MOODY'S DOWNGRADES VERIZON TO A3, PRIME-2; DOWNGRADES ALL VZ WIRELINE SUBS.; UPGRADES MCI TO Ba3; PLACES A3 RATING OF VZ WIRELESS ON REVIEW FOR POSSIBLE UPGRADE; RATINGS OUTLOOKS ON PARENT, WIRELINE SUBS AND MCI ARE STABLE
Approximately $45 Billion of Debt Securities Affected.
New York, December 21, 2005 -- Moody's Investors Service has downgraded the long- and short-term
debt ratings of Verizon Communications Inc. (VZ or Verizon) to
A3 and Prime-2, from A2 and Prime-1, respectively,
reflecting the likely pressure on cash flows arising from the company's
plan to upgrade its local wireline network with fiber-to-the-premises
(FTTP or FiOS) over the next several years. Moody's has also
lowered the ratings of the individual wireline operating companies to
reflect expected pressure on their operating and financial profiles from
competition, combined with the costs of the network upgrade.
Moody's upgraded MCI's long-term debt ratings to Ba3
from B2 based on expected synergy benefits resulting from its acquisition
by Verizon, as well as Verizon's likely willingness to financially
support MCI, should it be required. The A3 long-term
debt rating of Verizon Wireless (VZW) was placed on review for possible
upgrade reflecting Moody's expectation that continued strong revenue
growth, an excellent cost structure, and very low churn will
lead to steadily improving earnings and cash flows, which,
in combination with a very significant change in its earnings distribution
policy, will allow Verizon Wireless to delever rapidly.
These actions resolve the reviews, initiated on February 14,
2005 when Verizon announced its plan to acquire MCI for about $8.9
billion in cash, stock and assumed debt. The complete list
of rating actions follows at the end of the press release. The
outlooks for the ratings of VZ and its wireline operating companies are
Rationale for downgrade of Verizon Communications ratings
The downgrade of Verizon's rating reflects the agency's view
that Verizon's strategy of deploying fiber-to-the-premises
in order to meet increased competition in providing wireline services
to the residential market , while technologically robust,
will require significant upfront cost, weakening VZ's financial
metrics over the intermediate term in exchange for highly uncertain returns.
Moody's expects this deployment to significantly reduce dividends
from the wireline companies to the parent company for debt service,
which, when coupled with the competitive pressures on wireline revenues,
motivated the rating downgrade.
Moody's concerns center around the high cost and relatively slow
pace of VZ's FiOS deployment. Moody's projects it will
about 10 years to pass approximately 30 million households, which
increases the risk of losing residential telephony share to cable companies,
who Moody's expects will be able to offer a facilities-based
bundle at cost competitive prices to almost all of Verizon's customers
within the next three years. In addition, the expense of
the full fiber buildout will pressure near-term credit metrics.
Moody's estimates that Verizon's cost to pass a home with
fiber will average about $750, three times what the alternative
fiber-to-the-node strategy costs.
Overall business risk is increasing rapidly with accelerating local access
line losses and a shift in its asset base and investment needs toward
highly competitive business segments like video, broadband,
corporate data, and wireless. Furthermore, Moody's
views the threat to VZ's core residential wireline cash flow stream
from cable competition as significant.
Moody's recognizes the company's decisions to upgrade its
networks, enhance and diversify its consumer revenue streams (through
long distance, broadband, wireless and video service offerings)
and accelerate the development of its enterprise service business as strategically
appropriate, in light of this threat. Over time, Moody's
believes that the FiOS build-out may be the most robust technological
means to compete against cable competition. It has the potential
to generate significant new revenues from video and higher speed data
offerings and it may ultimately lower ongoing network operating costs
by about 50%. VZ's execution risk is still substantial,
however, with the fixed income investor shouldering most of the
Moody's believes the potential acquisition of MCI will not materially
weaken Verizon's consolidated credit metrics because of MCI's
relatively small size and the expectation that most of the anticipated
revenue and cost synergies will be achieved close to schedule.
The acquisition jumpstarts Verizon's efforts to compete in the large,
growing and profitable enterprise space. It also diversifies Verizon's
revenue stream, providing it with a solid foundation in the enterprise
market from which to grow its enterprise business.
Verizon's rating is supported by Moody's assessment that continued
strong growth of earnings and cash flows from Verizon Wireless will offset
lower dividend payments from the wireline subsidiaries. Moody's
believes that VZ will receive significant cash from VZW over the next
few years as VZW utilizes the bulk of its growing free cash flow to repay
about $15B of intercompany borrowings from Verizon.
Moody's expects consolidated debt levels to rise about $3.0
billion in 2006, as VZ absorbs MCI and increases network spending
on its FiOS deployment. In 2007, Moody's believes that
VZ will generate about $25 billion of cash from operations (after
Moody's standard adjustments) and about $2.0 billion
of free cash flow, and expects VZ to use this cash flow to reduce
about $40 billion of debt (estimated pre-MCI acquisition
for FYE2005 to include VZ plus 55% of Verizon Wireless' external
Moody's expects 2007 (proportionate for 55% of Verizon Wireless)
debt/EBITDA to above 1.5X, retained cash flow to debt to
be below 30%, and (EBITDA-capital expenditures)/interest
to be about 4.0X. VZ pays a significant portion of its cash
flow in dividends, which reduces cash flow available for debt repayment.
Moody's considers the potential proceeds from any sale or spin-off
of the directories business a potentially significant source of financial
flexibility if proceeds are applied to strategic investments or debt reduction.
However, the loss of this very high margin business and its relatively
significant and predictable earnings and cash flows would have negative
impact on Verizon's rating should the company return the bulk of
the proceeds to shareholders.
Rationale for placing debt rating of Verizon Wireless on review for possible
Moody's review for possible upgrade of Verizon Wireless's
ratings reflects the agency's expectation for continued strong revenue
growth, an excellent cost structure, and very low churn should
lead to steadily improving earnings and cash flows; which,
in combination with a very significant change in its earnings distribution
policy, should allow Verizon Wireless to delever rapidly.
The review of VZW will focus on: 1) the company's ability
to sustain earnings and cash flow growth rates in the face of fortified
competitors; 2) the timing and magnitude of the expected strengthening
of VZW's balance sheet given growing capex spending needs and the
possibility of additional spectrum purchases, and 3) Moody's
assessment of the timing of a possible unwinding of the Verizon Wireless
partnership and its impact on the balance sheets of both Verizon Wireless
and Verizon Communications.
Rationale for upgrade of MCI's ratings
The upgrade to Ba3 of MCI's debt ratings represents Moody's
view that the synergy benefits expected from its acquisition by Verizon
as well as Moody's perception of Verizon's likely willingness
to financially support MCI (should it be required) merits a two-notch
upgrade of MCI's standalone rating. We expect the MCI notes
will be refinanced at the Verizon Global Funding (VZGF) level shortly
after the merger closes.
Moody's believes that VZ will focus on generating multi-billion
dollar expense savings and increased revenue once its acquisition of MCI
closes. The agency regards these plans as achievable, in
the most part, because of obvious redundancies, network integration
opportunities and Verizon's past experience in integrating significant
acquisitions. Owning MCI's extensive long distance network
should improve VZ's cost structure in relation to its own long distance,
broadband and even wireless long-haul transport needs. We
expect that the benefits will ramp up over time as investments and expenses
(i.e. severance) necessary to achieve the synergies is front
loaded. Moody's recognizes the benefits to VZ of acquiring
a stronger player in the enterprise market through the purchase of MCI,
and the benefits to all the established players from in-market
Underpinnings of the stable outlook at Verizon
The stable outlook at the parent is based on Moody's expectations
that improving profitability at Verizon Wireless, as long as Verizon
captures the vast majority of the cash flows from Verizon Wireless,
will partially offset the effects of expanding wireline competition and
an expensive network upgrade.
The ratings could come under additional pressure if: 1) VZ's
acquisition of MCI fails to produce significant synergy benefits;
2) Verizon Wireless' operating performance falters; 3) revenue
declines at VZ's wireline operations accelerate or if margins decline;
4) VZ consolidates its ownership of Verizon Wireless or makes a material
acquisition or a sale of operations in a manner that causes a deterioration
in projected credit metrics, or 5) the cost of the fiber build-out
exceeds current estimates or if it falls significantly behind schedule.
The ratings could be upgraded if VZ were to demonstrate sustainable material
top line growth in its consolidated wireline businesses while maintaining
margins and Verizon Wireless were to sustain above industry average operating
performance (subscriber additions, churn, margins),
coupled with a demonstrated willingness by management to manage Verizon's
capital structure to stronger credit metrics than Moody's currently
expects. If VZ can drive significant revenue growth and profitablility
through the deployment of FiOS, ratings are likely to improve.
Rationale for ratings downgrades of the wireline operating companies
Moody's lowered the ratings of all VZ's operating companies
(in some cases several notches): Verizon -- New England (A3/Baa1
from A2/A3), Verizon -- New York (Baa3 from Baa2), Verizon-New
Jersey (A3 from A1), Verizon-Pennsylvania (A3 from A1),
Verizon-Virginia (Baa1 from A1), Verizon-Florida (Baa1
from A1), ( Verizon-Maryland (A3 from A1), Verizon-Delaware
(A3 from Aa3), Verizon-West Virginia (A3 from Aa3) Verizon-
South (Baa1 from A2), Verizon-North (A3 from A1), GTE
-- Southwest (Baa2/Baa1 from A3/A2), Verizon-Northwest
(A3 from A1) and Verizon-California (A3 from A1). Moody's
believes the funding strategy for Verizon's operating companies,
in light of the very expensive FiOS buildout being undertaken at the operating
company level, weakens their individual credit quality to no stronger
than the corporate family as a whole. Verizon's financial
strategy of managing cash flow at its operating subsidiaries (whether
through intercompany loans or dividend policy) limits the ability of the
individual operating companies to materially reduce debt. All the
operating companies, with the exception of Verizon-West Virginia,
have experienced very large (on average 40%) year-over-year
increases in capital spending as a result of Verizon's decision
to upgrade its local networks to fiber-to-the-premises.
Consequently, the pre-dividend free cash flow generating
ability of the operating companies has greatly diminished.
Further rationale for operating companies ratings below the parent ratings
The downgrade of the ratings on Verizon-Virginia, Verizon-Florida
and Verizon-South to Baa1, as well as the downgrade of GTE-Southwest's
senior unsecured ratings to Baa2, also incorporates Moody's
belief that these companies are more likely to rely on parent company
support given their relatively weaker financial metrics and operating
performances. In the case of Verizon-Virginia and Verizon-South,
the dramatic acceleration of line losses indicates intensifying competition.
The downgrade of the long-term debt rating of GTE-Southwest
to Baa2 also reflects above-average access line losses, weak
asset returns coupled with a relatively high cost structure, and
among the most leveraged balance sheets in the family.
The ratings of Verizon-New York and Verizon-New England
were historically the lowest of the ILEC's, given their weak
operating performance. Consequently, Moody's downgraded
these companies only one notch (long-term ratings of Verizon-New
York to Baa3 and the long-term guaranteed and unguaranteed debt
ratings of Verizon-New England to A3 and Baa1, respectively)
given the agency's current view on VZ's financial strategy.
Moody's believes that the steps Verizon-New York has taken
to generate free cash flow by eliminating upstream dividends to its parent,
and to substitute intra-company debt for external debt, provide
the company with some operating cushion at its current rating level.
Nonetheless, Moody's expects that Verizon-NY's free cash
flow will remain under considerable pressure for some time, given
the likelihood that access line losses will continue to drive lower revenues,
that much of the company's cost structure is fixed, and that it
faces the expense of a significant network upgrade.
Relatively weak return on assets and significantly underfunded pension
obligations also pressures the ratings of Verizon-New York and
Verizon-New England. While Moody's notes the progress
that these companies have made curbing revenue loss and improving EBITDA
margins, Moody's believes that accelerating access line losses
will challenge the sustainability of this trend.
Underpinnings of the stable outlook at Verizon's wireline operating
The stable outlooks for ratings at the wireline subsidiaries are based
on Moody's expectation that the steps that Verizon has taken to
shore up the credit quality at the various operating subsidiaries,
including significant reductions in dividends to Verizon Communications,
and the substitution of inter-company loans for external debt will
offset, at least for the next 12 to 18 months, expected additional
earnings and cash flows pressures at the operating companies.
Verizon's method for funding its operating companies has changed
over time. All maturing debt and new capital needs at the operating
companies is now funded with inter-company borrowings, rather
than external debt. While these inter-company notes rank
pari passu with external debt, Moody's believes that this
financing arrangement indicates relatively strong parental support for
these subsidiaries and gives most of the wireline subsidiaries several
notches of rating lift.
However, should Verizon once again choose to finance these subsidiaries
with any new external debt, it is very likely that the ratings at
those subsidiaries would fall by several notches to levels that solely
reflect their individual, stand-alone credit quality.
A possible sale, spinoff or divestiture of assets could also affect
the ratings of all operating companies.
The ratings of Verizon's operating companies could come under additional
pressure if: 1) revenue declines accelerate to close to 5%
annually; or 2) the Fiber-to-the-Premise (FTTP)
network upgrade does not, over-time, significantly
lower costs, support new revenue streams and lead to increases in
cash flow. Annual access line losses persistently above 10%
could further pressure all ILEC ratings. The operating companies'
ratings could also fall further if Moody's downgrades Verizon Communications'
senior unsecured rating.
Complete list of rating actions:
Ratings downgraded are:
Verizon Global Funding Corp.: issuer rating to A3 from A2
and short-term debt rating to Prime-2 from Prime-1
Verizon Network Funding: short-term to Prime-2 from
NYNEX Corporation: senior unsecured to A3 from A2
GTE Corporation: senior unsecured to Baa1 from A3
Verizon New York, Inc.: notes and debentures to Baa3
Verizon New England, Inc.: notes and debentures to
Baa1 from A3, except the $480M of Series B debentures,
due 2042, which are downgraded to A3 from A2 based on unconditional
and irrevocable guarantee from Verizon Communications
Verizon Delaware, Inc.: debentures to A3 from Aa3
Verizon West Virginia, Inc.: debentures to A3 from
Verizon New Jersey, Inc.: debentures to A3 from A1
Verizon Pennsylvania, Inc.: debentures to A3 from A1
Verizon Maryland, Inc.: debentures to A3 from A1
Verizon North, Inc.: debentures to A3 from A1
Verizon Northwest, Inc.: debentures to A3 from A1
Verizon California, Inc.: debentures to A3 from A1
Verizon Virginia, Inc.: notes and debentures to Baa1
Verizon Florida, Inc.: debentures to Baa1 from A1
Verizon South, Inc.: debentures to Baa1 from A2 except
the $300M of Series F debentures, due 2041, which are
downgraded to A3 from A2 based on unconditional and irrevocable guarantee
from Verizon Communications
GTE Southwest, Inc.: first mortgage bonds to Baa1 from
A2, notes and debentures to Baa2 from A3
MCI, Inc.: Corporate Family to Ba3 from B2; Senior
Notes to Ba3 from B2
Ratings placed on review for possible upgrade:
Verizon Wireless Capital, LLC: A3 senior unsecured
Please refer to Moodys.com for additional research.
Verizon Communications is a regional Bell operating carrier, headquartered
in New York City. MCI Inc. is a global telecommunications
provider headquartered in Ashburn, VA.
Senior Vice President
Corporate Finance Group
Moody's Investors Service
Corporate Finance Group
Moody's Investors Service