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AT&T's Debt Rating Put on Negative Review Following DirecTV Takeover Bid

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Fitch Ratings has placed AT&T on review for a possible debt ratings downgrade following the announcement of its USD48.5 billion takeover bid for DirecTV.

It has also put DirecTV's USD20.8 billion worth of debt on review for a possible upgrade if the takeover goes ahead as it will be absorbed by AT&T, whose current A rating massively outranks DirecTV's BBB rating.

Fitch said that it believes AT&T's acquisition of DirecTV will improve its financial flexibility owing to DirecTV's strong free cash flows and the significant equity component in the transaction financing. The transaction also strengthens the company's position in the evolving video landscape, offering the potential to capitalize on trends for mobile video and over-the-top (OTT) video delivery. The acquisition also diversifies AT&T's revenue stream.

DirecTV's video assets are complementary to AT&T's operations, but the longer term strategic benefits are less clear and depend on the post-merger company's ability to capitalize on emerging trends in the industry.

The Negative Watch reflects the modest increase in leverage for AT&T, pro forma for the transaction. AT&T's leverage is currently at the upper bounds for the current 'A' rating. As currently proposed the transaction would likely lead to a one-notch downgrade for AT&T to 'A-' and a Stable Outlook. On a pro forma basis, Fitch estimates leverage in 2015 will be less than 2.0x. However, the final rating would depend on any additional conditions placed on the transaction by the regulatory approval process, an updated view of anticipated spectrum spending, and an assessment of AT&T's post-acquisition financial policies.

For DTVH, the Positive Watch reflects AT&T's ownership of the company following the close and strong strategic ties. DTVH's final rating will depend on an evaluation of AT&T's financial policies with respect to DTVH's debt and the degree of linkage to AT&T's rating.

For the latest 12 months (LTM) ended March 31, 2014, AT&T's net leverage as calculated by Fitch was 1.8x, an increase from the 1.6x at year-end 2012. AT&T has maintained relatively aggressive stock repurchases over a period when free cash flow (FCF) has been lower due to temporary, growth-focused capital spending, leading to additional borrowing. Modestly growing EBITDA is softening the effect of the rise in debt on leverage.

In Fitch's view, liquidity is strong and provided by the company's FCF; additional financial flexibility is provided by availability on the company's revolving credit facilities (RCFs). At March 31, 2014, total debt outstanding was approximately $79.9 billion. At March 31, 2014, cash amounted to $3.6 billion and for the most recent LTM, AT&T produced $3.1 billion in FCF (net cash provided by operating activities less capital expenditures and dividends), an amount short of the $8.3 billion in stock repurchases over the course of the same period. Fitch expects FCF to range from $5 billion to $6 billion annually, on average, over the next two years.

At March 31, 2014, the company did not have any drawings on either its $5 billion RCF due 2018 or its $3 billion RCF due 2017. The principal financial covenant for both facilities requires debt-to-EBITDA, as defined, to be no more than 3x.

Relative to the company's expected FCFs, upcoming debt maturities are manageable. For the remainder of 2014, debt maturities are approximately $4 billion, and in 2015, $7.9 billion. Maturities in 2015 include debt putable to the company.

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