April 5 - Overview -- In our opinion, difficult conditions in the electricity and gas markets in Italy have delayed the recovery that we had anticipated in A2A's cash flow generation and credit metrics. -- In our view, A2A's cash flow generation and key credit metrics are unlikely to strengthen to levels that we consider commensurate with a 'BBB+' long-term rating. -- We are therefore lowering our long-term corporate credit and senior unsecured issue ratings on A2A to 'BBB' from 'BBB+'. -- The negative outlook reflects our view that A2A's profitability and cash flow generation may continue to suffer from increasingly difficult and volatile industry conditions for its nonregulated activities. Rating Action On April 5, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit and senior unsecured debt ratings on Italian utility A2A SpA to 'BBB' from 'BBB+'. At the same time, we affirmed our 'A-2' short-term corporate credit rating on A2A. The outlook is negative. Rationale The downgrade reflects our view that A2A's cash flow generation and key credit metrics are unlikely to strengthen to levels that we consider commensurate with a 'BBB+' long-term rating. In our view, A2A's credit metrics have been weak for the ratings for the past two years. There has been some improvement owing to disposals, positive cash flow generation, and a reduction in capital expenditures (capex), but the recovery in the group's credit metrics has been slower than we had anticipated. In our opinion, this is a result of difficult conditions in the electricity and gas markets in Italy, coupled with repeated delays to the completion of the shareholder restructuring of Italian utility Edison SpA (BB+/Watch Neg/B). We assess A2A's financial risk profile as "significant" and its business risk profile as "strong." We anticipate that conditions in the Italian energy market will remain challenging over the medium term. This is because we forecast an oversupply of electricity and gas due to a softening of demand, a growing contribution to supply from subsidized renewable generation assets, and the subsequent pressure on generation margins. We believe that these challenges are likely to persist, at least until 2013-2014, as a result of the ongoing economic downturn in Italy. Therefore, our base-case credit scenario factors in a weak electricity generation margin and flat gas margin in the medium term. At the same time, we expect the contribution of the regulated and quasi-regulated businesses to continue to support A2A's operating performance. We also anticipate that the binding agreement for the reorganization of Edison's ownership structure, signed by Edison's shareholders on Feb. 16, 2012, will be completed by June 30, 2012. This transaction will result in A2A acquiring the majority of Edipower SpA (not rated), a generation asset company with 6.5 gigawatts of installed capacity. (For further details, see section titled "Update On Edison's Shareholder Agreement" below.) On completion of the agreement, we understand that A2A will fully consolidate Edipower. On the basis of these assumptions, we forecast that A2A will post a Standard & Poor's-adjusted ratio of funds from operations (FFO) to debt of about 15%-16% in 2012, recovering to about 17%-18% in 2013. We had previously anticipated an adjusted FFO-to-debt ratio of at least 18% in 2012, and more than 18% in 2013 and beyond. We continue to view A2A's business risk profile as "strong," based on the diversification and vertical integration of the group's operations. A2A generates stable and predictable cash flows from its low-risk regulated activities in electricity, gas, and water distribution, and from its regulated and quasi-regulated waste activities. The former activities generated about 26% of EBITDA in 2011, while the latter generated about 29%. We could revise our assessment of business risk downward, however, if we see any sustained erosion in the company's profitability resulting from an increasingly difficult and volatile industry environment for A2A's electricity generation activities. That said, the share of earnings from the lower-risk regulated grid activities--primarily A2A's distribution network operations--and quasi-regulated activities--primarily A2A's waste and district heating businesses--continue to support the business risk profile. The 'BBB' rating is based on A2A's stand-alone credit profile (SACP), which we assess at 'bbb', as well as on our opinion that there is a "low" likelihood that A2A's municipal government shareholders would provide timely and sufficient extraordinary support to A2A in the event of financial distress. In accordance with our criteria for government-related entities (GREs), our view of a "low" likelihood of extraordinary government support is based on our assessment of A2A's: -- "Limited importance" of A2A's role for the main municipal shareholders, namely the City of Milan (BBB+/Negative/--) and the City of Brescia (not rated). Although A2A is a major provider of public services, making it strategically important for the municipal shareholders, its activities could, in our opinion, be undertaken by a private sector entity or another GRE if A2A ceased to exist; and -- "Limited" link between A2A and its municipal shareholders, given both cities' joint control of A2A (27.5% each) and the potential decision-making difficulties that we see as a result of A2A's shareholder structure and governance model. Liquidity The short-term corporate credit rating on A2A is 'A-2' and largely reflects the long-term corporate credit rating and our view of A2A's "adequate" liquidity profile under our criteria. Projected sources of liquidity exceed projected uses by more than 1.2x over the next 12 months. This is underpinned by: -- Access to unrestricted short-term cash and short-term marketable securities of EUR147 million (including EUR80 million at A2A's subsidiary EPCG) as of Dec. 31, 2011; -- A total of EUR1,150 million (including EUR45 million at EPCG) of undrawn committed credit facilities maturing in more than 12 months as of Dec. 31, 2011; and -- Our forecast that A2A will generate modest FFO of about EUR750 million-EUR800 million in 2012. This compares with our forecast that, in 2012, A2A faces: -- About EUR350 million-EUR400 million in capex; -- EUR40 million in dividend payments based on 2011 results; and -- EUR666 million in short-term debt maturing over the next 12 months. We further believe that the group has sound relationships with its banks, and we understand that there are no restrictive covenants in the documentation on the group's debt. Outlook The negative outlook reflects our opinion that A2A's profitability and cash flow generation may continue to suffer from increasingly difficult and volatile industry conditions for its nonregulated activities. In our view, weakening profitability and cash flow generation would reflect a less robust business risk profile than we currently assess. Consequently, we could lower the ratings if we revise our assessment of A2A's business risk profile downward to "satisfactory" from "strong." Furthermore, we could lower the ratings if the company struggles to maintain its credit metrics in line with our forecasts. This could result from weaker market conditions than we anticipate, or any unforeseen government actions, such as fiscal transfers or tariff freezes, which may impair the cash flows of power utilities in Italy. We could revise the outlook to stable if we see an improved macroeconomic outlook for Italy and a recovery in Italian generation spreads. This may have a positive effect on A2A's profitability, thereby supporting our current assessment of its business risk profile. Ratings stability also depends on A2A's ability to deliver adjusted FFO to debt of 15%-16% in 2012, owing to a focus on deleveraging through the divestment of noncore assets and a reduction in capex. Stability also relies on A2A being on track to strengthen adjusted FFO to debt to at least 18% by 2013, assuming that our assessment of its business risk profile remains unchanged. Update On Edison's Shareholder Agreement On Feb. 16, 2012, Edison's shareholders--A2A, Delmi SpA (not rated; an investment vehicle that is 51%-owned and controlled by A2A), and EDF--signed a binding agreement for the reorganization of Edison's ownership structure. The agreement stipulates that: -- Delmi will purchase a 70% stake in Edipower from Edison (which currently holds a 50% share) and Alpiq Holding AG (not rated; a Swiss energy company that currently holds a 20% stake) for a total price of EUR804 million. -- EDF will purchase from Delmi a further 50% stake in Transalpina di Energia S.r.l. for a price of EUR704 million. Transalpina di Energia is a holding company in which EDF already owns 50%, and which, in turn, holds 61.3% of Edison's voting share capital. The underlying valuation of Edison's share price in the transaction is EUR0.84. EDF will acquire full managerial control of Edison with at least an 80% share. -- Edison and Edipower will enter into a contract under which Edison will supply gas to Edipower to cover 50% of Edipower's shareholders' needs for a six-year period at market prices. The binding agreement remains subject to confirmation of Edison's share price by the Italian Stock Exchange Commission, and the approval of the relevant EU and Italian antitrust and regulatory authorities. The reorganization is due to be completed by the end of June 2012. Related Criteria And Research All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated. -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions, June 14, 2011 -- Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010 -- Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 Ratings List Downgraded; Ratings Affirmed To From A2A SpA Corporate Credit Rating BBB/Negative/A-2 BBB+/Negative/A-2 Senior Unsecured Debt BBB BBB+ Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.