Vodafone Being Investigated for Possible Debt Ratings Downgrade
Published on: 11th Jun 2014
Vodafone's debt ratings have been put on review for a possible downgrade by the ratings agency, Moody's due to concerns about actions being taken, or not taken to reduce its debt.
"We are putting Vodafone's ratings on review for downgrade because we expect that, in the absence of inorganic measures to reduce leverage, the company's medium- to long-term financial ratios will remain weaker than those commensurate with an A3 rating," says Iván Palacios, a Moody's Vice President -- Senior Credit Officer and lead analyst for Vodafone.
The rating review was prompted by the release of Vodafone's full year 2013-14 results and guidance for 2014-15, as a result of which Moody's has revised its forecasts for the company. The revised forecasts show that Vodafone's EBITDA will bottom out in 2015-16 and recover slowly thereafter, thanks to a combination of (1) better macroeconomic prospects; (2) the initial network differentiation benefits from Vodafone's GBP7 billion investment in Project Spring; and (3) the improved convergent offerings in Germany and Spain, following the acquisitions of Kabel Deutschland and ONO.
Due to the increased leverage resulting from the acquisition of ONO for a total consideration of EUR7.2 billion (GBP6.0 billion), Vodafone will report adjusted debt/EBITDA (as adjusted by Moody's) of around 2.7x-2.9x at least for the next two years, which exceeds the 2.25x threshold that Moody's had indicated for downward pressure on the A3 rating. Moody's also expects Vodafone to report retained cash flow (RCF)/net adjusted debt of around 21%-25% in 2014-15 and 2015-16, which is well below the minimum 30% level indicated by Moody's for the A3 rating.
Over the next couple of years, Vodafone's cash flow generation (defined as EBITDA minus capex) will be depressed because of the high investments associated with Project Spring. In Moody's view, this renewed investment focus could turn out to be a powerful competitive advantage for Vodafone, as long as the company is able to regain pricing power from this network differentiation strategy. However, the results from Project Spring will only be visible in the medium-to-long term. In the meantime, and due to the concentration of Project Spring investments in Europe, a larger proportion of the company's cash flows will be generated in emerging markets, mainly India and South Africa, which are exposed to higher foreign currency volatility than the core Western European markets.
In spite of the expected depressed level of cash flow generation over the next two years, Vodafone has committed to annual growth in dividends. In addition, Vodafone appears to be comfortable managing its balance sheet with leverage at 2.0x net debt/EBITDA (as reported by the company), a level equivalent to a Moody's adjusted debt /EBITDA ratio of around 2.7x-2.8x, which is not commensurate with the current A3 rating.
Moody's review will focus on the measures that Vodafone may decide to take in the near term to strengthen its financial profile, and the completion of the acquisition of ONO, which the European Commission will rule on in July 2014.
Vodafone's A3 rating reflects its large size and scale, and the diversification benefits associated with its strong positions in many different markets. The rating also takes into account management's approach of balancing shareholder remuneration with creditor protection. However, the rating additionally factors in the negative trends experienced in Vodafone's core Western European markets, including heightened competition, slowing growth, regulatory pressures and macroeconomic weakness. Furthermore, the rating reflects the structural challenges that Vodafone faces in light of its mobile-centric business model and position as challenger in most of the markets in which it operates. While the group is increasing its ownership of fixed-line assets in its core markets, this has led to an increase in event risk.
Prior to the review process, Moody's said that the rating could come under downward pressure if Vodafone's financial profile does not strengthen such that its adjusted RCF/net debt ratio remains sustainably below 30% and its adjusted debt/EBITDA ratio remains above 2.25x for a sustained period of time.
Prior to the review process, Moody's said that upward pressure on the rating is unlikely in light of Vodafone's current financial policies, which target a low-single A rating. However, longer-term, upward pressure could be exerted on the rating if Vodafone's credit metrics were to strengthen on a sustainable basis, with an RCF/net adjusted debt ratio comfortably in excess of 40% and an adjusted debt/EBITDA ratio decreasing below 1.5x, along with demonstrated strong free cash flow generation.