Vodafone Kept on Ratings Watch for Possible Downgrade
Fitch Ratings has maintained Vodafone Group's 'A-' debt rating on review for a possible downgrade, despite the US$130 billion sale of its 45% stake in Verizon Wireless.
Fitch said that the event-driven ratings watch negative (RWN) reflects two possible outcomes upon completion of the Verizon Wireless transaction.
Vodafone's rating could be affirmed at 'A-' if the disposal of the company's Verizon Wireless stake is successfully completed and if management continues to pursue conservative financial policies that give Vodafone the financial flexibility to deal with any erosion of its consolidated financial performance. A 'A-' rating with a Negative Outlook is possible even after the sale of the Verizon Wireless stake. Net debt would be lower but Vodafone's cash flow would be more exposed to its weak Southern European operations and slowing emerging market growth.
Fitch is also concerned that potential acquisitions could erode the GBP20bn cash which Vodafone is retaining from the Verizon Wireless disposal.
Balance Sheet Flexibility
The retained proceeds from the Verizon Wireless sale more than offset the increase in debt from Vodafone's planned acquisition of Kabel Deutschland. Vodafone's management has the flexibility to pick an appropriate capital structure and dividend policy for a company with a greater European focus, and has said that it will continue to target a low 'A' credit rating. Due to the planned reduction in share capital, there is still some uncertainty regarding the total annual dividend payment that Vodafone shareholders will receive in the financial year ending March 2015 and beyond. Fitch will also monitor the impact of Vodafone's announced GBP6bn organic investment on the company's medium-term operating and financial profile.
Greater Exposure To Southern Europe
Vodafone's 45% stake in Verizon Wireless has had a significant positive impact on Vodafone's credit profile. The substantial dividend Vodafone has received from Verizon Wireless has helped offset the declining profitability in Vodafone's controlled operations and significant spectrum investments. Without this valuable dividend stream, Vodafone will now be reliant on its European operations for around three-quarters of its operating free cash flow. This includes around 30% from Southern Europe, where performance has been poor.
Weak Cash Flow Generation
Vodafone's operating free cash flow has been under pressure over the past two years, falling to GBp7.7bn in FY13 from GBP8.5bn in FY12 and GBP9.8bn in FY11. Fitch is concerned that without the positive offset of the Verizon Wireless dividends, Vodafone's free cash flow is likely to come under further pressure. High single-digit pre-dividend free cash flow to sales (as defined by Fitch) is expected at the 'A-' rating level.
Potential Acquisition Risk
Following its planned acquisition of Kabel Deutschland, Vodafone faces similar strategic challenge choices in its other European markets as to whether it should remain mobile-focused, or whether it should improve its fixed-line capabilities to match its main European competitors. Vodafone says it takes decisions on European fixed-line infrastructure on a country-by-country basis and that it could obtain this infrastructure by buying an existing operator, building its own or agreeing a wholesale deal with an incumbent.
Fitch does not expect Vodafone to make acquisitions in all of its major European markets. With the cash from the Verizon Wireless disposal, Vodafone will spend GBP6bn over three years on organic investment, some of which will be spent on European fixed infrastructure. It is already building a fibre network in Spain with Orange while fixed-mobile integration is less of a risk in the UK as fixed-line incumbent BT Group does not have a national mobile network. However, Fitch said that it believes Vodafone is still looking for a fixed-line solution in Italy and might consider accelerating its fixed-line investments in other markets.
Liquidity Not a Concern
Vodafone has a strong liquidity position, which will be enhanced by the disposal of its Verizon Wireless stake. As the Verizon Wireless cash is unlikely to be received in the next six months, the planned purchase of Kabel Deutschland could be financed from existing cash and investments and by drawing down on existing credit lines.