Record Cash Flows for Europe's Telcos

The first quarter of 2004 was particularly rich in telecoms news in Europe, including the publication of record cash flow across the industry, the return of large acquisitions, and the announcement of substantial share buybacks for many market players, said Standard & Poor's Rating Services in a report published on its 25 rated European investment-grade telecoms companies.

"We view these developments as a good indication of what should lie ahead for the sector in 2004: continued substantial free cash flow providing significant debt reduction capacity, which in turn should revive merger and acquisition activity and increase cash returns to shareholders," said Milan-based Standard & Poor's credit analyst Guy Deslondes, one of the authors of the report. "Again, financial policies will be the main differentiating factor for the credit quality of Europe's largest telecoms operators."

Nearly all European investment-grade telecoms operators reported record free cash flow levels for 2003. These funds were mostly dedicated to reducing net debt over the year, resulting in a sharp improvement in free operating cash flow-to-net debt ratios, which now firmly indicate solid high 'BBB' to mid-'A' rating-category metrics for most investment-grade telecoms operators.

Standard & Poor's expects European telecoms incumbents to sustain their 2003 free cash flow levels in 2004. If cash flow is again used to reduce debt, this will imply substantial debt reduction over the next 12 months, and possibly higher ratings.

Acknowledging the swift improvement in credit measures and the prudent financial policies of certain telecoms operators, first-quarter 2004 upgrades outpaced downgrades, and ratings outlooks are now mostly favorable.

Although many high-grade telecoms operators still publicly make debt reduction one of their primary objectives, Standard & Poor's believes that the strategic focus has shifted markedly compared with just six months ago. Financial policies have started to converge toward new temptations: The acceleration of revenue growth, seizing of acquisition opportunities, and increasing of shareholder value now generally prevail over balance-sheet strengthening. In particular, aggressive expansion in emerging countries would also negatively affect the business risk profile of acquirers.

"Rather than resulting in an overall decline in the sector's average credit quality, however, this shift in financial policies more likely means that room for further rating upside is, at present, almost exhausted," added Mr. Deslondes."

Posted to the site on 21st April 2004