network. AT&T can use the network for commercial purposes, although first responders will have priority access to the network when needed. DERIVATION SUMMARY AT&T's 'A-' IDR reflects its large scale of operations, diversified revenue streams by customer and technology, and relatively strong operating profitability. Current leverage is moderately high for the rating. AT&T'S principal competitor is Verizon (VZ; A-/Stable), as they compete head to head in the wireless and business services segments, where they are currently the largest two operators. In wireless, AT&T faces competition from Sprint (S; B+/Stable) and T-Mobile, and a host of smaller regional carriers. In the enterprise business, in addition to Verizon, AT&T faces competition from a number of carriers, such as CenturyLink (CTL; BB+/Watch Negative) and Level 3 Communications (LVLT; BB/Stable). Once CenturyLink completes its acquisition of Level 3, it will become the second largest enterprise service provider by revenue. Cable has been a strong competitor in the residential and small business segments for voice and data services. Following the close of the Time Warner acquisition, AT&T's leverage is expected to be higher than its current 'A-' peers, Verizon and Comcast Corporation (CMCSA; A-/Stable). KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Fitch assumes the Time Warner transaction closes at yearend 2017. --Fitch estimates AT&T's revenue on a stand-alone basis grows less than 1%. EBITDA margins are forecast to be in the low 30% range during the forecast period. --Fitch has assumed there are no stock repurchases through the next several years given the company's near-term focus on debt reduction. --In 2017, Fitch expects consolidated capital spending to be in line with company guidance of approximately $22 billion. Fitch's assumptions reflect similar levels over the forecast horizon for AT&T, with incremental capital spending for Time Warner following the merger close. --Fitch's assumptions do not include potential spending on the FirstNet nationwide public safety broadband network and will be incorporated into its assumptions on the resolution of the Rating Watch. For Time Warner, Fitch's key assumptions within the agency's rating case include: --Fitch assumes that Turner cable networks businesses' revenues continue to grow by mid-single digits, driven by higher affiliate fees and stable advertising revenues. --HBO revenues grow in the mid-single digits driven in large part by an acceleration of subscription revenue growth. --The film and television studios grow by low- to mid-single digits during the forecasted periods. This segment benefits from continued demand for television content, international expansion, and digital delivery, offset by ongoing declines in DVDs. --Stable operating margins due to positive operating leverage of its businesses and higher margin profile of digital versus physical delivery are offset somewhat by higher overall investment in programming and production. --Increased programming and production investment in the businesses. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Should the acquisition of Time Warner be terminated, Fitch would potentially affirm AT&T's ratings with a Stable Outlook under the agency's base case. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --At the 'BBB+' level, a further downgrade would result if AT&T adopted a more aggressive financial strategy or event-driven merger and acquisition activity that drives leverage beyond Fitch's 3.5x threshold in the absence of a creditable de-leveraging plan. Negative rating actions could also result if Fitch observes weakening of AT&T's competitive position in its multiple lines of business. LIQUIDITY Strong Liquidity Profile: At June 30, 2017, the company did not have any drawings on its revolving credit facility (RCF). AT&T has a five-year $12 billion RCF in place through December 2020. The principal financial covenant for the RCF requires net debt-to-consolidated EBITDA, as defined, to be no more than 3.5x. At June 30, 2017, the company's reported cash and cash equivalents totalled $25.6 billion (approximately $866 million of this amount resided in foreign jurisdictions). Subsequent to the end of the second quarter of 2017, AT&T issued $22.5 billion in debt in order to close the Time Warner transaction. The company also has a $10 billion term loan that may be used to raise cash proceeds needed to close the transaction, to refinance Time Warner debt and for the repayment of related expenses. FULL LIST OF RATING ACTIONS Fitch affirms the following ratings: AT&T, Inc. --Short-term IDR at 'F2'; --Commercial paper at 'F2'. Fitch maintains the following ratings on Rating Watch Negative: AT&T, Inc. --Long-term IDR 'A-'; --Senior unsecured debt 'A-'; --$12 billion revolving credit facility due December 2020 'A-'. AT&T Corp. --Long-term IDR 'A-'; --Senior unsecured 'A-'. DIRECTV Holdings LLC (DTVH) --Long-term IDR 'A-'; --Senior unsecured notes 'A-'. BellSouth Corp. --Long-term IDR 'A-'; --Senior unsecured 'A-'. BellSouth Capital Funding Corp. --Senior unsecured 'A-'. BellSouth Telecommunications, Inc. --Long-term IDR 'A-'; --Senior unsecured 'A-'. AT&T Mobility LLC (formerly Cingular Wireless, LLC) --Long-term IDR 'A-'; --Senior unsecured 'A-'. New Cingular Wireless Services, LLC (formerly AT&T Wireless Services, Inc.) --Long-term IDR 'A-'; --Senior unsecured 'A-'. Ameritech Capital Funding --Long-term IDR 'A-'; --Senior unsecured 'A-'. Indiana Bell Telephone Company --Long-term IDR 'A-'; --Senior unsecured 'A-'. Michigan Bell Telephone Company --Long-term IDR 'A-'; --Senior unsecured 'A-'. Pacific Bell Telephone Company --Long-term IDR 'A-'; --Senior unsecured to 'A-'. Wisconsin Bell Telephone Company --Long-term IDR 'A-'; --Senior unsecured 'A-'. The following ratings are withdrawn: AT&T, Inc. (debt repayment) --$2.286 billion Tranche A term loan facility due March 2018 'A-'; --$1.869 billion Tranche B term loan facility due March 2020 'A-'. Southwestern Bell Telephone Company (no longer any debt outstanding) --Long-term IDR 'A-'. Contact: Primary Analyst John C. Culver, CFA Senior Director +1-312-368-3216 Fitch Ratings, Inc. 70 W Madison Street Chicago, IL 60602 Secondary Analyst Bill Densmore Senior Director +1-312-368-3125 Committee Chairperson David Peterson Senior Director +1-312-368-3177 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Adjustments for outstanding equipment installment plan receivables related to financial services operations (assessed using a debt-to-equity ratio of 5x) resulted in a reduction of the level of debt used in calculating our leverage metrics by approximately $10.7 billion (year-end 2016). Fitch added back off-balance sheet securitization debt ($3.4 billion) before determining the reduction. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. 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