Fitch Assigns Telefonica Deutschland 'BBB' Rating; Outlook Stable
Fitch Ratings has assigned Telefonica Deutschland a Long-Term Issuer Default Rating (IDR) of 'BBB' with a Stable Outlook.
The ratings reflect Telefonica Germany's stand-alone position in a competitive market with four players, which is largely dominated by the two larger operators, Deutsche Telekom and Vodafone. The ratings take into account the company's somewhat limited scale, competitive position and single market dependence, offset by a financial profile that otherwise compares well with the peer group. A free cash flow margin of 13.7% (2011) suggests an ability to deleverage in time of need, albeit stated financial policy is to distribute free cash flow to the extent necessary to maintain leverage (net debt to EBITDA) below 1.0x over the medium term.
Single Market Integrated Operator:
With 19.1m mobile customers and 2.4m fixed broadband customers (at Q312), Telefonica Germany is the country's third largest integrated network operator. While the market number four in terms of mobile customers, in a market dominated by incumbents' T-Mobile and Vodafone, the competitive environment appears rational and Telefonica Germany is likely to benefit over time, from market number three E-Plus's lack of 800 MHz spectrum. The company's fixed line presence -largely a result of the Hansenet acquisition in 2010 - is limited and unlikely to grow. Although not disclosed by the company, alternative operator fixed line operating margins, are typically low and will be dilutive to the company's margin structure.
The largest, and one of the few growing economies in Europe, Germany benefits from low unemployment, strong consumer confidence and high levels of private consumption. The telecom market remains reasonably resilient, with Telefonica Germany positioned most notably in the more vibrant segments of mobile (voice and data) and fixed broadband (which it combines with fixed voice), which collectively are expected to account for over 70% of telecom revenues in 2012. Smartphone penetration of 29% is relatively low providing reasonable growth potential.
Independent Management & Financial Policy:
Telefonica Germany's management are independent of the parent and dedicated to managing the German business. With the exception of CEO - Rene Schuster - who sits on the Telefonica Europe Board - the senior management are solely responsible for running the German operations (i.e. have no wider group responsibilities). The supervisory board comprises six shareholder representatives (one of whom is independent) and six employee representatives.
Measured Business Plan:
The company's business plan is built around an assumption that it will be able to take modest incremental share from its mobile competitors - not an unreasonable assumption given its challenger position and spectrum advantage over E-Plus - and to shift the mix of its prepay / postpay base. Its fixed line position is primarily a defensive strategy allowing it to meet the demand for integrated services, with Fitch not expecting any meaningful growth in this part of the business. Fitch's view is that the business plan represents a reasonable reflection of market conditions and extrapolation of the company's present strategy.
Modest Spectrum Risk
LTE spectrum was acquired and paid for in 2010, removing a significant potential variable from budgeted capex, with what appear sufficient levels of tangible investment in LTE budgeted for each of the next two years, suggesting a recognition and commitment to network quality and need to remain competitive from a bandwidth and speed perspective. While 2G spectrum renewal is scheduled for 2015 or 2016, Fitch assumes this will be a manageable cost.
Parent- Subsidiary Linkage
Telefonica Germany's ratings have been assigned on a largely stand-alone basis, although with some ultimate linkage to the parent. While benefiting from group-wide synergies, the company has been established as a stand- alone entity, with separate management, independent governance and its own financial policy. Given its scale and maturity Fitch regards Telefonica Germany as a sustainable independent business with an ability to finance itself based on its stand-alone business and financial profile.
In the event of a downgrade of the parent company however, Fitch guides that Telefonica Germany could potentially be rated up to two notches higher than the parent.