France's Orange Suffers Ratings Downgrade on Weak Home Market Performance

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France's Orange has had its debt ratings downgraded by Moody's to Baa1 from A3 due to the ongoing business risk in its home market especially between the mobile networks.

"In addition, we expect that Orange's financial ratios will remain weak for 2013 and 2014 with no prospects of recovery in the short term to levels commensurate with the previous A3 rating category." says Carlos Winzer, a Moody's Senior Vice President and lead analyst for Orange.

"Management has implemented a number of actions including accelerated cost cutting, the sale of non-strategic assets, a moderate shareholder remuneration policy and an effective marketing strategy to contain market share erosion," continues Mr. Winzer. "However, we expect further revenue declines this year of close to mid-single-digit percentage points, which will negatively affect cash flow. We anticipate that this will increase the group's financial risk beyond the level of tolerance for the previous rating category."

Today's downgrade reflects a lowering of Orange's baseline credit assessment (BCA), a measure of its standalone credit quality, to baa2 from baa1. It reflects the negative business and financial risk implications for Orange of the persistent price war in the French mobile market. Moody's expects that Orange's operating performance will remain under pressure, affected by regulation, strong competition and the adverse macroeconomic conditions in France as well as in some other countries in which the group operates. As a result, Moody's now expects that Orange's adjusted leverage ratio, measured by net debt/EBITDA, will deteriorate in 2013 and 2014 to around 2.7x. This ratio exceeds the maximum level of 2.5x that Moody's had indicated for the previous rating category.

Moody's expects continuing pressures on Orange's domestic operations in the next 12 to 24 months with the company's operating performance prospects affected by (1) the increasingly competitive nature of the French mobile and fixed-market services; (2) the impact of roaming rate cuts; and (3) the increasing difficulty the company will face in continuing to execute operating cost cuts, despite the very successful initiatives that management implemented last year.

The visibility of Orange's financial performance over the next 24 months has significantly diminished due to the intense competitive pressure being led by Iliad's aggressive price initiatives and this represents an increase in business risk.

Moody's expects that, while the impact on Orange's weaker cash flow will continue to be mitigated by a contention in capex and accelerated opex cuts, the company will exhibit in the near term at best stabilizing credit metrics with a Moody's estimated adjusted RCF/net debt of around 20.0% and an estimated adjusted net debt/EBITDA close to 2.7x as of year-end 2014, which will position Orange more adequately in the Baa1 (with a BCA of baa2) rating category than in the A3 category.

Orange's Baa1 rating is supported by (1) the group's scale and international diversification which partially mitigates the exposure to the domestic market; (2) managementīs commitment to conservative financial ratios and balanced cash distribution; (3) strategy to offset competition based on its strong Orange brand, the quality of its infrastructure and multi-brand strategy; (5) strong liquidity and (6) its continued effort to cut costs to preserve solid cash flow generation.

Orange is a government-related issuer (GRI) and its Baa1 rating currently benefits from one notch of uplift as a result of (1) the group being 26.9% government-owned; (2) its moderate level of default dependence; and (3) Moody's moderate support assumptions for the group.

The stable rating outlook reflects Moody's expectation that continuing management initiatives will to a large extent balance the increasingly tough market in which the company will have to continue to weather macroeconomic, regulatory and competitive pressures. The outlook also factors in Moody's expectation that Orange's management will preserve the company's financial strength within the stated new ratio guidance. Moody's expects that Orange will suffer mid-single-digit percentage point declines in revenues this year and next, which will somewhat affect the company's ongoing efforts to sustain margins and cash flow.

Although not currently expected in view of recent rating action, Moody's could consider a rating upgrade if Orange's debt protection ratios were to strengthen significantly as a result of improvements in its operational cash flows and a reduction in debt. The rating could come under positive pressure if it became clear that the company would achieve sustainable improvements in its debt protection ratios, such as adjusted RCF/net debt of at least 25% and adjusted net debt/EBITDA comfortably below 2.5x on a sustainable basis, and, at the same time, experience a significant improvement in the business environment.

Moody's could downgrade Orange's rating if (1) the company were to embark on an aggressive expansion/acquisition programme (most likely outside of its existing footprint), leading to higher financial, business and execution risk; or (2) its credit metrics were to deteriorate, including adjusted RCF/net debt falling to below 18% or adjusted net debt/EBITDA exceeding 2.8x on an ongoing basis.

In addition to the factors listed above, the ratings may also be adversely affected by significant changes in the rating of the supporting government, or by changes in the rating agency's assessment of default dependence and support.

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