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20 Apr 2004
MOODY'S DOWNGRADES THE A2 SENIOR UNSECURED DEBT RATING OF VERIZON NEW YORK TO Baa2
APPROXIMATELY $3.1 BILLION IN DEBT AFFECTED
New York, April 20, 2004 -- Moody's Investors Service downgraded Verizon New York's ("VZ-NY"
or the "company") senior unsecured debt rating to Baa2 from
A2. The ratings outlook is stable. This action concludes
the review for downgrade that began on October 27, 2003.
The downgrade reflects Moody's belief that: 1) rapidly expanding
competition, particularly from cable MSOs will increasingly erode
the free cash flow generating capacity of the company's traditional
wireline operations; 2) UNE-P rate hikes and/or price increases,
if implemented, are unlikely to stem inherently strong competitive
pressures in the medium term; 3) VZ-NY faces regulatory strain
stemming from its failure to meet requisite service quality standards;
4) VZ-NY has a largely static cost structure, which impedes
cost reduction efforts; and 5) VZ-NY's credit metrics
will remain weak for at least the next few years.
VZ-NY faces rapidly expanding competition in its service areas
from cable MSOs (e.g. Cablevision, Time Warner) who,
because of their relatively deep relationships with consumers, are
a formidable threat. VZ-NY derives roughly two-thirds
of its revenues from consumers. In addition, technology substitution
(e.g. e-mail, instant messaging, wireless
telephony), and CLECs using both UNE and facilities-based
competition will exacerbate access line losses, and revenue and
cash flow declines.
While the company has actively lobbied for both retail (basic exchange)
rate and UNE-P line price increases, Moody's believes
that such rate relief, if implemented, would be fleeting,
and that competitive pressures would negate potential longer-term
benefits. However, a UNE-P price increase could encourage
VZ-NY faces significant regulatory exposure as the New York State
Public Service Commission (NYSPSC) set rates, including those by
which the company leases portions of its networks to competitors (i.e.
UNE-P and UNE-L) and monitors service quality. Because
of poor service quality, (VZ-NY has missed two out five service
quality standards), the NYSPSC suspended pricing flexibility in
May 2003. This constraint, if not reversed, will further
hinder the company's ability to compete effectively. Additionally,
the NYSPSC may fine VZ-NY $40 million (refundable to those
customers impacted by poor service quality) pursuant to its failure to
meet all five quality standards.
A largely static labor cost structure characterizes the company's
New York market. Union arbitration agreements prevent VZ-NY
from reducing workforce levels quickly and achieving meaningful cost efficiencies.
Unions have the right to challenge layoffs through the contractual arbitration
process under the labor contracts. In July 2003, an arbitrator
ordered the company to re-hire 2,300 employees that had been
previously eliminated. We also note that while wage rates in New
York remain high, the company has had some success reducing wage
costs through targeted headcount reductions (primarily, incentivized
early retirement packages), increasing repair and installation dispatch
productivity, and reducing field technician overtime. We
expect these cost reduction activities to continue throughout 2004 and
The company's credit metrics have deteriorated rapidly over the
past several years, as a result of access line losses and a relatively
high cost structure. From 2001 through 2003, access lines
declined an average 4.2% per year, while revenues
declined 4.5% per year. EBITDA margins have gone
from well over 35% in 2002 to just under 23% in 2003 (as
adjusted for non-recurring charges). Interest coverage has
declined from 7.7x in 2002 to 4.8x in 2003 while total leverage
(total debt to EBITDA) has increased from 2.4x to 3.6x over
the same period. Improvements in these metrics will be slow and
challenging. Moody's believes that the company's ability
to generate material free cash flow over the next few years is quite limited
amid declining operating cash flow and a limited ability to reduce capital
spending further, given increasing competition from cable MSOs and
service quality issues.
The rating also recognizes that the company may divest non-performing
assets and utilize the proceeds to reduce external debt, which is
currently $3.1 billion and represents about one-half
of total company debt. Debt due to affiliates (i.e.
intra-company debt) is about $3 billion. We also
expect that over the next few years, the company will be substituting
external debt for intra-company debt -- a modest credit positive
all other things being equal.
We recognize that VZ-NY has strengthened its balance sheet somewhat
over the last year. Moody's notes that during 2003, the company
reduced net debt by roughly $450 million though they accomplished
much of this via capex cuts (about $367 million). Moody's
believes that VZ-NY's future capital expenditures will be
on par with that recorded in 2003, though it may actually increase
as a percentage of revenues, and will be used to address network
quality issues, and for stepped-up broadband, data
and enterprise investment in response to increasing competition and recovering
Moody's acknowledges the steps the company has taken to preserve
cash flow by cutting its dividend to the parent, Verizon Communications.
We also anticipate that the company will significantly reduce, or
eliminate, its dividend to Verizon Communications as a means of
sustaining positive free cash flow. Free cash flow for 2003 was
$284 million. Given the likelihood that revenues will continue
to slide because of access line losses (not giving effect for material
regulatory relief) and that much of the company's cost structure
is fixed, we expect free cash flow to be lower in 2004 -- despite
anticipated dividend cuts.
The stable outlook reflects our view that: 1) competition will exacerbate;
2) any regulatory relief is likely to be short-lived; and
3) the company's ability to control its costs may be limited;
however we do not believe such issues will be sufficient to impact the
Baa2 rating over the next twelve to eighteen months. Moody's
also expects that Verizon Communications will support VZ-NY's
balance sheet via dividends cuts, and the replacement of external
debt with intra-company subordinated debt.
Verizon New York, one of Verizon Communications' sixteen local
telephone operating companies, provides local and long distance
service by means of 11.2 million access lines in New York as well
as a small portion of Connecticut.
Verizon New York's parent, Verizon Communications (A2,
senior unsecured), provides domestic and international wireline
and wireless communications services and is headquartered in New York,
Senior Vice President
Moody's Investors Service
Moody's Investors Service
No Related Data.
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