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Rating Action:

Moody's affirms BT's Baa2 rating following planned EE acquisition; positive outlook

05 Feb 2015

Madrid, February 05, 2015 -- Moody's Investors Service has today affirmed the Baa2 issuer rating, Baa2 senior unsecured debt ratings and Prime-2 (P-2) short term ratings of British Telecommunications Plc (BT) and British Telecom Finance B.V. The outlook on the ratings remains positive.

The rating action follows the announcement that BT has agreed definitive terms to acquire EE Limited for GBP12.5 billion. The consideration for EE will be payable as a combination of cash and new BT shares issued to both Deutsche Telekom AG and Orange. The cash consideration will be financed by a combination of new debt financing and approximately GBP1 billion from the placing of new BT shares. The transaction is subject to approval by the shareholders of BT and merger clearance, in particular from the UK Competition and Markets Authority. It is expected to complete before the end of BT's 2015/16 financial year.

"We have affirmed BT's ratings with a positive outlook reflecting the prudent financing of the EE acquisition and the strengthened business risk profile of the combined entity," says Iván Palacios, a Moody's Vice President - Senior Credit Officer and lead analyst for BT.

"The positive outlook reflects our expectation that BT's rating could improve over the intermediate term following the acquisition of EE, as long as the company successfully executes its business plan, remains disciplined in the upcoming Premier League rights auction and the pension deficit does not materially increase from current levels."

RATINGS RATIONALE

Today's action primarily reflects Moody's view that BT's acquisition of EE will materially strengthen the business risk profile of the combined entity, which will benefit from increased size and scale, and the business diversification associated with an integrated business model. EE is one of the leading mobile operators in the UK, with a reported 35% market share in terms of subscribers, the best 4G coverage and the largest spectrum portfolio - although its share of spectrum in the most efficient frequency band, below 1GHz, is fairly low.

The combined fixed and mobile network will allow BT to offer attractive bundles of fixed voice, broadband, mobile and television services, with which BT will gain a competitive advantage over mobile-only players and reduce churn.

BT expects the combination to unlock significant cost and capex synergies in areas such as procurement, distribution, branding, marketing, head offices, call centres and networks. The company estimates synergies of around GBP360 million per annum, to be achieved at full run-rate in four years, while integration costs required to achieve these synergies will be in the region of GBP600 million.

Moody's believes that these synergies and integration costs are reasonable when compared with similar transactions in the sector. Nevertheless, BT will remain exposed to integration risks, as it will have to digest a very large asset, which itself has already gone through a complex period of integration of two smaller entities (Orange UK and T-Mobile UK).

BT will finance the deal prudently, with around 62% of total consideration being paid with equity. As a result, the combined entity's credit metrics will remain broadly unchanged when compared with BT's standalone ratios pre-transaction. For the year ending March 2017, the first full-year post-transaction closing, Moody's expects that the new entity's debt/EBITDA ratio will be in the 2.8x-2.9x range, and its retained cash flow (RCF)/net debt ratio will be in the 22%-24% range. Moody's also derives comfort from the fact that BT has kept its financial policies and strategies unchanged, with the intention to continue reducing net debt and achieving a Baa1 credit rating over the medium term.

Despite these positive considerations, Moody's notes a number of uncertainties that will continue to weigh on the rating over the next 12 to 18 months. The regulatory approval of the deal is likely to be lengthy, and while Moody's expects that the deal will be finally approved and any potential remedies will be limited, this long period will delay the integration of the two businesses and the generation of expected synergies.

In addition, BT's acquisition of EE has spurred other consolidation moves, such as the planned acquisition of O2 UK by Hutchison. Consolidation in the UK telecoms market and the move towards convergence may lead to disruptive competitive responses, with weaker operators potentially lowering prices to avoid market share losses.

BT also plans to participate in the auction for the Premier League rights from the 2016-17 season, and there is a risk that the company may overpay, in light of increasing inflation for sports rights.

At the same time, despite the agreed GBP1.5 billion pension top-up payment , the pension deficit remains large and volatile, and further drops in interest rates may lead to increases in the deficit and a weakening of credit metrics.

RATIONALE FOR POSITIVE OUTLOOK

The positive outlook reflects the potential upward pressure on the rating once the transaction closes in the second half of FY2015/16, given the strengthened business profile of the combined entity, as well as the expected gradual improvement in credit metrics. The acquisition of a mobile operator is a step change for BT's business model, which could outweigh the near-term execution and integration risks of this combination.

WHAT COULD CHANGE THE RATING UP/DOWN

In light of the improved business risk profile, Moody's ratings for BT will accommodate slightly higher leverage. As a result, the rating agency has adjusted its ratio guidance bands for BT's Baa2 rating category. Upward rating pressure could develop once the transaction is completed if BT delivers the following credit metrics: RCF/net adjusted debt of more than 22% (25% pre-transaction), adjusted total debt/EBITDA below 2.8x (2.5x pre-transaction) and solid free cash flow generation.

Downward pressure on the rating is unlikely given the positive outlook on the rating. However, the outlook could stabilise if the pension deficit increases substantially from current levels or if the upcoming Premier League rights auction results in a significant increase in programming costs that constrains financial performance and delays anticipated improvement in credit metrics. Credit metrics that would support a change in outlook to stable include RCF/net adjusted debt in the 18%-22% range (20%-25% pre-transaction) and adjusted total debt/EBITDA in the 2.8x -3.5x range (2.5x-3.5x pre-transaction) on a sustained basis.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Global Telecommunications Industry published in December 2010. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

BT Group Plc, which operates principally through its 100%-owned subsidiary British Telecommunications Plc, is the leading provider of local, long-distance and international telecommunications services in the UK and one of the world's leading providers of communication solutions and services, operating in 170 countries. In the year ended 31 March 2014, BT reported revenue of GBP18.3 billion and EBITDA of GBP6.1 billion.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Ivan Palacios
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service Espana, S.A.
Calle Principe de Vergara, 131, 6 Planta
Madrid 28002
Spain
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Michael J. Mulvaney
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Espana, S.A.
Calle Principe de Vergara, 131, 6 Planta
Madrid 28002
Spain
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's affirms BT's Baa2 rating following planned EE acquisition; positive outlook
No Related Data.
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