2008-08-21 18:47:02 -
- Fitch Ratings has affirmed the 'BBB+' Issuer Default Ratings (IDRs) of Telephone and Data Systems, Inc. (TDS) and its subsidiary United States Cellular Corp. (USM). The Rating Outlook on TDS and USM is Stable. Approximately $1.6 billion of debt is affected by Fitch's action. The following ratings have been affirmed:
TDS
--IDR at 'BBB+';
--Senior unsecured
debt at 'BBB+';
--Revolving credit facility at 'BBB+'.
USM
--IDR at 'BBB+';
--Senior unsecured debt at 'BBB+';
--Revolving credit facility at 'BBB+'.
The rating affirmation reflects TDS' relatively conservative financial policies, the improved credit metrics, its diversified operations and good financial flexibility. In the past 18 months, TDS's financial profile has benefitted from both increased cash flow from the wireless operations, debt reduction associated with the maturity of the prepaid forward contracts, as well as increasing levels of free cash flow. Consequently, leverage improved to 1.2 times (x) as of June 30, 2008 compared with 1.9x at the end of 2006. These factors are balanced against the competitive challenges in both segments of its business. In particular, while past wireless growth has been solid, one concern is USM's ability to grow revenue and cash flow given the decline expected in net additions and slowing ARPU (average revenue per unit) growth. This comes at the time of a more economically sensitive environment and significantly larger nationwide wireless competitors that have become more aggressive on subsidies on higher priced handsets. Consequently margins are being pressured, as USM lacks the scale and resources of the national operators. Fitch believes USM must better focus and take advantage of opportunities to remove costs from the business and improve its efficiencies to offset some of these pressures.
Fitch also believes there is material event risk with USM's potential interest in the wireless markets that Verizon Wireless has offered to divest as a result of the Alltel acquisition. The 85 markets are generally rural in nature, highly contiguous to USM's footprint and would significantly enhance USM's geographical coverage footprint, particularly in the Western region. It is uncertain at this point whether Verizon Wireless would seek to sell the properties to multiple operators. The potential acquisition, depending on the size, could also provide other strategic benefits, possibly enhancing USM's scale and increasing cost efficiencies that could improve its competitiveness and profitability. Fitch estimates that the total markets that Verizon Wireless has offered to divest are in excess of 8 million POPs and 1.4 million subscribers. Consequently, valuations for these properties could exceed $2.5 billion and Verizon Wireless may be required to divest additional markets depending on the reviews by the Federal Communications Commission and Department of Justice. Nevertheless, while TDS has good financial flexibility, the company has traditionally chosen smaller, more conservative value-oriented acquisition strategies with a strong commitment toward maintaining investment grade ratings. The largest acquisition to date was approximately $600 million for the Chicago market in 2002.
TDS and USM have substantial liquidity provided by cash, committed credit lines and other assets. At the end of second-quarter 2008, TDS's consolidated cash balance was approximately $1.1 billion. TDS will also have approximately $300 million in additional cash tax payments for the second half of 2008 related to the prepaid forward contracts monetization. TDS and USM maintain approximately $1.3 billion of undrawn revolver capacity, principally through TDS's $600 million revolving credit facility and USM's $700 million revolver which both mature in December 2009. Fitch expects TDS and USM to opportunistically seek new revolving facilities over the next couple of quarters. TDS also has other sizeable assets that could be monetized including USM's cellular towers and a 5.5% minority interest in Verizon Wireless' Los Angles partnership. For the first six months of 2008, distributions from the partnership were $45 million.
In 2007, the board of directors of TDS and USM authorized a three-year repurchase of up to $250 million of TDS special common shares. As of June 30, 2008, TDS had repurchased a total of $211 million of special common shares under the authorization. Based on past share repurchases, Fitch believes TDS could complete the remaining share repurchase program during the third quarter. However, Fitch does not expect the company to initiate material share repurchase activity beyond the current program until clarity exists over USM's potential interest in the markets that Verizon Wireless must divest.
The company has par call options on several remaining debt securities, including TDS's $500 million, 7.6% notes and USM's $130 million 8.75% notes that are currently callable, providing the flexibility to repay or refinance debt as conditions warrant. Over the past year, as the entire $1.6 billion portfolio of prepaid forward contracts matured, TDS and its subsidiaries elected to deliver shares of the underlying stock to satisfy the obligations. Since Fitch viewed the prepaid forward contracts as having 65%-70% of equity consideration, the maturity of the forward contracts was deleveraging for TDS.
As of second-quarter 2008, one material weakness related to accounting for income taxes remained. TDS has made significant progress at addressing the past material weaknesses and internal control issues. The dimensions of the remediation plan have required long-term planning and significant internal and external resources. Fitch expects the company should be able to fully address its remaining material weakness over the near term.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 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 Ratings
Bill Densmore, +1-312-368-3125 (Chicago)
John Culver, CFA, +1-312-368-3216 (Chicago)
Cindy Stoller, +1-212-908-0526
(Media Relations, New York)
