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KPN Debt Ratings Downgraded Following Radio Spectrum Auction

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The debt ratings agency, Fitch has downgraded KPN's debt rating to 'BBB ' from 'BBB'. The Outlook is Stable.

­Fitch said that the downgrade has been triggered by KPN's purchase of frequency licences in the Dutch spectrum auction at a total cost of EUR1.35bn, almost EUR1bn higher than Fitch's expectations. After reducing the dividends to be paid in 2013, KPN will have very limited financial flexibility within the constraints of an intensely competitive domestic market to deal with leverage which is high for a 'BBB' rating.

KPN's higher than anticipated spectrum costs means that actions that could have been used to reduce leverage, such as a reduction in dividends and asset disposals (tower sales in the Netherlands and Germany), have only prevented leverage from increasing. Fitch expects KPN to end 2012 with net debt/EBITDA (as defined by Fitch, including Reggefiber-related liabilities) of 3.2x, with only a slight reduction in 2013, even after cutting the dividend. This is higher than the key 3.0x leverage threshold which Fitch had previously stated would lead to a downgrade.

The agency continues to believe that management's plan to stabilise KPN's core domestic business involves execution risk, which along with macroeconomic headwinds, could keep KPN's EBITDA and cash flow under pressure beyond 2012. Management's actions to offset the high spectrum costs means that Fitch does not expect leverage (including Reggefiber-related liabilities) to increase after 2012. KPN has some headroom at the 'BBB-' rating level as net debt/EBITDA (including Reggefiber-related liabilities) needs to approach 3.5x before negative rating pressure builds.

KPN has managed to obtain a good spectrum in the auction, which should help underpin the company's longer-term competitive position in the Dutch mobile market. However, Tele2 plans to launch the fourth mobile network in the Netherlands after purchasing attractive 800MHz spectrum in the auction to complement its previously acquired 2.6GHz spectrum. This new entrant is likely to be intent on gaining market share, which could lead to increased price competition.

Competition also remains intense in the fixed-line segment, where Dutch cable TV operators are the main threat. Although KPN stabilised domestic residential broadband subscribers in Q312, profitability remains under pressure. In response to the cable threat, KPN is upgrading its network through Reggefiber, KPN's joint venture to rollout a fibre-to-the-home (FTTH) network in the Netherlands. Fitch acknowledges the strategic nature of this fibre business to defend KPN's core fixed-line business against cable TV competition. However, Fitch calculates that the full consolidation of Reggefiber from 1 January 2014 (subject to regulatory approval) could increase KPN's net debt/EBITDA ratio (as defined by Fitch) by as much as 0.35x by 2014 (including the 2017 put liability to gain 100% control of Reggefiber).

KPN's operating profile as an incumbent in the Netherlands offsets some of its weak financial metrics. If the domestic business can be stabilised, and leverage brought under control, Fitch fundamentally views KPN as an investment grade credit.

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Tags: kpn  fitch ratings  Netherlands