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Rating Action:

Moody's affirms BT's Baa2 rating; outlook positive

09 Sep 2014

Madrid, September 09, 2014 -- Moody's Investors Service has today affirmed the Baa2 issuer rating, Baa2 senior unsecured debt ratings and Prime-2 (P-2) ratings of British Telecommunications Plc (BT) and British Telecom Finance B.V.. The outlook on the ratings remains positive.

"We have affirmed BT's ratings with a positive outlook to reflect its solid and stable operating performance, the management's track record in executing its current business plan and the company's continued efforts to reduce net financial debt," says Iván Palacios, a Moody's Vice President - Senior Credit Officer and lead analyst for BT. "Our decision balances these factors against the lack of improvement in BT's credit metrics, primarily driven by the large increase in the company's pension deficit, compared to our expectations when we changed the outlook to positive in September 2012."

RATINGS RATIONALE

Today's action reflects BT's continued solid and stable operating performance, as well as its ability to continue cost cutting, a more favourable UK regulatory environment and the recent launch of new mobile offerings, which strengthen its business model. In addition, on-balance sheet net debt has decreased by more than GBP2 billion over the past two years. However, the IAS 19 pension deficit has increased by more than GBP4 billion in the same period, offsetting management's deleveraging efforts.

While the IAS 19 pension deficit remains a large drag on BT's credit profile, however, it is volatile in nature and Moody's expects that it will progressively come down as interest rates rise over the medium term. In addition, Moody's notes that the BT Pension Scheme Trustee has taken constructive steps to de-risk its large pension exposure, including a decision in July to lay off a portion of the pensioner longevity risk through an arrangement with Prudential Insurance Company of America.

Moody's expects that BT's credit metrics will improve going forward, driven by the monetisation of its investment in fibre and sports content, its new mobile propositions and reduced regulatory headwinds. Assuming a stable pension deficit and an operating performance in line with the management's business plan, Moody's expects that BT's adjusted debt/EBITDA and retained cash flow (RCF)/net adjusted debt ratios will improve over the next 12 months to around 2.8x and 25%, respectively. This compares with adjusted debt/EBITDA of 3.3x and RCF/net adjusted debt of 22% as of the end of fiscal year (FY) 2013-14.

In FY2013-14, BT returned to revenue growth for the first time since FY2008-09, mainly driven by the initial success of BT Sport, which has helped its Consumer business to reduce churn and increase its broadband market share. BT's strategy of securing expensive sports rights appears to be working as planned, although this exposes the company to the risk of price escalation in future auctions, such as the upcoming Premier League rights auction from the 2016-17 season. The company will have to demonstrate that its ability to monetise the content (both directly and indirectly), as well as its sustained ability to cut operating costs, can provide a cushion to offset any potential increase in content costs.

BT continues to benefit from some of the more favourable structural features of the UK market compared with other European countries, such as relatively stronger GDP growth prospects, better demographics, price inflation in telecoms services and a more favourable regulatory environment for telecom network owners. However, the market remains very competitive and the growth potential in the broadband market will slow down with the increase in penetration of triple-play and quadruple-play services.

BT has the opportunity to accelerate revenue growth via the recent launch of its new mobile offerings, which it will provide through a cost efficient network that combines (1) a mobile virtual network operator (MVNO) agreement for coverage, (2) its Wi-Fi network, (3) its 4G spectrum and (4) the development of small cells. This move makes sense from a business profile perspective as BT is the only incumbent in Europe lacking a mobile network and with its new mobile propositions it will be able to offer convergent products. However, the network architecture is untested and the economics will be challenging as the UK is one of the lowest margin mobile markets in Europe. In addition, event risk may increase should the group decide to accelerate its strategy through the acquisition of a mobile network operator.

RATIONALE FOR POSITIVE OUTLOOK

The positive outlook reflects BT's strong position within the Baa2 rating category, with the potential for moving to Baa1 on the basis of the operational and financial measures taken by management. However, positive momentum on the rating also depends on the outcome of the upcoming Premier League rights auction and the triennial actuarial pension review, which will be completed next year.

WHAT COULD CHANGE THE RATING UP/DOWN

Upward rating pressure could develop over the next 18 months if BT delivers on its business plan, while the pension deficit progressively declines. Improved credit metrics, such as RCF/net adjusted debt of more than 25%, adjusted total debt/EBITDA below 2.5x and solid free cash flow generation, would support upward pressure on the rating.

Downward pressure on the rating is unlikely given the positive outlook on the rating. However, the outlook could stabilise if (1) the company overpays in the upcoming Premier League rights auction resulting in a material deviation in expected EBITDA generation; or (2) the outcome of the triennial actuarial pension review, leads to substantially higher cash contributions than the around GBP700 million per annum assumed by Moody's.

Credit metrics that would support a change in outlook to stable include RCF/net adjusted debt in the 20%-25% range and adjusted total debt/EBITDA in the 2.5x-3.5x range 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; outlook positive
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