Fitch Downgrades TDS to 'BBB'; Outlook Stable

CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded the ratings for Telephone & Data Systems, Inc. (TDS), and its subsidiary United States Cellular Corp (USM) as follows:

TDS

--Issuer Default Rating (IDR) to 'BBB' from 'BBB+';

--Senior unsecured debt to 'BBB' from 'BBB+';

--Revolving credit facility to 'BBB' from 'BBB+'.

USM

--IDR to 'BBB' from 'BBB+';

--Senior unsecured debt to 'BBB' from 'BBB+';

--Revolving credit facility to 'BBB' from 'BBB+'.

The Rating Outlook on TDS and USM is Stable. Approximately $1.5 billion of debt is affected by Fitch's action.

The ratings downgrade reflects the increased business risk and resulting pressure on the operating trends within TDS' business segments, particularly in wireless. Factors affecting the wireless operations include the competitive environment, the weak economy, the high unemployment rates and high industry penetration rates which has resulted in increased voice ARPU declines of 7% and decreased retail postpaid gross additions of 20% for the first half of 2010. Accordingly, USM recently revised downward its EBITDA guidance for 2010 by approximately 8% to $800 million - $850 million, which continues the decline in profitability since mid-2008 when the wireless operations generated in excess of $1.05 billion in EBITDA. Some of the recent EBITDA pressure was also a result of the material loss in high margin roaming revenue (down 23% in 2009) after Verizon's acquisition of ALLTEL although the most recent quarter showed significant improvement in the y-o-y loss at 2%. Other impacts to EBITDA include the multi-year initiatives that should benefit USM's longer-term competitive position and lower costs through an improved billing and operational support system, a new Customer Relationship Management System and a new Internet/Web platform. However, as the challenges within the operating environment intensify, these improvements will take considerable time (2012 timeframe) before benefits can be realized.

In the near to medium term, Fitch remains relatively pessimistic about the company's ability to generate positive revenue growth and increase profitability levels in the wireless operations during the near term given the prospects for a slow economic recovery. The likely consequence of a slow recovery is a persistent high unemployment rate that will continue to affect the outlook of certain consumers. USM has reported a higher take rate with its new prepaid unlimited offering, which the company believes reflects in part a mix shift from its postpaid plans. In addition, the competitive environment will remain challenging for USM as a result of the national market dominance of Verizon and AT&T Wireless, extended exclusivity agreements for devices like the iPhone, the renewed competitive position of Sprint Nextel and the aggressive unlimited-minute operators. These factors have caused all carriers to respond with aggressive handset subsidy offers and more deeply valued calling plans. Fitch believes the company maintains a better competitive position in its more mature markets where the company has greater market share to more effectively combat the national momentum of Verizon and AT&T Wireless.

Positive offsets to the above concerns incorporates TDS' solid financial profile which includes a healthy liquidity position, good financial flexibility, a conservative balance sheet, light maturity profile and strong credit protection metrics for its ratings. In addition, Fitch believes the company maintains a defensible market niche with its focus on network quality, customer service and aggressive/unique retention offerings that while affecting profitability, have resulted in relatively low postpaid churn rates. Postpaid churn rates for the second quarter decreased by approximately 30 basis points from a year ago to 1.4%.

While USM has generated good revenue growth from its data revenue in excess of the 30% range, the company was much later with a broad-based deployment of 3G services. Consequently, USM has a relatively low penetration of 3G enabled devices, which was in the mid-teen range as of the second quarter 2010, reflecting their weaker competitive position. While this gives the company good prospects for data revenue growth, the company must improve its adoption rate of data optimized devices, which was 24% of device sales during the second quarter of 2010. This rate significantly lags some of its national peers that were in the 60-70% range. Nevertheless, Fitch believes data growth should limit the downside risk to steeper revenue declines. Consequently, Fitch also expects that USM will likely have flat to modestly negative subscriber and revenue growth for the next several quarters. Longer-term, while Fitch believes prospects for industry wireless growth is in the mid-single digit range, it's relatively uncertain whether USM can materially improve profitability from current levels and return to sustainable revenue growth. The choice of a new CEO with a marketing background to replace the retiring Jack Rooney reflects TDS' focus to address the past negative growth trends.

TDS' good financial flexibility is due to cash, committed credit lines, free cash flow and other assets. At the end of second-quarter 2010, TDS' consolidated cash balance and short-term investments was approximately $758 million. TDS and USM maintain approximately $700 million of undrawn revolver capacity, principally through TDS' $400 million revolving credit facility and USM's $300 million revolver which both mature in June 2012. The principal covenant contained within the facility is a consolidated leverage ratio of 2.75 times (x), which allows the company considerable flexibility. Consolidated free cash flow (FCF) as defined by Fitch for the first half of 2010 was $160 million. For 2010, Fitch expects FCF of approximately $325 million. TDS also has other sizable assets that could be monetized, including USM's cellular towers and a 5.5% minority interest in Verizon Wireless' Los Angeles (VZW) partnership that generates the majority of TDS' partnership distributions, although a sale of this interest could potentially affect the ratings given the significant cash generation of the VZW assets that accounts for approximately 30% of FCF. For the first six months of 2010, distributions from all of TDS' partnerships were $49 million.

TDS does not have any significant maturities until after 2030. The company has par call options on its remaining debt securities, including TDS' $500 million 7.6% notes due 2041 and USM's $330 million 7.5% notes due 2034 providing the flexibility to refinance the debt if desired. For the last 12 months, according to Fitch's calculations, TDS' consolidated leverage was 1.3x and interest coverage was 9.2x, which are strong for its rating category. Fitch expects modest pressure on these metrics going forward. With its sizable cash balances and lack of any material near-term maturities, TDS has an active share repurchase program. In 2009, TDS completed a $250 million share repurchase program and announced a new share repurchase program for $250 million expiring in 2012. TDS has indicated plans to repurchase shares at a more measured pace. As of June 30, 2010, TDS had repurchased a total of $31 million of special common shares under the new share repurchase program and $21 million under USM's share repurchase program

The key rating drivers for TDS remain (1) maintaining a solid financial profile, (2) generation of growth in its wireless operations, and (3) improvement in profitability. The Outlook is Stable. While operating trends remain pressured, Fitch believes the company's solid financial profile affords the company further flexibility at its current rating to offset additional operational erosion.

Additional information is available at 'www.fitchratings.com'.

These rating actions reflect the application of Fitch's current criteria which are available at 'www.fitchratings.com' and specifically include the following reports:

--'Corporate Rating Methodology' (Aug. 13, 2010);

--'Liquidity Considerations for Corporate Issuers' (June 12, 2007).

Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646

Liquidity Considerations for Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=328666

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