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Fitch Affirms BT Group at 'BBB'/Positive on EE Announcement
February 5, 2015 / 10:05 AM / in 3 years

Fitch Affirms BT Group at 'BBB'/Positive on EE Announcement

(The following statement was released by the rating agency) LONDON, February 05 (Fitch) Fitch Ratings has affirmed BT Group plc's (BT) Long-term Issuer Default Rating (IDR) at 'BBB' with a Positive Outlook. A full list of rating actions is below. The affirmation follows the company's announcement of the agreed terms of its acquisition of UK mobile network operator (MNO), EE. The transaction has an enterprise value of GBP12.5bn made up of 16% of the equity of the enlarged BT group (valued at around GBP6.8bn based on BT's closing share price on 4 February), GBP1.0bn raised from an equity placement, GBP2.3bn of assumed EE net debt and GBP2.4bn from existing cash and net new debt financing. The conservative financing of the transaction and the enlarged group's improved operating profile are likely to lead to an upgrade of BT's IDR following the closing of the deal. Fitch considers the acquisition of the UK's largest mobile operator by subscribers has good industrial logic and materially improves BT's scale and market position. It positions the company to provide quad-play services in a market where convergence is yet to be significantly established, despite consumers being willing to pay for bundled and high quality communications services. It increases the company's cash flow scale and removes its more limited platform diversification relative to the incumbent peer group. These factors underline a moderate relaxation in Fitch's 'BBB+' upgrade guideline (to below 2.5x funds from operations (FFO) net adjusted leverage), while the deal's financing structure supports the Positive Outlook. Our base case suggests the upgrade metric is likely to be met in year one of transaction close, with our expectation being that we will upgrade BT's ratings, absent material changes to the operating environment, upon transaction close. KEY RATING DRIVERS Diversified Service Platform, Market Position The acquisition of EE, subject to regulatory approval, significantly improves BT's operating profile and market position. Subject to any further consolidation of the UK mobile market, an integrated BT/EE will be the country's largest MNO by customers, and one of the few European incumbents with a stable domestic fixed line revenue base. BT would be the only UK operator able to provide a quad-play bundle on controlled infrastructure. While the UK telecoms market remains competitive it does not have the competitive pressures that markets such as France or the Netherlands have, or the economic pressures of southern Europe. BT still faces triple-play competition from Sky and Virgin Media; both of which have proven effective competitors. The company faces the near term threat of material TV content cost inflation, although in our view, these are manageable and better absorbed given the larger cash flow scale of the enlarged group. Strong & Improving Cash flow Regardless of the EE deal, BT is strongly cash generative with a pre-dividend free cash flow margin that is higher than the European incumbent average. EE is a well-established mobile business, strongly cash generative, as evidenced by the reported GBP500m plus a year it has been paying in shareholder dividends. The company has the most advanced LTE coverage and strongest spectrum portfolio in the market. The integration of the acquisition does not rely on revenue synergies for the business to deleverage while initial metrics are not considered aggressive for the rating. Forecast deleveraging along with an enhanced operating profile and larger cash flow scale support the moderation in proposed upgrade guidelines and the Positive Outlook. Leverage Friendly Deal Structure The deal structure incorporates a significant equity component with more than half the equity value paid for in new shares of the enlarged company. BT's underlying cash flow complimented by EE is expected to lead to pro-forma year 1 FFO net leverage below 2.5x, which is the revised upgrade guideline to 'BBB+' given the enhanced operating profile presented by a combined BT/EE. Our calculation of FFO includes the pension deficit contributions that are to be made in line with the recovery plan agreed with the pension trustee following the 2014 triennial funding valuation. Measured on a net debt/CFO less capex metric, reducing from approximately 4.0x, the company has a conservative metric relative to the peer group. Integration Risk, Management Track Record As with any acquisition, there is integration/execution risk. BT's management is well regarded with a solid track record of delivering operating efficiencies, although with limited experience of running a mobile business. The transaction does not rely on revenue synergies while cost synergies do not appear overly optimistic. RATING SENSITIVITIES Future developments that may, individually or collectively, lead to positive rating action include: - FFO net lease adjusted leverage that is expected to remain consistently below 2.5x, which is a moderation to the previous guideline of below 2.0x and assumes the successful close of the EE deal. - A sustained position in the highly competitive UK triple-play market supporting stable revenues, a sustained margin profile and solid free cash flow generation. - Visibility on the cost implications of significant content rights renewal, most notably the Premiership content renewal due in 2015. Future developments that may, individually or collectively, lead to negative rating action include: - A downgrade to 'BBB-' would be likely if FFO net adjusted leverage was expected to remain consistently above 3.5x. This represents a relaxation of the existing guideline of 3.0x and assumes the EE transaction closes. - Deterioration in the key operating and financial metrics at BT's main operating subsidiaries, or significant risk taking in relation to the development of BT Consumer's pay-TV offering. FULL LIST OF RATING ACTIONS: BT Group plc Long-term IDR: affirmed at 'BBB'; Positive Outlook Short-term IDR: affirmed at 'F2' British Telecommunications plc Long-term IDR: affirmed at 'BBB'; Positive Outlook Short-term IDR: affirmed at 'F2' Senior unsecured rating: affirmed at 'BBB'. Commercial Paper Programme: affirmed at 'F2' Contact: Principal Analyst Jonathan Levy Analyst +44 20 3530 1701 Supervisory Analyst Stuart Reid Senior Director +44 20 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Alex Griffiths Managing Director +44 20 3530 1709 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available at For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable criteria, 'Corporate Rating Methodology', dated 28 May 2014 is available at Applicable Criteria and Related Research: Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage here Additional Disclosure Solicitation Status 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 WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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