January 11, 2017 / 10:16 PM / 7 months ago

Fitch Rates Sprint's Secured Credit Facility 'BB+/RR1'; Affirms IDRs at 'B+'

(The following statement was released by the rating agency) NEW YORK, January 11 (Fitch) Fitch Ratings has affirmed Sprint Corporation (Sprint) and its wholly owned subsidiaries Sprint Communications Inc. and Clearwire Communications LLC's Issuer Default Ratings (IDR) at 'B+'. In addition, Fitch has assigned a 'BB+/RR1' rating to Sprint's new $3.5 billion senior secured credit facility, including a $2 billion four-year senior secured revolving facility and $1.5 billion seven-year secured term loan B. The Rating Outlook for Sprint's ratings is Stable. A full list of ratings follows at the end of the release. KEY RATING DRIVERS SoftBank Support Key Fitch's rating of Sprint is primarily supported by the material benefit Sprint's IDR receives from SoftBank's tangible support, which essentially sets a rating floor at 'B+'. Additionally, Fitch believes SoftBank's support for Sprint has not changed or lessened. Past financing structures including the Mobile Leasing Solutions LLC (MLS) tranches, network equipment sale leaseback and unsecured bridge facility, while being more short-term oriented, have leveraged SoftBank's extensive and deep financial relationships, which have been a credit positive, injecting substantial liquidity and demonstrating further tangible support of Sprint. Fitch views the operational and strategic linkages as moderately strong given the extensive operational oversight, while the legal linkages are weak given the lack of any guarantees provided to existing debtholders. Weak Standalone Profile Stabilized Fitch views Sprint's standalone rating as 'B-' and believes it will remain within that range during at least the next 12 months given the challenges inherent to Sprint's financial and business profiles and the numerous ongoing strategic initiatives to address these issues. As such, Sprint has focused significant attention on increasing liquidity through several sources combined with profitability improvements to reduce operating deficits and refinance upcoming debt maturities. In October 2017, Sprint issued $3.5 billion of a $7 billion total program in five-year 3.36% wireless spectrum-backed notes that has further stabilized the liquidity position while materially reducing interest costs. During the past two years, Sprint has made good progress on operational improvements. Rating concerns would increase if Sprint's operational improvements are not sustained or fall short of current expectations, since continued significant operating deficits would require additional increases in debt beyond FY2017. Consequently, Fitch believes potential risks exist that at a future date SoftBank could reassess its level of support if the turnaround strategy does not gain sufficient traction. Increased 2.5GHz Portfolio Transparency Sprint contributed 2.5GHz licenses and 1.9GHz licenses into the spectrum financing program representing approximately 14% of Sprint total spectrum holdings on a MHz-pops basis. The spectrum portfolio is currently utilized by approximately 77% of all of Sprint's 2.5GHz enabled sites and approximately 33% of Sprint's 1.9GHz enabled sites. While the securitization carves out a material portion of spectrum, Fitch believes the improved transparency with Sprint's 2.5GHz spectrum portfolio has allowed Fitch to increase the underlying asset value estimate relative to our prior recovery analysis for the company. As part of the analysis, Fitch incorporated discussion and market values provided by third party consultants along with comparable sales and auction data. Fitch's recovery valuation also reflects the uncertainties related to a distressed market transaction by applying an applicable discount. Fitch also expects Sprint will use a material portion of the expected $7 billion of the overall potential proceeds from the spectrum securitization program, with a next tranche issued in early 2017, to repay upcoming senior notes. Thus, Fitch believes the Recovery Ratings on the loan and bond instrument ratings have not changed within Sprint's capital structure including an average recovery expectation ('RR4' = 31%-50%) for the senior notes. Substantial Maturity Wall Sprint's upcoming maturities are substantial and include approximately $2.0 billion, $5.4 billion which assumes the Clearwire notes are retired and $4.0 billion in fiscal 2016, 2017 and 2018, respectively. Maturities include senior notes, securitizations (network, handset and spectrum) and tower financing obligations. Debt maturities exclude capital leases, any off-balance-sheet facilities and other obligations. The new credit agreement also allows for an additional permitted spectrum securitization that has limitations on the total MHz-POPs that can be contributed from its 800MHz, PCS and 2.5GHz spectrum bands. This flexibility could be used to support upcoming debt maturities that are in excess of $10 billion (including spectrum notes amortization) in fiscal 2019, 2020 and 2021, respectively. Fitch would expect a material portion of net proceeds from a new spectrum securitization program, if completed, would be used to reduce senior notes. A failure to execute on current strategic plans to improve the cash generation and position the company to reduce debt materially over the long term increases the risk that Sprint's capital structure becomes unsustainable. Key Operational Trends Sprint faces several challenges, including the ongoing operating deficits, and significant risk executing Sprint's numerous strategic initiatives while sustaining and improving operational trends. The competitive intensity remains high due to competitor footprint expansion, the market maturity within the wireless industry along with the much stronger financial profiles, and the good execution of its peers that only serves to amplify the operational risk. Sprint's operational imperatives include further improvements related to cost structure, network, gross addition share, post-paid churn and brand. Sprint has seen positive progress and stabilization within its operating profile through its cost reduction efforts, network enhancements, aggressive rate plans (50% off and $60 unlimited), new marketing messaging (former Verizon spokesman), which have all increased post-paid gross addition share, improved post-paid handset mix, stabilized ABPU trends and reduced churn. Nevertheless, a key aspect to sustaining positive operating momentum and enabling longer-term service revenue growth is the overhaul needed to address deficiencies within Sprint's postpaid and prepaid distribution footprint. Sprint has plans to strategically improve its distribution through targeting increased store densification in underpenetrated areas, relocating poorly performing stores, remodelling/updating certain retail locations and migrating to more sophisticated prepaid dealers. Sprint's prepaid segment has underperformed for the past several quarters due to competitive gaps in rate plans and devices as MetroPCS and Cricket brands have increased geographical distribution with aggressive offerings. Additionally as promotional postpaid service plans begin to roll-off in 2017, gross addition share and churn improvement could be pressured. Thus, while current progress is encouraging, substantial work remains to further improve the customer value proposition in light of lingering negative brand perceptions and competitive headwinds. Right-Sizing Cost Structure Sprint's top operational priority is right-sizing the cost structure to improve cash generation. During the second quarter of FY 2015 (2Q15), Sprint announced plans to reduce costs on a run rate basis by at least $2 billion by the end of FY2016. The current cash cost target is expected to be $1 billion, split equally between operational expenses and capital expenditures with most restructuring costs occurring in FY2016. Fitch believes the company has a relatively good line of sight and is on track to achieve $2 billion or more of exit-run savings by the end of FY2016. Fitch anticipates further cost reduction opportunities will continue after this current program ends resulting in further material restructuring charges. Network Performance Gap Closing Through SoftBank's technical support, Sprint has significantly improved the performance of the LTE network with improved reliability, capacity and speed through its triband spectrum deployment (1.9GHz, 800MHz, and 2.5GHz), two-channel (2x20 MHz) carrier aggregation utilizing the 2.5GHz band and smart antenna technology. As part of these upgrades, Sprint has increased its network densification of 2.5GHz spectrum to approximately 200 million POPs. Sprint is also in the beginning stages of deploying three-channel carrier aggregation and other technologies like high performance user equipment (HPUE) to further boost network speeds, coverage and capacity. In order to better leverage the improved network performance and enable top-line growth, Sprint has evolved its marketing message in an effort to address the negative consumer perceptions of Sprint's network. Leverage, Covenants & Guarantees Sprint's leverage (Fitch defined total debt / EBITDA) as of Sept.30, 2016 was 3.8x. However, given the substantial noise with financial metrics related to the accounting for leases and installment billing, Fitch does not view reported EBITDA-based metrics as an accurate measure of financial risk. With Softbank's implied support reducing the importance of Sprint's standalone financial position, Fitch believes a more relevant metric to measure improved financial progress would be trends in EBIT and FCF generation. For FY2016, Fitch anticipates EBIT of approximately $1.5 billion and FCF deficit modestly negative after adjusting for net proceeds of device financings. FCF will remain pressured in FY2017 due to increased capital investment for network densification. Sprint's existing unsecured credit facilities benefit from upstream unsecured guarantees from all material subsidiaries. During the quarter ended December 2016, Sprint repaid $300 million of first priority senior secured notes at Clearwire Communications LLC. As a result, Clearwire and its subsidiaries became a subsidiary guarantor under various existing borrowing agreements, including all current credit facilities, junior guaranteed notes, and a co-borrower for the secured equipment credit facilities. The guarantors will be the same under the new secured credit agreement. The unsecured junior guaranteed debt is senior to the unsecured notes issued by Sprint Corporation, Sprint Communications Inc. and Sprint Capital Corporation. The unsecured senior notes at these entities are not supported by an upstream guarantee from the operating subsidiaries. Sprint has substantial flexibility under its bond indentures and credit agreement to pursue additional funding through permitted securitizations, liens arising in connection with sale and leaseback transactions, or liens on capital assets and inventory. Under its bond and credit agreement indentures, Sprint has a carve-out for permitted liens up to 15% of consolidated net tangible assets. Sprint will have approximately $4.5 billion of secured capacity after netting the revolving commitment, term loan, 9.25% debentures and Export Development Canada loan. Financial covenants for the credit agreement include maximum leverage of 6x stepping down to 4.75x and below beginning in 2018, minimum interest coverage, and limitations on non-guarantor restricted subsidiary indebtedness. Sprint's vendor financing facilities are jointly and severally borrowed by all of the Sprint subsidiaries that guarantee its revolving credit facility, Export Development Canada loan and junior guaranteed notes. The facilities additionally benefit from parent guarantees and first priority liens on certain network equipment. This places the vendor facilities structurally ahead of the unsecured notes. The Clearwire 2040 exchangeable notes benefit from a full and unconditional guarantee by the issuers' wholly-owned direct and indirect domestic subsidiaries that own the spectrum assets along with an unconditional guarantee from Sprint Corporation and Sprint Communications Inc. The exchangeable notes have both a par and call option on Dec. 1, 2017. Fitch assumes the entire $629 million of exchangeable notes will be redeemed. KEY ASSUMPTIONS --Post-paid gross addition share grows moderately from FY2015; --Post-paid churn of approximately 1.5%; --EBIT of approximately $1.5 billion; --Capital spending less than $3 billion; --FY2016 FCF deficit modestly negative after adjusting for net proceeds of device financings; --Total proceeds of up to $7 billion to be issued from the wireless spectrum-backed notes program. RATING SENSITIVITIES Fitch does not view an upgrade as likely at this time given the execution risk around its many initiatives. Future developments that may, individually or collectively, lead to a positive rating action include: --Strong execution on public guidance for long-term improvements in cost structure; --Sustained post-paid gross addition share in upper-teens range with strong mix of post-paid prime handset additions; --Sustained improvement in churn to below 1.3%; --Material positive net post-paid additions with sustained improvement in net porting ratios; --On-going improvement in network operating performance including progress with new cell-site deployments related to network densification plans; --The improved operating trends above drive financial results that mostly exceed Fitch's current expectations for trends in revenue, EBIT, EBITDA, FCF and leverage. These improvements would lead to increased confidence and transparency as to Sprint's ability to generate material levels of FCF in order to reduce debt. Future developments that may, individually or collectively, lead to negative rating action include: --Lack of improvement or sustaining results in the operating metrics for gross addition share, churn, net post-paid additions, handset subscriber mix, net porting ratios and network operating performance that further degrades financial profile. Fitch would become more concerned with Sprint's ability to effectively compete in the marketplace if the company does not demonstrate and sustain material improvement in these core metrics in FY2017; --Changes in the level or the expectations for support from SoftBank that materially affect the operating and financial profile of Sprint; --Challenges with successfully raising funds in future financing transactions that negatively affect Sprint's liquidity position; --If Fitch believes Sprint will continue material deficits beyond FY2017. LIQUIDITY Sprint's financial objectives include a commitment toward deleveraging, targeting a minimum liquidity position of 18 months, reducing interest expenses and generating FCF in FY2018. Sprint has taken several steps during the past year to bolster liquidity. Sprint raised $2.2 billion in network-related financing and completed two sale-leaseback transactions related to iPhones with MLS that provided an upfront cash infusion in excess of $2 billion. Fitch believes the MLS transactions were an important initial step toward mitigating the negative working capital effects associated with the leasing model. Fitch expects Sprint may seek other alternative funding sources for installment billing and leasing handset receivables to lower interest costs and further optimize its cost of capital. At the end of 3Q16, Sprint had approximately $11 billion of liquidity that included $5.7 billion of cash, $3 billion in availability from its unsecured revolver and $2.5 billion in availability from its unsecured bridge facility. The bridge facility was terminated following the $3.5 billion spectrum financing transaction in October 2016. The new secured credit agreement provides $1.5 billion in term loan B proceeds and $2 billion of revolver capacity. The secured credit agreement also allows for incremental term loans and facilities of up to $2 billion. Sprint maintains a $4.3 billion securitization facility that matures November 2017. The receivables facility consists of leasing, installment and service receivable sales components. Additionally, Sprint has $1.1 billion availability under vendor financing agreements that can be used toward the purchase of 2.5GHz network equipment. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Sprint Corporation --Issuer Default Rating (IDR) at 'B+'; --Senior notes at 'B+/RR4'. Sprint Communications Inc. (SCI) --IDR at 'B+'; --Unsecured credit facility at 'BB/RR2'; --Junior guaranteed notes at 'BB/RR2'; --Senior notes at 'B+/RR4'. Sprint Capital Corporation --Senior unsecured notes at 'B+/RR4'. Clearwire Communications LLC --IDR at 'B+'; --Senior exchangeable notes at 'BB+/RR1'. The following ratings have been revised: SCI --9.25% Secured debentures due 2022 to 'BB+/RR1' from 'B+/RR4'. The following ratings have been assigned: Sprint Communications Inc. --Secured revolving credit facility at 'BB+/RR1'; --Secured term loan B at 'BB+/RR1'. The ratings on the existing unsecured revolving facility will be withdrawn when the new secured credit agreement closes. The Rating Outlook is Stable. Contact: Primary Analyst William Densmore Senior Director +1-312-368-3125 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst David Peterson Senior Director +1-312-368-3177 Committee Chairperson John Culver Senior Director +1-312-368-3216 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Additional information is available on www.fitchratings.com. 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 lease and equipment installment plan accounting differences, cash restructuring and other charges to determine cash EBITDA used for recovery; --Financial statement adjustments for adding back the portion of off-balance-sheet receivables securitization and MLS tranche 1. 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