Fitch Downgrades Deutsche Telekom on Guidance Revision, Weak Operating Results

Fitch Ratings has downgraded Deutsche Telekom's (DT) Long-term Issuer Default rating (IDR) to 'BBB+' from 'A-' (A minus) and assigned a Stable Outlook. This follows DT's downward guidance revision for 2009 as operating pressures continue apace in key markets.

"DT's domestic business remains difficult, particularly on the fixed-line side. On the other hand, international operations which have so far have been the key growth driver and have largely compensated for domestic pressures, have recently demonstrated significant weaknesses which are unlikely to be resolved in the short run," says Nikolay Lukashevich, Senior Director with Fitch's TMT team.

DT's guidance revision came only two months after confirming stronger targets which, in Fitch's view, reflects the intensified pace of business contraction and lower visibility over future cash flows. DT revised its 2009 free cash flow (DT's definition) guidance to EUR6.4bn from EUR7bn, and adjusted EBITDA is now expected to decline 2%-4% y-o-y, versus the previous projection of no growth (EUR19,459m in 2008), suggesting a drop of EUR390m-EUR778m. In Q109 organic adjusted EBITDA fell EUR0.3bn which implies an annualised reduction of EUR1.2bn.

Achieving the previous targeted adjusted EBITDA would therefore require significant additional cost-cutting over a short period of time which may prove challenging. Also, this may entail additional restructuring costs which would further reduce unadjusted EBITDA (this is used by Fitch for calculating leverage metrics) and lead to a slight increase in net leverage to 2.5x net debt/EBITDA by end-2009 from 2.4x at end-2008. As the company is close to the bottom of its targeted adjusted net debt/adjusted EBITDA (DT's definition) range of between 2x and 2.5x, material de-leveraging from this level is unlikely. A stabilisation of the operating and financial performance, coupled with net leverage declining to below 2.5x on a sustainable basis, could benefit the ratings. The Stable Outlook reflects that DT's profile is fairly strong for its current 'BBB+' rating level, providing some flexibility to accommodate modest pressures.

On an organic basis, DT's Q109 revenues declined 2% y-o-y and its adjusted EBITDA shrank 6%. This is significantly worse than in Q108 when adjusted EBITDA was down only 1.9% and in Q408 when it grew 1.8%. Weak results were driven by pressures across all key segments. In spite of DT stabilising its retail broadband market share, domestic broadband/fixed-network revenues declined 6% y-o-y and adjusted EBITDA fell 3%. Fitch notes that these developments reflect continuing pricing pressures in the domestic market and a highly competitive environment. Positive mobile dynamics that were observed in the domestic market in Q208-Q308 seem to have retreated with revenues and adjusted EBITDA stagnating and average revenue per user (ARPU) declining.

Fitch notes that the key international operations demonstrated sharp weaknesses. US Q109 organic revenues grew only 1.6% y-o-y while adjusted EBITDA declined 4.4% with adjusted EBITDA margin falling to 25.5% from 27.9%. This was driven by material ARPU pressures, higher subscriber acquisition/retention costs and the 3G roll-out. Fitch notes that with its below-average scale in the US, continued high churn and its 3G coverage lagging behind peers, DT is unlikely to be able to address these weaknesses in the short- to medium-term and, therefore, improving profitability in this market remains challenging. In the UK Q109 organic revenue decreased 5.1% and adjusted EBITDA margin fell to just 13.5% from 21.7%, which DT plans to address with management changes, among other things. In Poland organic adjusted EBITDA fell 24.8% with EBITDA margin dropping to 26.4% from 35%. The management reported that in the CEE region margin pressures have so far been confined to Poland only. However, given similarities in DT's business models in CEE markets and common macroeconomic issues, Fitch believes pressures in other regional markets are likely to follow.

DT's liquidity remains strong. At end-2008 DT had EUR3bn of cash on its balance sheet, and EUR16.3bn of unused bilateral credit lines with a three-year maturity.  Its senior unsecured rating was also downgraded to 'BBB+' from 'A-' (A minus). DT's Short-term IDR was affirmed at 'F2'.

Posted to the site on 23rd April 2009