Fitch Ratings Maintains Negative Outlook on Sprint Nextel Debt
Fitch Ratings has affirmed the Issuer Default Rating (IDR) and long-term debt ratings of Sprint Nextel and its subsidiaries. The Rating Outlook for Sprint Nextel and its subsidiaries is Negative.
The ratings for Sprint reflect the on-going execution risk both operationally and financially regarding several key initiatives that the company expects will improve cash generation, network performance and longer-term profitability. Risks include achieving expected cost benefits associated with its network modernization, improving its competitive position with its 4G deployment, maintaining postpaid CDMA subscriber trends, improving iPhone dilution rates and retaining its iDEN subscribers.
Second quarter results show the company has generally managed these risks with improved CDMA churn, strong ARPU growth, better than expected iDEN subscriber retention and accelerated iDEN network shutdown. Consequently, Sprint Nextel materially increased EBITDA guidance for 2012. However, execution risk and cash burn rates will increase materially in the coming quarters as Sprint advances on its multi-faceted plans. The company's performance during the next two to three quarters will be a strong indicator whether Sprint Nextel can successfully navigate these risks, improve profitability and remain competitive.
Sprint Nextel has significantly fortified its liquidity position and reduced medium-term refinancing risk since late 2011. The past two debt issuances and vendor financed secured credit agreement raised an additional $7 billion of financing. During this time, Sprint has also repaid $3.25 billion of maturing debt. The company's liquidity at the end of the second quarter 2012 was approximately $8 billion, including $6.8 billion in cash. In addition, up to $500 million is available through May 31, 2013 under the first tranche of the secured equipment credit facility. The current liquidity helps address Sprint Nextel's material cash requirements expected through at least 2013 which could be in excess of $5 billion due primarily to the network modernization project and iPhone rollout.
Sprint's $2.24 billion unsecured revolving credit facility expires in October 2013. Sprint negotiated an amendment to the credit facility to give it cushion relief into 2013, due to iPhone-related losses. The leverage ratio for the covenant is currently 4.25x and will reduce to 4x beginning in January 2013. As of June 30, 2012, the ratio was 3.4 to 1.0 as compared to 3.7 to 1.0 as of Dec. 31, 2011.
Sprint still has sizeable maturities during the next three years totaling approximately $4.8 billion. Maturities include approximately $800 million in 2013, $1.4 billion in 2014 and $2.6 billion in 2015. Fitch expects the company will opportunistically seek debt refinancing to reduce maturity risk going forward. Sprint Nextel will also likely need to consider parameters for a new facility by the end of 2012 given the 2013 maturity.
The Sprint Nextel credit agreement allows sizeable carve-outs for additional senior indebtedness. The carve-outs include unsecured junior guaranteed indebtedness that is subordinated in right of subsidiary guarantees to the credit facilities not to exceed $4 billion. Between the last two debt offerings, Sprint has now issued $4 billion in junior guaranteed debt. The unsecured junior guaranteed debt is senior to the unsecured notes at Sprint Nextel, Sprint Capital Corporation and Nextel Communications Inc. The unsecured senior notes at these entities are not supported by an upstream guarantee from the operating subsidiaries.
The credit agreement additionally allows capacity for unsecured senior guaranteed indebtedness of $2 billion. This debt would benefit from the same guarantee and rank equally in right of payment to the unsecured credit facilities.
Sprint Nextel has indicated potential plans for an additional $1 billion to $2 billion of secured vendor financing. Fitch expects this would be similar in nature to the $1 billion secured credit agreement reached at the end of May 2012. The borrowers under the existing credit agreement are all of the material Sprint Nextel subsidiaries that currently guarantee Sprint Nextel's revolving credit facility and junior guaranteed notes.
Within the past three quarters, Sprint has placed $5 billion of debt including the $1 billion vendor financed secured credit agreement that is senior to the senior unsecured notes (no upstream guarantee) at Sprint Nextel and Sprint Capital and Nextel Communications (NCI). Consequently this has diminished recovery prospects for the unsecured notes to the low end of the range for the RR4 recovery level. Fitch believes that any further secured vendor financing would cause a one notch downgrade of the unsecured (no upstream guarantee) debt at Sprint Nextel Corp and Sprint Capital Corp. due to reduced recovery support. Currently some uncertainty exists as to the timing, the amount and whether Sprint Nextel will reach an agreement for additional vendor financing.
Fitch acknowledges the preferred position structurally of NCI bondholders versus the unsecured (no upstream guarantee) bondholders at Sprint Nextel and Sprint Capital. This difference has become more pronounced with the increasing complexity of more senior debt in Sprint Nextel's capital structure. The NCI bondholders are supported primarily by the value resident in the spectrum licenses held by Nextel operating entities since the operating cash flows from Nextel operating subsidiaries are becoming de minimis with a complete shutdown in mid-2013.
Recovery distinctions between NCI bondholders and the unsecured bondholders of Sprint Nextel Corp. and Sprint Capital Corp. are difficult due to the uncertainty of whether that part of the capital structure would face substantive consolidation or retain its structural subordination. There is evidence that bankruptcy proceedings use substantive consolidation when there has been material flow of capital from one entity to another, which is present in this scenario.
Notwithstanding, in the event Sprint Nextel layers in more secured vendor financing which further diminishes recovery prospects for the unsecured notes, it's likely Fitch will recognize that NCI bondholders could experience enhanced recovery versus the rest of the unsecured (no upstream guarantee) notes. Fitch expects Sprint Nextel will continue paying down NCI debt first given the $3.8 billion in maturities the next three years.
The ratings have limited flexibility for execution missteps, weakened core operational results, significantly higher cash requirements, Clearwire event risk or lack of expected benefits from the network modernization project. Fitch expects leverage for Sprint Nextel to peak in the low 5x range during 2012. As a result, Fitch will not remove the Negative Outlook during 2012. A stabilization of the Outlook could occur by mid-2013 if Sprint Nextel executes on stated objectives and the company demonstrates further operational and financial improvements.