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Fitch Downgrades Frontier Communications' to 'BB-'; Maintains Negative Outlook
February 22, 2017 / 9:05 PM / 9 months ago

Fitch Downgrades Frontier Communications' to 'BB-'; Maintains Negative Outlook

(The following statement was released by the rating agency) CHICAGO, February 22 (Fitch) Fitch Ratings has downgraded the Issuer Default Rating (IDR) of Frontier Communications Corp. (Frontier, NYSE: FTR) and its subsidiaries to 'BB-' from 'BB'. The Rating Outlook remains Negative. Additionally, Fitch has affirmed the first mortgage bonds at Frontier Southwest Inc. and has revised the long-term issue ratings of Frontier and other subsidiaries as listed at the end of this release. KEY RATING DRIVERS The downgrade reflects lower than anticipated EBITDA due to weak revenue and subscriber trends that, when coupled with low free cash flow (FCF) generation, have resulted in a slower deleveraging path. Frontier will need additional time to deleverage as it incorporates the Verizon assets into its operations and to stabilize revenue and subscriber trends in its legacy and new markets. Fitch now anticipates gross leverage of 4.3x at year-end 2018, versus 3.8x by year-end 2017. The expected range is more reflective of a 'BB-' rating. Frontier's Rating Outlook is Negative, as Frontier is not expected to reach Fitch's leverage threshold of 4.2x-4.3x for the current rating until approximately the end of 2018. Improved Scale, FCF Prospects Frontier nearly doubled in size after acquiring Verizon Communications Inc.'s wireline properties in California, Texas and Florida (the Verizon transaction) in April 2016. Pro forma consolidated revenue increases to approximately $10 billion from $5.6 billion in 2015. Fitch believes Frontier's enhanced scale should lead to improved FCF, defined as net cash provided by operating activities less capex and dividends, over time. The acquisition is not expected to require material additional capital spending given past network upgrades by Verizon. Operational Challenges Pressure Revenue Challenges faced by Frontier at the close of the Verizon transaction resulted in elevated subscriber churn and weaker than expected revenue. Frontier anticipated slower subscriber gross additions as a result of the company's decision to temporarily suspend marketing activities during the first half of 2016. However, the company faced additional, unexpected headwinds during the second and third quarters of 2016 after onshoring its call centers. Although the call center issues appear to have subsided, Fitch believes it will take additional time for marketing efforts to ramp up and stabilize subscriber gross addition trends. Subsidiary Debt Ratings The 'RR1' Recovery Rating assigned to the approximately $850 million of outstanding subsidiary debt reflects its structural seniority to all of the parent debt. Of this amount, $100 million is secured and the remainder unsecured. The 'RR2' assigned to the secured revolver and secured term loans reflects the potential limitations in value of Frontier North as the only source of collateral security, including potential revolver drawings (per Fitch's approach), if cash flows are stressed. In addition, Frontier North has $200 million of unsecured debt that is structurally senior to the equity pledge providing security to the parent secured debt. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Frontier include: -- Consolidated revenues rising to just under $10 billion at the end of 2017, reflecting a full year of revenue contribution from the Verizon wireline properties. Fitch expects Frontier to slowly regain its footing during 2017 following weak revenue trends after the close of the Verizon transaction; -- Lower EBITDA from elevated customer churn largely offsets the $1 billion of annualized cost synergies realized by Frontier in 2Q16, resulting in EBITDA margins of 40% during 2017; -- Capex around $1.3 billion in 2017. Fitch's assumption reflects capital intensity of 12.5%, and includes additional capital spending for CAF II, and to a lesser extent, integration; -- Cash taxes are expected to be a refund of $100 million to $110 million in 2016, and minimal in 2017 as a result of the tax-basis step-up from the Verizon transaction and bonus depreciation. RATING SENSITIVITIES Fitch will use gross leverage versus net leverage going forward, comparable to most Fitch-rated companies across the telecommunications sector. Fitch will take into consideration any prefunding of maturing debt on a pro forma basis if necessary. Future developments that may, individually or collectively, lead to a negative rating action would likely coincide with: --Gross leverage sustained above 4.2x-4.3x as a result of weaker than expected operating trends, shareholder-friendly activities or additional material acquisitions; --While not expected, a return to mid-single-digit declines in revenue. Rating concerns would increase if Frontier's leverage (as defined by Fitch) is not below 4.2x-4.3x by the end of 2018. A positive rating action would likely coincide with: --Gross leverage sustained below 3.7x-3.8x; --FCF margins sustained in the mid- to high-single digits. LIQUIDITY Manageable Maturities Upcoming principal repayments are manageable and amount to $509 million and $733 million during 2017 and 2018, respectively. Fitch expects Frontier to rely on its revolver and the capital markets to refinance upcoming maturities until FCF improves. Frontier has some capacity under its covenants to issue secured debt, which could be a way for the company to refinance upcoming maturities and reduce annual interest expense. Improving Financial Flexibility Anticipated Financial flexibility is expected to strengthen in step with improvement in FCF. Pressured EBITDA, heavy integration spending prior to the close of the Verizon transaction, and sustained dividend payments resulted in a FCF deficit of $711 million at the LTM period ended Sept. 30, 2016. However, Fitch expects FCF will be positive, albeit minimal, in 2017 as the majority of integration costs have subsided. Fitch also expects FCF margins will improve to the mid-single digits over the forecast horizon. Frontier's liquidity position was adequate at the end of Sept. 30, 2016, supported by $311 million of cash and full availability under its $750 million (RCF). The $750 million senior secured RCF is in place until May 2018. Management stated it is looking to renew and extend the revolver in the coming year. The facility is available for general corporate purposes but may not be used to fund dividend payments. The main financial covenant in Frontier's secured facilities requires the maintenance of net debt-to-EBITDA of 4.5x or less. Net debt is defined as total debt less cash exceeding $50 million. FULL LIST OF RATING ACTIONS Fitch has downgraded the ratings and maintained the Negative Outlook as follows: Frontier Communications Corp. --IDR to 'BB-' from 'BB'; --$750 million senior secured revolving credit facility due 2018 to 'BB/RR2' from 'BB+/RR2'; --$1.6 billion senior secured term loan due 2021 to 'BB/RR2' from 'BB+/RR2'; --Senior unsecured notes and debentures to 'BB-/RR4' from 'BB/RR4'. Frontier North Inc. --IDR to 'BB-' from 'BB'; --Senior unsecured debentures to 'BB/RR1' from 'BB+/RR1'. Frontier West Virginia Inc. --IDR to 'BB-' from 'BB'; --Senior unsecured debentures to 'BB/RR1' from 'BB+/RR1'. Frontier California Inc. --IDR to 'BB-' from 'BB'; --Senior unsecured debentures to 'BB/RR1' from 'BB+/RR1'. Frontier Florida LLC --IDR to 'BB-' from 'BB'; --Senior unsecured debentures to 'BB/RR1' from 'BB+/RR1'. Frontier Southwest Inc. --IDR to 'BB-' from 'BB'. Fitch has affirmed the following long-term issue rating: Frontier Southwest Inc. --First mortgage bonds at 'BB+/RR1'. The Rating Outlook is Negative. Contact: Primary Analyst Connie McKay Associate Director +1-312-368-3148 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst John C. Culver, CFA Senior Director +1-312-368-3216 Committee Chairperson Bill Densmore Senior Director +1-312-368-3125 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: 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: -- Historical and projected mandatory convertible preferred stock is given 100% equity credit. Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 21 Nov 2016) here Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1019387 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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