AT&T's Debt Ratings Downgraded Due to Share Repurchase Plans
Moody's Investors Service downgraded AT&T's debt ratings. The downgrade primarily reflects the expected deterioration in AT&T's credit profile from debt incurred to finance its share repurchase program.
The change to A3 from A2 reflects Moody's view that AT&T's debt-financed share repurchase program will result in materially higher leverage for several years before it can be offset by organic growth. Further, the previously announced boost to capital spending will temporarily stress free cash flow.
Moody's believes that higher wireless capex will help AT&T improve its competitive position, which has weakened relative to its main rival Verizon Wireless. But, this higher capital spending is unlikely to result in an acceleration of EBTIDA growth and thus will not offset the higher leverage from debt-financed share repurchase.
AT&T has not formally adopted a new financial policy, and reiterates its long-term leverage target of 1.5x net Debt to EBITDA (equivalent to 2.0x Moody's adjusted). However, the company's leverage will be materially higher than this target for a sustained period, and Moody's believes that the company may eventually formalize a higher leverage target to support higher growth and to continue to address the imbalance between its cost of debt and cost of equity.
"We view the step up in leverage as semi-permanent," said Moody's analyst Mark Stodden. Management has indicated that the company is likely to exhaust its current share repurchase authorization by mid-year 2013. "But even if AT&T stops or pauses the repurchase activity, spectrum purchases or tuck-in acquisitions are highly likely over the next few years, and leverage will probably stay above the company's formal target of 1.5x for a while," Stodden continued.
AT&T's underlying A3 senior unsecured rating reflects its scale and its strong, resilient and well-diversified cash flows. The rating is also supported by AT&T's position as the #1 or #2 operator in nearly all of the key segments in which it operates. Growth has been dampened in recent years due to the disruptive effect of evolving technology and macroeconomic weakness. Yet, AT&T has maintained the financial flexibility and discipline to invest in an asset base which has solidified its market position and which most rivals cannot match. However, growth is limited because the company is now so large that it cannot grow faster than the overall economy and its high market share precludes regulatory approval for any substantive M&A.
AT&T has a history of temporarily exceeding its target leverage, followed by decisive debt reduction. However, past instances of higher leverage were primarily driven by strategic M&A and offered post-transaction cash flow growth. In this instance, AT&T is funding share repurchase with debt, a strategy that will not benefit future leverage (i.e. Debt/EBITDA) levels. Moody's projects that debt incurred to finance share repurchase and proposed acquisitions will push AT&T's leverage to between 2.3x and 2.5x (including Moody's standard adjustments which add 0.7x to reported leverage) before falling by approximately 0.1x per year going forward. Moody's base case forecast does not include debt-financed share repurchase beyond 2013.
AT&T maintains a solid liquidity profile. At the end of fiscal 2012, AT&T had $5 billion in cash. Moody's anticipates that AT&T will generate approximately $4 billion in free cash flow (after dividends) in 2013, even with higher capex and taxes than 2012.
The company maintains solid alternate liquidity to support outstanding commercial paper (none at December 31, 2012) in the form of a $5 billion bank facility maturing December 2016 and a $3 billion bank facility maturing December 2017. Both have one financial covenant under which AT&T had ample room, and no need to represent as to no material adverse change.
Moody's could raise AT&T's ratings if leverage were to approach 2.0x Debt/EBITDA and free cash flow to debt were in the high single digits. Moody's could lower the ratings further if leverage were to exceed 2.5x and free cash flow to debt fell below 5% for an extended period (all on a Moody's adjusted basis).