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Fitch Upgrades Telenet to 'BB-'; Outlook Stable

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Fitch Ratings has upgraded Belgium based Telenet.'s Long term Issuer Default Rating (IDR) to 'BB ' from 'B '. At the same time, the agency has affirmed the group's senior secured rating at 'BB' with a Recovery Rating of 'RR2'. The Outlook on the IDR is Stable.

­The upgrade reflects Fitch's revised view of Telenet's ability to generate free cash flow (FCF) and support a leveraged balance sheet. Telenet has a strong operating profile that is supported by a favourable market structure, which enables robust and stable cash generation. While pending cable wholesale regulation in Belgium is a risk to the company's credit profile, Fitch now believes that the company has sufficient margin in its pre-dividend FCF to weather the impact and maintain funds from operations (FFO) adjusted net leverage below 5.25x or approximately 4.3x net debt to EBITDA, which is at the upper end of the company's target of 3.5x to 4.5x.

Telenet's assessment of operational risk is a key element to determining share holder remuneration and the extent to which leverage is increased as result of share buybacks and dividends.

Strong Operating Position

Telenet operates within Flanders and seven of the 19 communes of Brussels. Consolidation of local loop unbundling providers has resulted in duopolistic competition in infrastructure-based fixed line within the consumer segment. Fibre-to-the-home deployment from incumbent Proximus has so far been at a slower pace than other western European markets such as France, Spain and the Netherlands. Within its franchise area, Telenet services around 70% of households where it provides either TV, broadband or fixed line telephony. In addition, Telenet provides mobile services through a mobile virtual network operator (MVNO) with Mobistar until end-2017. This provides the company with sufficient scale to generate a stable underlying pre-dividend FCF margin of 12% to 14%.

Sustaining Competitiveness

Telenet is able to sustain its leading market position by investing in its network infrastructure, providing rich, value-for-money content bundles and improving customer service. The company has a five-year, EUR500m capital investment programme that will lift broadband capacity to 1 GHz from 600 MHz currently, enabling downstream speeds of at least 1 Gbps.

Telenet already offers speeds in excess of 200 Mbps to B2B customers. This compares with Proximus's current 30 to 50 Mbps on VDSL and trajectory of 100 Mbps with use of vectoring technology. Telenet has also made content investments in non-exclusive local soccer rights and exclusive foreign soccer rights and local Flemish content providers to supplement its portfolio. This is important for the Flemish market with over 80% of subscribers in Flanders watching local content in prime time.

Wholesale Regulation a Risk

Belgium is to introduce cable wholesale regulation from 1Q16. The move will enable third parties access to Telenet's cable infrastructure on a wholesale basis based on a retail minus pricing formula applying to TV and broadband combined. The final prices are yet to be announced but consultation documentation from the Belgian regulator BIPT indicate prices (subject to EU approval) based on a 18% retail-minus for Telenet's double-play offer for an initial two year period. The regulation is fairly new in western Europe and the impact on Telenet will be the extent to which it loses retail market share.

We believe the impact on Telenet is likely to be limited. In our base case scenario we assume that new cable wholesalers take a 10% retail market share over a three-year period in Flanders and Brussels, of which 80% is taken from Telenet and 20% from Belgacom. Assuming a loss of the average subscriber, no increase in initial wholesale prices and no reduction in the company's fixed cost base, this has the impact of reducing Telenet's EBITDA by EUR60m to EUR70m in 2018 (equivalent to 3.5% to 4.1% of 2014 revenue). Factors which constrain market share loss include market maturity and churn levels, the prevalence of triple play take-up among the subscriber base and the cost of providing attractive content economically. We therefore believe that the greatest loss in market share is likely to be at the more price-sensitive end of the market.

Commensurate Shareholder Remuneration

Telenet does not have a fixed shareholder remuneration policy but has a formal policy to manage leverage up to 4.5x net debt to EBITDA. Since 2010, Telenet has managed leverage between 3.5x and 4.3x net debt to EBITDA with the higher end achieved in 2013, following a EUR900m exceptional dividend payment. The approach enables Telenet to link its shareholder remuneration to its growth and operational risk profile. We see this as a credit positive as it provides flexibility for M&A, investment and preservation of its credit metrics.

Mobile Acquisition Improves Profile

Telenet announced its intention to acquire BASE, the third-largest mobile operator in Belgium for EUR1.325bn in April 2015. The acquisition is subject to EU approval and in our opinion stands a good chance of clearance as it does not involve mobile spectrum and network consolidation. Both BASE and Telenet have moved to convert branded resellers on the BASE network into MVNOs, which will help mitigate, from the regulator's perspective the potential loss of competition from Telenet's own existing MVNO operations.

The acquisition increases the diversification of Telenet's own network ownership and improves the economics of its converged product offerings. The combination with BASE will give Telenet a combined market share of approximately 30% and hedge the group for growth in mobile data services, which could have been more costly to provide and potentially restrictive via an MVNO agreement.

The combination of a successful integration of BASE along with the impact of wholesale regulation in line with our base case is likely to result in an improved credit profile. However, the rating does not factor in the acquisition of BASE, which is treated as event risk.

Acquisition Leverage Spike

Telenet intends to finance the acquisition of BASE through a combination of EUR1bn of new debt and existing liquidity. The combination of new debt, restructuring costs, mobile network investments and increasing cash tax will see Telenet's FFO adjusted net leverage increase to 4.6x in 2016 on a pro-forma basis from a projected 4.0x in 2015; however, the company has strong cashflow generation and assuming a disciplined approach to balance sheet management it will be able to reduce this within a 12- to-18 month period.

Notching of Secured Debt

The upgrade of Telenet's IDR leads to a transitional approach to notching the company's debt, moving from a bespoke to generic approach to recoveries. In line with Fitch's notching criteria, the company's secured debt remains rated 'BB', one notch higher than the IDR.

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