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Fitch: BT Has Greater Deal Headroom than TI at Current Ratings

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BT Group and Telecom Italia's recent announcements of potential consolidation are both driven by similar desires to boost scale, cut competition and bundle complementary services, but BT's lower leverage gives it much more flexibility at the current ratings, Fitch Ratings says.

BT said it has been asked if it wants to buy two UK mobile operators, one of which is Telefonica's O2 and the other is likely to be Orange and Deutsche Telekom's joint venture EE. An acquisition would improve BT's operating profile, giving it immediate scale in the UK mobile market, where there is currently little overlap in the provision of mobile and fixed-line services. This could enable the group to capture some of the revenue lost to fixed-to-mobile substitution and benefit from mobile data revenue growth. It would also give BT a lead in the provision of quad-play services (mobile, fixed-line, broadband and TV) following its significant investment in football TV rights.

BT's 'BBB'/Positive rating has reasonable headroom to accommodate leverage from a deal. Funds from operations (FFO) adjusted net leverage stood at 1.8x at 1HFY15 and we expect it to fall over the next two or three years. Leverage would need to be around 3x for a sustained period to trigger a potential downgrade, although a return to above 2x could lead to a removal of the Positive Outlook. Taking into account acquired cashflow, BT potentially could increase debt by almost GBP10bn and stay within the current leverage threshold of 3.0x for its 'BBB' rating.

Telecom Italia's (TI) statement that its management will examine options for combining its majority-owned TIM Participacoes unit with Grupo Oi leaves the door open for several different deal structures. TI's Brazilian business adds minimal diversification at present from a ratings perspective since it is a small part of TI's cash flow. An acquisition or merger with Oi could tangibly increase this exposure, aiding the credit profile in the medium term, while the overall market would probably benefit from less competition.

However, TI has virtually no headroom at its current 'BBB-'/Negative rating and any deal that resulted in an increase in leverage would put significant further pressure on the rating. A merger could be structured without increasing leverage, but Oi is a 'BB+' credit with a cashflow under pressure, so a merger with some or all of Oi may not give the new entity significant rating headroom.

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