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Vodafone Debt Ratings Increasingly Dependent on Verizon Wireless Payouts

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Fitch Ratings says that it has affirmed Vodafone Group's Long term Issuer Default Rating (IDR) at 'A ', but warned that this is increasingly dependent on dividends from its Verizon Wireless joint venture. The ratings outlook is currently stable.

The ratings agency said that Vodafone benefits from global scale, diverse operations, sound liquidity, and stable cash flow generation. However, slowing growth, partly due to continued underperformance of its Southern European operations is a growing concern. Vodafone is well positioned to benefit from increasing mobile data usage, but the inflection point in revenue growth remains uncertain. The receipt of substantial and regular dividends from Verizon Wireless is increasingly more important to maintain Vodafone's 'A-' rating.

Vodafone's H1FY13 results (six months to end September) revealed the extent of the weakness in Southern Europe, with underlying revenue and profitability trends coming in below Fitch's expectations. Continued negative trends in Southern Europe (30% of Vodafone's FY12 consolidated EBITDA came from Spain, Italy, Portugal and Greece) is likely to put pressure on Vodafone's credit profile.

Shift to Mobile Data

The transition to mobile data is well underway in the telecoms industry. In more technologically advanced telecoms markets, up to 70%-80% of mobile network traffic is data. Operators, including Vodafone, are starting to shift their pricing strategy to data-centric tariffs. As smartphone penetration increases into the mass market, estimating the propensity of customers to spend on service bundles including data is difficult. Therefore the inflection point in Vodafone and other operators' revenue and ARPU trends, is hard to predict. Although the experience in the US has been positive, the spend on mobile data is likely to be driven by country-specific factors - culture, the economic environment and the competitive landscape. Vodafone continues to invest in its network as it seeks to maintain its competitive advantage in network quality to benefit from growing mobile data revenue.

Verizon Wireless Dividend Credit Positive

Vodafone should receive a substantial ongoing dividend from Verizon Wireless. Vodafone's share of the first substantial dividend of USD4.5bn (for calendar 2011) was received in January 2012. The announced second payment of USD3.825bn (for calendar 2012) should be received in December 2012. There is limited visibility around the timing of these dividends, but they are significant relative to Vodafone's FCF (before dividends and spectrum) of around GBP5.3bn-GBP5.5bn in FY13

Financial Flexibility

Fitch believes that the Verizon Wireless dividend stream gives Vodafone enough flexibility to manage leverage within the 2.5x FFO adjusted net leverage threshold to maintain an 'A-' rating, a level which management has committed to. FY13 is the last financial year of Vodafone's stated three year policy to grow dividend per share at 7% per annum. Fitch would expect future shareholder remuneration to be compatible with maintaining conservative credit metrics, and to support financial flexibility in the face of any further erosion of its consolidated financial performance.

Accounting Changes

New IFRS 11 accounting standards regarding joint ventures will come into effect in FY14 (which starts in April 2013). This will mean that Vodafone's current practice of proportionate accounting of its Italian operations will end, reducing reported EBITDA. This change in accounting will be neutral for Vodafone's rating. Fitch's methodology focuses on effective control over cash flow from operating assets and adjustments for accounting treatments can be made when assessing a company's credit profile.

Liquidity remains strong

Vodafone had GBP4.3bn of cash and cash equivalents on its balance sheet at the end of September 2012, as well as GBP3.0bn of short-term investments (index-linked UK government bonds and high quality money market funds) and almost GBP6.2bn equivalent of undrawn committed facilities. This compares with GBP1.7bn of outstanding commercial paper and GBP6.9bn of other short-term borrowings at the end of September 2012.

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