(The following statement was released by the rating agency)
Nov 21 -
-- Dutch telecom incumbent Koninklijke KPN N.V.’s credit measures continued to deteriorate in third-quarter 2012 and the group is still confronted by a challenging domestic market.
-- We are therefore revising our outlook on Koninklijke KPN N.V. to negative from stable and affirming our ‘BBB/A-2’ long- and short-term corporate credit ratings.
-- The negative outlook reflects the risk that we could lower the rating by one notch if we came to believe that the group’s business risk profile had durably weakened or if credit metrics appeared unlikely to sufficiently recover in 2013.
On Nov. 21, 2012, Standard & Poor’s Ratings Services revised its outlook on Dutch telecom incumbent Koninklijke KPN N.V. (KPN) to negative from stable. At the same time, we affirmed our ‘BBB/A-2’ long- and short-term corporate credit ratings on the group.
The outlook revision reflects our view of the company’s weak operating performance in the first nine months 2012, the still tough competitive and economic conditions in its domestic market, and a declining cushion from its German operations. We note a continued deterioration in credit metrics at end-September and we are therefore concerned that credit metrics could deteriorate more than we previously anticipated in full-year 2012. We also think that sustainably restoring adequate credit metrics by year-end 2013 is likely to be more challenging than we previously anticipated.
At this stage, we think that KPN’s Standard & Poor‘s-adjusted debt-to-EBITDA ratio at the end of 2012 will likely increase to the maximum 3.5x adequate limit for the current rating, or slightly higher, from 3.1x at end of 2011. However, we continue to think that the recent decision to sharply cut dividends will enhance KPN’s capacity to trim absolute debt in 2013, which should allow this ratio to fall back below 3.5x. In our view, KPN’s management could consider taking additional deleveraging measures to bring the reported debt-to-EBITDA ratio back within its 2.0x-2.5x financial policy framework and based on the company’s calculation, from 2.7x posted at end-September 2012.
The rating continues to reflect our assessment of KPN’s “significant” financial risk profile balanced by a “strong” business risk profile, including our “satisfactory” management and strategy assessment which, at this stage, reflects our assumption that KPN’s turnaround strategy for the domestic mobile and broadband segments will prove successful.
We anticipate that KPN’s EBITDA will drop by around 10% in 2012, after a 6% fall in 2011. In our base-case scenario, we now forecast that KPN’s EBITDA will continue to fall in 2013, albeit significantly less than in 2012, and somewhat rebound in 2014, on successful cost savings and benefits from recent commercial investment aiming at defending domestic fixed broadband market share.
The group is facing intense pressures on its domestic mobile revenues in particular, owing to the cannibalization of consumer revenues by IP-based instant messaging applications. KPN has implemented a new product structure to help secure revenues derived from data usage, but the timing and extent of the benefits of these new offers remain to be determined.
KPN is accelerating fixed-cost cutting in 2012, which we think should help mitigate the effect of revenue pressure in its domestic market, The Netherlands. We also think that the group will continue to compensate for lower domestic revenues with growth in Belgium and Germany, where it’s a challenger to the incumbent operators. Its targeted marketing strategies in these countries have resulted in solid underlying growth rates so far, albeit softening in Germany in the third quarter.
We believe that fierce ongoing competition from cable operators will continue in the already highly penetrated Dutch fixed-line telecoms market. That said, KPN’s ongoing copper network upgrades and fiber-to-the-home services should help better defend its domestic market share against cable in the following quarters.
We think KPN will generate annual free cash flows of EUR1.2 billion-EUR1.4 billion in 2012-2013 (after “tax recapture” outflows and excluding spectrum), significantly lower than average past levels. This is because of lower EBITDA, last year’s temporarily low tax outflows, and heavy fixed capital outlays of more than EUR2 billion per year following network upgrades. In addition, we think that part of 2012’s free cash flow will be dedicated to the acquisition of spectrum.
Still, we anticipate that discretionary cash flows available to reduce debt will significantly increase in 2013, given the likely absence of spectrum outlays and the beneficial full-year impact of the 60% dividend cut that should save about EUR0.7 billion in cash outflows in 2013 compared with 2011. At this stage, we think this should provide sufficient absolute debt reduction capacity to bring our adjusted debt-to-EBITDA ratio back below 3.5x by year-end 2013.
The short-term rating on KPN is ‘A-2’, reflecting our assessment of KPN’s liquidity as “adequate” under our criteria.
We assess KPN’s liquidity using debt maturities and undrawn facilities available over the coming six months, given our opinion of its well-established and solid relationships with banks, and our view that it will continue to have good access to capital markets in the future owing to its domicile in The Netherlands, in the absence of any exposure to more risky emerging economies. For example, KPN issued a 4.25% EUR750 million 10-year bond in February 2012 and a 3.25% EUR750 million 8.5 year bond in July 2012. We also consider that KPN has prudent financial management, including a well-spread debt maturity structure with about EUR1 billion-EUR1.4 billion of annual long-term debt maturities through 2017 and a 6.8-year average maturity.
Tempering these positive aspects is our anticipation of significantly lower free cash flows in 2012, compared with previous years, given a strategic focus on investments to defend market shares, and continuously heavy postretirement obligations, whose fluctuations, net of dedicated assets, may require additional cash contributions at times.
The ratio of sources to uses was comfortably above 1.2x at end-September 2012, based on the next-six-months’ debt maturities and undrawn facilities. Liquidity sources comprise:
-- A EUR2 billion committed line maturing in July 2017, without any financial maintenance covenants, that was fully undrawn at end-September 2012;
-- EUR1.5 billion in reported cash at end-September 2012; and
-- Our anticipation of about EUR3.5 billion in annual funds from operations (FFO).
Liquidity uses include:
-- About EUR2.0 billion-EUR2.2 billion in annual capital expenditures;
-- EUR0.5 billion in dividends, factoring in the recent cut; and
-- EUR2.1 billion of short-term debt (of which EUR1 billion repaid on Nov. 13, 2012).
The negative outlook reflects the risk of a one-notch downgrade within the next 18 months if KPN’s adjusted credit metrics deteriorate significantly more than we expect in 2012 or fail to be restored within more commensurate levels for the rating by year-end 2013. This could be triggered by heavy outlays on spectrum acquisition in the fourth quarter of 2012, or if KPN’s EBITDA were to drop by more than our assumption of a low-single-digit decline in 2013.
In addition, should the group fail to substantially soften the drop in its domestic EBITDA in 2013, we could lower our assessment of its business risk profile to “satisfactory” from “strong” which in turn, if not sufficiently balanced by a much stronger financial risk profile, would result in a downgrade.
At this stage, we consider Standard & Poor‘s-adjusted debt-to-EBITDA and FFO-to-debt ratios of 3.5x and the mid-20% as, respectively, adequate maximum and minimum levels for the rating, given our so far unchanged assessment of a “strong” business risk profile.
We might revise the outlook to stable if we perceive that KPN is likely to sustainably and sufficiently improve its credit ratios from 2013 onward, and sustain its “strong” business risk profile.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Key Credit Factors: Business And Financial Risks In The Global Telecommunication, Cable, And Satellite Broadcast Industry, Jan. 27, 2009
Ratings Affirmed; CreditWatch/Outlook Action
Koninklijke KPN N.V.
Corporate Credit Rating BBB/Negative/A-2 BBB/Stable/A-2
Senior Unsecured BBB