Fitch Downgrades TDS Ratings to 'BB+'; Outlook Stable
CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded the Issuer Default Ratings (IDRs) and long-term, senior unsecured debt ratings of Telephone and Data Systems, Inc. (TDS) and its subsidiary United States Cellular Corp. (USM) to 'BB+' from 'BBB-'. USM's ratings consider the consolidated ratings at TDS. The Rating Outlook remains Stable.
KEY RATING DRIVERS
The downgrade reflects Fitch's belief that in 2014 USM's wireless operations will continue to struggle with the highly competitive wireless environment, leading to weak EBITDA margins and lower EBITDA. While subscriber trends in core markets may stabilize in the second half of 2014, the billing system and related issues that surfaced in late 2013 and in early 2014, as well as higher losses on equipment driven by strong smartphone sales, are expected to suppress 2014 operating profitability.
Billing system issues that contributed to higher voluntary churn in the fourth quarter of 2013 have declined, but higher levels of involuntary churn occurred in the first quarter of 2014 as a small but impactful percentage of customers had stopped paying their bills and the company dropped their service.
Postpaid subscriber additions at USM have been under material pressure for several years. In the fourth quarter of 2013, USM began selling the iPhone which Fitch believes may reduce voluntary churn over time, and should the company succeed in improving gross additions, may eventually lead to subscriber growth. USM's gross adds in its core markets improved in the first quarter of 2014 by approximately 12% to reach 197,000, but Fitch believes continued improvement is needed to generate subscriber growth even if total postpaid churn can return to recent historical levels approximating 1.6%. Moreover, increased losses on equipment are expected as USM loads more costly 4G LTE smartphones onto its network, with the impact being offset by increased service revenue over time. Losses on equipment could come down if there is a strong uptake of equipment installment plans.
The ratings at TDS, and by extension, USM, reflect the current strong liquidity position owing to the substantial cash balances, conservative balance sheet, undrawn revolving credit facilities and long dated maturities. The consolidated company does not have any material maturities until 2033.
Fitch expects TDS's gross leverage to rise to approximately 3.0x-3.1x at yearend 2014, up from 2.1x at year-end 2013. Fitch has included a portion of partnership distributions (at a level which Fitch views is sustainable) received from entities it does not control in its calculations. Assuming participation in upcoming wireless spectrum auctions, the sale of its non-core tower business, the completion of the acquisition of the BendBroadband group of companies and continued wireless network investment, Fitch expects leverage to remain around the 3.0x-3.1x level in the intermediate term.
Fitch expects free cash flow (FCF) levels in 2014 and 2015 to be negative due to the continued high level of capital investment and weaker wireless performance. In 2013, FCF was a negative $444 million. FCF would have been less severely negative if adjusted to remove the taxes paid on asset sale gains and the portion of USM's special dividend paid to noncontrolling shareholders. Fitch notes that this is a significant change from positive levels of FCF, which through 2011 exceeded $200 million per annum.
The sale of noncore assets has mitigated the effect of negative FCF on USM and TDS. USM is in the process of selling the wireless towers located in the Chicago and St. Louis markets that were sold to Sprint. This follows the sale of certain wireless spectrum licenses in 2013 and 2014 for more than $400 million.
In relation to its total outstanding debt of $1.721 billion at March 31, 2014, TDS has relatively high balances of cash and short-term investments, which amounted to $873 million and $40 million, respectively. A portion of the company's cash balance is expected to be used to finance the $261 million cash acquisition of BendBroadband in the third quarter of 2014.
Per policy, the company's maturities are very long. The earliest notes at TDS are due in 2045 ($116 million) and at USM the earliest maturity is in 2033 ($532 million). At TDS, the $400 million, undrawn revolving credit facility matures in December 2017, and at USM, the $300 million undrawn revolving credit facility also matures in December 2017.
TDS has authorized share repurchase programs at both TDS and USM and under both programs has repurchased a total of approximately $15 million over the last 12 months ending March 31, 2014. Future repurchases are expected to continue at a moderate level.
Negative Rating Action: Longer term, Fitch believes TDS's ability to grow revenues and cash flows while competing effectively against much larger national operators is key to maintaining its 'BB+' IDR. In addition, if gross leverage--calculated including partial credit for material wireless partnership distributions in EBITDA--approaches 3.5x, a negative action could be contemplated.
Positive Rating Action: Fitch believes that competitive factors, current subscriber trends and the company's relative position in the wireless industry would not likely allow a positive rating action at this time.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Rating Global Telecom Companies: Sector Credit Factors' (Aug. 9, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Rating Telecom Companies