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Fitch Affirms SBC Communications' 'A+' Rating; Removes From Rating Watch Negative

Posted on: Tuesday, 26 October 2004, 12:00 CDT

Fitch Ratings has affirmed the 'A+' rating assigned to SBC Communications' (SBC) senior unsecured debt as well as the entities listed at the end of this release that no longer issue external debt but still have debt outstanding as SBC has consolidated financing at the parent level. The ratings have been removed from Rating Watch Negative. In addition, Fitch has upgraded the rating assigned to the senior unsecured debt of Cingular Wireless, LLC (Cingular) to 'A' from 'A-' and also removed it from Rating Watch Negative. The Rating Outlook for both SBC and Cingular is now Stable. The 'F2' commercial paper rating assigned to Cingular has been withdrawn, following the disclosure it will cease to issue short-term debt publicly. Fitch has also upgraded the outstanding senior unsecured notes of AT&T Wireless Services, Inc. (AT&T Wireless) to 'A' from 'BBB' and removed AT&T Wireless from Rating Watch Positive. AT&T Wireless' Rating Outlook is also Stable. Cingular has agreed to assume the senior notes of AT&T Wireless. The ratings assigned to the senior subordinated debt issued by TeleCorp Wireless, Inc. (TeleCorp) and Tritel PCS, Inc. (Tritel), both subsidiaries of AT&T Wireless, have also been upgraded to 'A' from 'BBB' and removed from Rating Watch Positive. Fitch now has a Stable Rating Outlook for TeleCorp and Tritel. The 'F1' commercial paper ratings of SBC and SBC International are affirmed and were not under review.

The rating actions conclude Fitch's review of the ratings initiated in February 2004 following the announcement that Cingular, which is 60% owned by SBC (and 40% by BellSouth Corporation), would acquire AT&T Wireless in a $41 billion cash transaction. Following the receipt of approval of the transaction by the Federal Communications Commission (FCC) and the Department of Justice (DoJ), Cingular is expected to close the AT&T Wireless transaction shortly, after receiving approvals on Oct. 25 and 26, 2004. The divestitures required by the FCC and DoJ to obtain approval are not expected to materially impact the transaction. Cingular is now the largest wireless operator in the United States with approximately 47 million subscribers.

The affirmation of SBC's rating at the 'A+' level reflects Fitch's expectation that the company will be able to reduce post-acquisition leverage to the 1.5 times (x)-1.6x range within a reasonable period of time (12-18 months), the positive impact the increased presence of wireless in SBC's product portfolio and expectations for strong and relatively stable cash flows from its wireline and directory businesses. The rating balances these strengths against the near-term challenges expected to be faced by Cingular as it integrates AT&T Wireless into its business and the challenges SBC has in its wireline business arising from wireless substitution and wireline facilities-based competition (primarily cable operators).

The upgrade to 'A' of Cingular and the AT&T Wireless debt to be assumed by Cingular reflects the strategic importance and strong linkage of the company to its parent companies, SBC and BellSouth. Fitch also incorporated into Cingular's rating, BellSouth's 'A' rating on its senior unsecured debt (see separate release) and the merger integration challenges to be faced by Cingular. On a pro forma basis, Cingular will have approximately $13 billion in external debt, but the level is expected to decline over time as Cingular will no longer issue debt publicly. SBC and BellSouth have entered into a revolving credit facility to finance Cingular's needs to the extent Cingular is not funded internally. SBC and BellSouth also have in place subordinated shareholder loans to Cingular totaling approximately $9.7 billion. Fitch expects the shareholder loans to be reduced over time as Cingular enters a free cash flow position. Although the senior subordinated debt of Telecorp and Tritel is not guaranteed by AT&T Wireless or Cingular, as of June 30, 2004 the total amount of senior subordinated debt was only $411 million and is expected to decline as the company retires this debt over time.

SBC has maintained strong credit protection measures over the past three years through reductions in debt as well as through cost management activities. In the first nine months of 2004, SBC's debt-to-EBITDA on an annualized basis was approximately 1.2x, including proportional debt and EBITDA from Cingular. SBC's debt reduction and current cash position has been enhanced by the disposition (net of acquisitions) of more than $13 billion in assets since the year-end 2000. A substantial portion of these assets consisted of minority interests in international operators that produced a moderate level of cash (dividend income) to SBC.

SBC's share of the funding requirement for the $41 billion will be approximately $22 billion, after the use of an expected $5-$6 billion of cash on AT&T Wireless' balance sheet at the close of the transaction. SBC's external funding needs are estimated to be $8-$10 billion, after taking into account existing cash on its balance sheet (which was $13.3 billion at the end of Sept. 2004) and SBC's anticipated free cash flow from operations until the close of the transaction. Approximately 50% of SBC needs are expected to eventually be termed out in the long-term markets, with the remainder in short-term. SBC has a $12 billion bridge financing facility in place to aid in completion of the transaction. To complete the purchase, SBC and BellSouth will infuse as equity into Cingular the necessary funds to complete the transaction.

At the close of the transaction, Fitch expects the combination of SBC's debt and SBC's 60% share of Cingular's public debt to be in the range of $34-$36 billion. Strong free cash flows in 2005 are expected to allow SBC to reduce the portion of the transaction financed by short-term debt, so that Fitch estimates SBC's adjusted leverage (including proportionate EBITDA and external debt for Cingular) could approximate 1.6x at the end of 2005. SBC's return to a conservative leverage profile in 2005-06 serves to offset the company's higher degree of business risk.

An important determination in SBC's affirmation and Stable Outlook is the increasing role wireless is expected to play in SBC's future revenue mix. Following the close of the transaction, approximately one-third of SBC revenues are expected to be derived from the wireless business, when Cingular's proportionate revenue is included. The proportion of wireless revenues in the revenue mix is expected to grow, and continued growth in high-speed data services, long distance services, and an increased penetration of the large enterprise market is expected to mitigate the erosion in the consumer market caused by increased voice over Internet protocol (VoIP) competition and wireless substitution, and competitive effects in the business segment. SBC's fiber-to-the-node (FTTN) network build out could also contribute to prospective revenue growth, although in its 2005-06 assumptions Fitch has not included significant results from video or higher speed data over the FTTN network, given the early stage development of this project.

Cingular's acquisition of AT&T Wireless is a strategic positive move for Cingular and its parent companies as Fitch believes wireless continues to have good growth prospects and should maintain stable margins, particularly as growth slows. However, near term challenges exist for Cingular. In addition to the financial risk posed by the financing of the transaction, Fitch believes there will be execution risk in the integration of the two companies and there is some uncertainty regarding the ultimate level and/or timing of operating and capital synergies. Operationally, both Cingular and AT&T Wireless have suffered churn levels at the high end of the industry range over the past year, in part due to network quality issues stemming from the migration from TDMA to GSM technology deployments. Fitch's expectations built into its Outlook for SBC and Cingular incorporate, conservatively, churn of approximately 3% in 2005, which is somewhat above Cingular's current level of 2.8% in the third quarter of 2004 (but below AT&T Wireless churn of 3.7% in the same period). Fitch believes some improvement in 2006 could take place. The level of churn and its reduction is one of the key variables in Cingular's ability to capitalize on the acquisition and drive future revenue and EBITDA growth; Fitch estimates lowering churn by 0.2 percentage points could increase Cingular's revenues and EBITDA by approximately $310 million and $120 million, respectively.

The rating affirmation and Stable Rating Outlook also applies to the senior unsecured debt of the following issuers:

SBC Communications Corp.; SBC Communications Capital Corp.; Ameritech Capital Funding; Illinois Bell Telephone Company; Indiana Bell Telephone Company; Michigan Bell Telephone Company; Pacific Bell Telephone Company; Wisconsin Bell Telephone Company; Southern New England Telecom Corp.; Southern New England Telephone; Southwestern Bell Telephone; Southwestern Bell Capital Corp.

Source: Business Wire

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