CHICAGO--(BUSINESS WIRE)--Fitch Ratings has placed the 'BB+' Long-Term Issuer Default Ratings (IDRs) of CenturyLink Inc. (CenturyLink) (NYSE: CTL) and its subsidiaries on Rating Watch Negative. The rating action affects approximately $19.9 billion of debt outstanding as of June 30, 2016.
Fitch has affirmed the Long-Term IDRs of Level 3 Communications, Inc. (LVLT) and its wholly owned subsidiary Level 3 Financing, Inc. (Level 3 Financing) at 'BB'. The Rating Outlook remains Stable. The rating action affects approximately $11 billion of debt outstanding as of June 30, 2016.
See the full list of rating actions at the end of this release.
KEY RATING DRIVERS
Acquisition of LVLT: CenturyLink and LVLT have a definitive agreement whereby CenturyLink will acquire LVLT in a cash and stock transaction; LVLT's existing debt will remain outstanding. The cash portion of the transaction, which is approximately 60%, will be financed by approximately $7 billion in incremental, senior secured debt as well as cash on hand at both companies. The transaction is expected to close by the end of the third quarter of 2017, following customary shareholder and regulatory approvals.
Fitch views CenturyLink's acquisition of LVLT positively from a strategic perspective. The two companies combined will create the second largest enterprise service provider in the U.S. and should benefit from the enhanced scale and operating synergies over time. Post-acquisition, CenturyLink will also have an extensive international network.
The Negative Watch for CenturyLink's IDR reflects the increase in leverage pro forma for the transaction. Fitch estimates that at the end of 2018, the first full year following the expected close of the transaction, gross leverage will approximate 3.9x. As currently proposed, the transaction would potentially lead to a one-notch downgrade for CenturyLink to 'BB' and a Stable Outlook. Based on a potential one-notch downgrade of the IDR to 'BB', Fitch would also downgrade CenturyLink's senior unsecured debt one notch. The one-notch downgrade is consistent with Fitch's notching treatment of issue ratings with 'RR4' recoveries, reflecting a rating at the same level as the IDR.
Resolution of the Rating Watch will be based on an evaluation of a number of factors, including Fitch's further analysis of CenturyLink's final, post-acquisition capital structure, an assessment of CenturyLink's financial policies, the execution risks associated with the integration of LVLT, and the effect of conditions placed on the transaction by the regulatory approval process.
LVLT's affirmation reflects the proposed structure of the transaction. A new holding company (HoldCo) will be formed and become the parent of LVLT. The Holdco is expected to guarantee the acquisition financing at CenturyLink and the stock of LVLT is expected to also secure the new financing at CenturyLink. The existing LVLT capital structure will remain in place and LVLT will not provide a guarantee to the HoldCo or to the acquisition debt.
To fund the transaction, CenturyLink has $10.2 billion in secured financing commitments, including a $2 billion revolver. The remaining $8.2 billion of other secured facilities includes financing for debt maturing at CenturyLink prior to the expected close of the transaction. The secured financing is expected to be guaranteed by existing CenturyLink subsidiaries (including Embarq Corporation [EQ]), except for Qwest Corporation (QC), and by HoldCo. LVLT and QC are expected to pledge stock to secure the facilities.
Parent-Subsidiary Relationship: Following the close of the transaction, Fitch anticipates linking the IDRs of CenturyLink and LVLT based on the strong operational and strategic ties.
Deleveraging Expected: Following the close of the transaction, Fitch expects CenturyLink to delever at a moderate pace through EBITDA growth and debt repayment; however, Fitch does not expect the company to approach its 3.0x net leverage target in the three year period following the close of the transaction.
KEY ASSUMPTIONS
For CenturyLink, Fitch's key assumptions within the agency's rating case include:
-- Fitch's base case assumes the data centers are sold as of Jan. 1, 2017 and thus reflects a full year loss of revenue and EBITDA. Although the LVLT acquisition is expected to close around Sept. 30, 2017, the forecast assumes it closes towards the end of fiscal 2017. LVLT's operations are fully incorporated starting in fiscal 2018.
--Fitch assumes CTL revenues will decline 2% or less in 2016 and 2017, before stabilizing in 2018.
--Fitch's forecast cost synergies slightly below synergies expected by CenturyLink and integration expenses in line with CenturyLink's expectations.
--The company benefits from $9.6 billion of unused NOLs from LVLT starting in 2018.
--Fitch assumes additional one-time cash taxes related to the data center sale are paid in 2017.
--Share repurchases are suspended while the company deleverages back to its net leverage target.
For LVLT, Fitch's key assumptions within the agency's rating case include:
--The base case assumes a continuation of a rational pricing environment and stable macro-economic conditions.
--LVLT is largely successful in capitalizing on operating leverage to expand growth in gross margin and EBITDA margin during the forecast period.
--CNS revenue growth ranging between 2% and 3% driven by continued strong growth within the company's North American Enterprise segment.
--LVLT's network access margin (gross margin) growing to over 67% by year-end 2017.
--Capital expenditures will approximate 15% of consolidated revenues.
--Free cash flow (FCF) generation exceeding 11.5% and 13.5% of revenues during years ended 2016 and 2017, respectively.
--Debt levels are expected to remain relatively consistent.
RATING SENSITIVITIES
What Could Lead to a Positive Rating Action:
Should CenturyLink's IDR be downgraded one notch to 'BB', Fitch does not anticipate a positive action within a 12- to 18-month rating horizon. To return to the 'BB+' IDR, Fitch would expect CenturyLink to maintain leverage at 3.0x or lower while consistently generating positive FCF in the mid-single digits. Additionally, the company will need to demonstrate consistent revenue growth, stable or improving margins, and no extensive delays in reaching expected cost synergies.
What Could Lead to a Negative Rating Action:
Negative rating actions could result from a weakening of CenturyLink's operating results, including deteriorating margins and revenue erosion brought on by difficult economic conditions or competitive pressure. Additionally, should CenturyLink's IDR be downgraded one-notch to 'BB', negative rating actions could result from discretionary management decisions including, but not limited to, execution of merger and acquisition activity that increases leverage beyond 4.5x in the absence of a credible deleveraging plan.
LIQUIDITY
CenturyLink's total debt was $19.9 billion at June 30, 2016, and readily available cash totalled $137 million (cash excludes $54 million in foreign bank accounts). Financial flexibility is provided through a $2 billion revolving credit facility that matures in December 2019. As of June 30, 2016, there were no borrowings outstanding on the facility.
Fitch believes CenturyLink has the financial flexibility to manage upcoming maturities due to its FCF and credit facilities. In 2016, maturities only consist of $11 million of term loan amortization payments. Maturities amount to approximately $1.5 billion and $196 million in 2017 and 2018, respectively.
The principal financial covenants in the $2 billion revolving credit facility limit CenturyLink's debt to EBITDA for the past four quarters to no more than 4.0x and EBITDA to interest plus preferred dividends (with the terms as defined in the agreement) to no less than 1.5x. QC has a maintenance covenant of 2.85x and an incurrence covenant of 2.35x. The facility is guaranteed by certain material subsidiaries of CenturyLink.
FULL LIST OF RATING ACTIONS
Fitch has placed the following CenturyLink ratings on Rating Watch Negative:
CenturyLink
--Long-Term IDR 'BB+';
--Senior unsecured $2 billion RCF 'BB+/RR4';
--Senior unsecured debt 'BB+/RR4'.
Embarq Corp.
--IDR 'BB+';
--Senior unsecured notes 'BBB-/RR2'.
Embarq Florida, Inc. (EFL)
--IDR 'BB+';
--First mortgage bonds 'BBB-/RR1'.
Qwest Communications International, Inc. (QCII)
--IDR 'BB+'.
Qwest Corporation (QC)
--IDR 'BB+';
--Senior unsecured notes 'BBB-/RR2'.
Qwest Services Corporation (QSC)
--IDR 'BB+'.
Qwest Capital Funding (QCF)
--Senior unsecured notes 'BB+/RR4'.
Fitch affirms LVLT's ratings as follows:
LVLT:
--IDR at 'BB';
--Senior unsecured notes at 'BB-/RR5'.
Level 3 Financing, Inc.:
--IDR at 'BB';
--Senior secured term loan at 'BB+/RR1';
--Senior unsecured notes at 'BB/RR2'.
The Rating Outlook for LVLT remains Stable.
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:
--For CenturyLink and LVLT, no material adjustments have been made that have not been disclosed in public filings of this issuer.
Additional information is available on www.fitchratings.com
Applicable Criteria
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 05 Apr 2016)
https://www.fitchratings.com/site/re/879564
Additional Disclosures
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https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014089
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014089
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https://www.fitchratings.com/regulatory
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