Vodafone Debt Ratings Downgraded

The debt ratings service, Moody's has downgraded the ratings of Vodafone Group to Baa1, from A3 following the announcement that Vodafone had completed the acquisition of a controlling 67% interest in Hutchison Essar for a cash consideration of $10.9 billion, and the assumption of net debt of approximately $2 billion. The Prime-2 short-term rating, which was not under review, was affirmed. The outlook is stable.

Moody's said that the downgrade to Baa1 reflects its view that the positive impact of the acquisition on Vodafone's business risk profile is outweighed by the heightened financial risk implied by an increased debt burden and the high level of capital investment needed in the next two to three years. Although Hutch Essar should boost Vodafone's revenue and profitability growth rates in the long-term, the Group's cash generation is expected to be depressed in the short to medium-term as a result of increased financing costs and network investment.

Niel Bisset, senior vice president and lead analyst for Vodafone said, "the Baa1 rating also factors in more cautious assumptions for revenue and profitability growth in Vodafone's mature markets as a result of more competitive pricing initiatives, and regulatory pressures on termination rates and roaming."

Moody's believes that the Group's ebitda margin is therefore expected to decline gradually from the 40% reported in the first six months of 2006/7 notwithstanding the savings being made on cost reduction programmes in progress. The rating downgrade factors in the risk that such competitive and regulatory pressures might intensify more than currently expected in the next few years, as well as the possibility that Vodafone might invest and make further acquisitions in accordance with its strategy to deliver strong growth from emerging markets, and broaden its offering to cover its customers' total communications needs.

Moody's said that it sees Vodafone as well positioned at Baa1, reflecting its brand, scale and breadth of coverage, as well as the solid cash generated from its operations in mature markets notwithstanding the more challenging environment, thanks also to some expected easing of capital investment needs. The Baa1 takes account of the good growth prospects of its EMAPA assets, including Hutch Essar, and the value represented by its associate holdings including its 44.4% stake in Verizon Wireless and 43.9% stake in SFR. The rating assumes that these associate holdings will be retained for the foreseeable future, and that Verizon Wireless should be in a position to increase its dividend payout over time.

Moody's said that the acquisition of Hutch Essar, which is to be renamed Vodafone Essar, was consistent with the Group's strategy to emphasise investment in faster growing less developed mobile markets in order to offset the negative impact of slowing growth in its mature, core European assets. The Shareholders' Agreement with Essar, which will retain its 33% stake, provides for operational control by Vodafone, and anticipates a gradual broadening of the company's product offering. With a nationwide presence and some 23.3 million customers, Hutch Essar had 16.4% of the fast growing Indian mobile market at end-2006. Its rapid growth potential is underlined by year-on-year revenue growth of 51% to $908 million, and ebitda generation of $297 million in the six months to June 2006. Growth at Hutch Essar is expected to contribute to pushing EMAPA's contribution to statutory ebitda from under 20% in FY2007, to more than a third by FY2012.

Moody's notes that Vodafone has entered into a memorandum of understanding with Bharti Airtel relating to infrastructure sharing between Hutch Essar and Bharti in India, which should reduce the cost of investment and delivering services. Nevertheless capital investment is expected to be high in the first two or three years. As a result investment in Hutch Essar is likely to absorb a significant proportion of Vodafone Group's free cash flow in the early years even if this should benefit from lower capital investment in its more mature core businesses.

The Baa1 rating reflects that Group net debt proforma for the GBP6.5 billion acquisition of Hutch Essar is expected to be in the region of GBP22 billion in March 2007. It also takes account of Vodafone's planned disposal of its 5.6% stake in Bharti for $1.6 billion (GBP0.8 billion), and factors in as a debt-like liability the option granted to Essar to sell to Vodafone its 33% shareholding for $5 billion (GBP2.5 billion). Combined with Moody's more cautious expectations for underlying ebitda growth, the rating downgrade factors in that retained cash-flow and free cash flow measures are likely to be at levels more consistent with a Baa1 rating at around 20% and 5% respectively in the near to medium term.

Against the background of intense regulatory and competitive pressures especially in its more mature markets, the stable outlook assumes that Vodafone's scale and operating performance should ensure it meets current expectations for revenue and cash flow generation in the next couple of years, and factors in flexibility for additional moderate scale acquisitions in line with the Group's portfolio management strategy."

Posted to the site on 16th May 2007