Fitch Affirms Deutsche Telekom at 'A-'; off RWN; Outlook Negative

Fitch Ratings has affirmed Deutsche Telekom's (DT) Long-term Issuer Default rating (IDR) at 'A-' and removed it from Rating Watch Negative. A Negative Outlook is assigned. DT's Short-term IDR is affirmed at 'F2'. The rating action follows DT's announcement of the terms of its acquisition of a stake in Hellenic Telecommunications Organisation (OTE).

In affirming the ratings, Fitch notes that the transaction should not lead to an increase in DT's net leverage, as the acquisition will be made in several phases. This is despite Fitch's decision not to initially give DT credit for EBITDA generated at OTE. However, the agency will also not include OTE's debt in DT's metric calculations. DT remains strongly free cash flow-generative, which allows it to undertake moderate-sized acquisitions without negatively impacting its financial flexibility.

In addition, Fitch notes that this strategic acquisition will secure DT's entry into new regional markets adjacent to its already established geographical franchise and improve its growth profile. As the European telecom industry is entering a new wave of consolidation, OTE is likely to be a good strategic fit for DT in the long-run.

The Negative Outlook reflects continuing pricing and market share pressures in the domestic market along with cost-cutting challenges. As the company is at the weaker end of its 'A-'  rating, unforeseen negative market developments in Germany or restructuring cost overruns may impair its ability to de-leverage and hence lead to a downgrade. Fitch notes that, under its methodology, the 'A-' rating is only consistent with the lower end of DT's targeted 2x-3x net debt/EBITDA.

Although losses in the German fixed-line market have yet to be stemmed, Fitch notes that DT has achieved significant improvements in cost efficiency and customer satisfaction in its domestic market. In spite of continuing revenue declines, domestic fixed-line EBITDA has shown improved resilience. While Q108 revenue declined 6.1% yoy (versus 5.8% decline in Q107), unadjusted EBITDA fell 6.7%, compared with a 16.8% slide in Q107. Similar dynamics have been observed in the domestic mobile segment. DT's international operations, particularly on the mobile side, have demonstrated strong growth and improving financial performance over the last 18 months. Although growth is likely to be slowing, reflecting saturation in mobile markets and pricing pressures, the trend is expected to remain positive. For DT's Outlook to be Stable, the key pre-requisite is a stabilisation of the domestic market situation and the company's commitment to keep leverage under control.

Under an earlier announced conditional agreement, DT would purchase just under 20% in OTE for EUR2.5bn. In addition, DT has committed to acquire a further 2% stake in the open market, which is likely to cost it approximately EUR200m at current prices, and a 3% stake from the Greek government for EUR426m. As a result, DT is expected to accumulate a 25% plus one share stake in OTE, totalling approximately EUR3.2bn. DT also provided a put option to the Greek government to sell another 5% stake in OTE for EUR617m with the earliest execution date in October 2008, and another 10% stake at a 20% premium to the market price from H209.

Although the 25% plus one share and management control should allow DT to consolidate OTE in its financial results, Fitch assumes that cash flows at OTE will not be available to support other parts of the group through intercompany loans while dividend leakage is considerable. Under its methodology the agency will therefore not give DT any credit for EBITDA generated at OTE; however, it will not include OTE's debt into DT's total liabilities either.

DT's liquidity remains strong as evidenced by EUR2.3bn of cash and equivalents and EUR17.6bn of unused credit lines at end-Q108.

Posted to the site on 15th May 2008