Fitch Downgrades France Telecom Debt Ratings

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Fitch Ratings has downgraded France Telecom's Long term Issuer Default Rating (IDR) and senior unsecured rating to 'BBB ' from 'A '. The Outlook on the Long term IDR is Stable. The agency has affirmed France Telecom's Short term IDR at 'F2'.

­The downgrade is based on the continued pressures in France Telecom's core domestic business, where increased competition is causing the company's cash flows to decline.

The company's domestic EBITDA fell to EUR8.2bn in LTM H112 from EUR9.3bn in 2009. Fitch expects that this is likely to remain under pressure over the coming few years. This is likely to cause the company's FFO adjusted net leverage to move to around 3x, a level that is more consistent with a 'BBB+' rated telecom operator than a 'A-' telecom operator. The company has announced cost-savings measures, a dividend cut and a commitment to return to a leverage metric close to 2x (net debt:EBITDA, as the company defines it) by 2014. These are credit positive and underpin the Stable Outlook.

The company is rolling out LTE and FTTH networks in France. A key development for France Telecom will be whether these investments allow the company to differentiate its services from its competitors, and enable France Telecom to charge a premium for these services. The commercial exploitation of these services is still relatively nascent, so it is too early to determine if such a strategy will be successful in the next few years. Although Fitch recognises the importance of these investments for the company's long-term success, in Fitch's opinion the current economic climate is not conducive to such an investment, as consumers may not be willing to increase their telecoms spend in times of austerity.

France Telecom's pre-dividend FCF margin stood at 14.6% in 2010 and 13.7% in 2011. Fitch expects that this could fall to below 10% (before spectrum payments) over the coming years. Also, the company's French cash taxes are likely to increase, while the company is introducing cost-cutting measures that involve not replacing all retiring French workers in order to reduce its headcount. If government policies change, so that the company's tax bill is increased further, or if the company's cost reduction plan is impeded, the company's deleveraging plans may be affected and the company's pre-dividend FCF could be further pressured.

France Telecom's liquidity remains healthy. As at end-Q312, it had EUR7.8bn of cash and cash equivalents, and EUR7.4bn of undrawn credit facilities. This is enough to cover upcoming bond, debt and lease repayments well into 2016. After long-dated bond issues in H112, average debt maturity was 9.4 years at end-June 2012 (versus 9.0 years at end 2011, excluding TDIRA, perpetual convertible debt).

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