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Rating Action:

Moody's changes outlook on BT to negative; affirms Baa1 ratings

26 Jan 2017

Madrid, January 26, 2017 -- Moody's Investors Service, ("Moody's") has today changed the outlook on British Telecommunications Plc (BT) and British Telecom Finance B.V to negative from stable, following the company's recent revision in performance expectations for the current year-end 2016/17 and the following year 2017/18. The reductions reflect the conclusion of the independent review in the Italian business and pressures in UK public sector and international services.

Concurrently, Moody's has affirmed BT's Baa1 senior unsecured and issuer ratings, the (P)Baa1 MTN programme and senior unsecured shelf rating as well as the Prime-2 short-term rating.

Moody's has also changed the outlook to negative on EE Limited (EE) and EE Finance Plc, both wholly owned subsidiaries of BT, and affirmed EE's Baa1 issuer rating as well as the Baa1 senior unsecured debt ratings and (P)Baa1 MTN programme rating of EE Finance Plc.

A full list of affected ratings can be found at the end of this press release.

"Changing BT's outlook to negative reflects the company's weaker expectations for operating performance over the medium term, which further weighs on BT's financial profile from an already stretched level for the Baa1 rating, following the surge in the company's reported pension deficit in the first half of 2016," says Laura Pérez, Vice President-Senior Analyst and lead analyst for BT.

"So far, we tolerated a higher pension deficit because it was balanced against our expectation of BT's improving operating performance. However, the profit warning will further delay the deleveraging that we had anticipated in a context of relatively high leverage ratios for the current Baa1 rating," adds Mrs. Pérez.

RATINGS RATIONALE

The change in outlook to negative reflects BT's significant revision in earnings outlook, which will put further pressure on the company's already high leverage following the hike in the pension deficit reported last October. Given the recent revision in operating profits, Moody's expects a slower deleveraging path. BT's recent announcement also reduces visibility on the company's operating performance over the medium term.

Moody's estimates that the expected earnings reduction will increase leverage, as measured by adjusted debt/EBITDA, to 3.5x in FY2016/17 and to 3.4x in FY2017/18. The leverage ratios are considerably above the threshold for the Baa1 rating of adjusted debt/EBITDA not to exceed 2.8x.

In addition, Moody's expects Retained Cash Flow (RCF) to net debt to deteriorate to below 20% in both years, a level which is also below the 22% threshold for the Baa1 rating.

BT has meaningfully reduced the performance outlook for the medium term with a reduction in EBITDA and free cash flow coupled with flat revenue growth, compared to previous guidance of moderate growth.

BT has revised down its expectation of adjusted EBITDA growth for the full year by around GBP400 million to GBP7.6 billion for the next two years, which include GBP175 million related to the ongoing investigation in Italy and GBP225 million related to pressures in the UK public sector and international corporate markets.

In addition, the company's reported normalised free cash flow is now expected to reduce by GBP500 million to GBP2.5 billion in 2016/2017 and to GBP3.0-3.2 billion in 2017/2018 from previous management guidance. The impact on free cash flow exceeds the reduction in earnings due to negative one-offs arising from revisions of working capital movements. Furthermore, the company has maintained the dividend growth guidance at 10% per year.

The investigation into the Italian business has revealed inadequate accounting practices and a complex set of improper sales, purchase, factoring and leasing transactions which led to a meaningful overstatement of the results over a number of years. Management has indicated that the revision is largely complete and therefore it should reduce uncertainty going forward. Although the Italian business is a relatively small part of BT's group, the recent investigation signals less than adequate operational controls at BT group level.

The profit warnings comes in a context of a record high pension deficit (GBP11.5 billion gross of tax reported as of October 2016, up from GBP 7.6 billion in June), in large part due to falling corporate bond yields and higher inflation expectations, although Moody's recognises that this spike in the deficit could be at least partly cyclical, and is not the key driver of today's rating action. Nevertheless, the rating agency notes that the next triennial actuarial valuation should be finalised in the first half of 2018 and it appears increasingly likely that it could lead to an increase in pension cash contributions.

The affirmation of the Baa1 ratings also reflects the company's strong business profile as the integrated fixed and mobile telecommunications operator in the UK following the acquisition of EE and its leading market share.

RATIONALE FOR NEGATIVE OUTLOOK

The negative outlook reflects the lower visibility in terms of future operating performance, as well as the expectation of a slower deleveraging path in light of the recent profit warning. The negative outlook also reflects the record high pension deficit, which has reduced the company's headroom under the rating category.

WHAT COULD CHANGE THE RATING UP/DOWN

Downward pressure on the rating could arise if the company fails to successfully execute its business plan; or the pension deficit increases substantially from current levels or content costs inflation significantly increases, constraining financial performance and leading to weaker credit metrics. Credit metrics that would support a rating downgrade include adjusted RCF/net debt sustainably falling below 22% and adjusted total debt/EBITDA exceeding 2.8x on an sustained basis.

The outlook on the rating is negative and therefore upward pressure is unlikely to materialise over the medium term. However, upward rating pressure could develop over the medium term if the execution of the company's business plan is better than initially expected following the acquisition of EE. The rating would come under positive pressure if the company were to achieve sustainable improvements in its debt protection ratios, such as adjusted retained cash flow (RCF)/net debt of at least 30% and adjusted total debt/EBITDA comfortably below 2.2x on sustained basis, coupled with strong free cash flow generation.

LIST OF AFFECTED RATINGS

Affirmations:

..Issuer: British Telecom Finance B.V.

....Backed LT Issuer Rating, Affirmed Baa1

....Backed Commercial Paper, Affirmed P-2

..Issuer: British Telecommunications Plc

....LT Issuer Rating, Affirmed Baa1

....Commercial Paper, Affirmed P-2

....Senior Unsecured Medium-Term Note Program, Affirmed (P)Baa1

....Senior Unsecured Regular Bond/Debenture, Affirmed Baa1

....Senior Unsecured Shelf, Affirmed (P)Baa1

..Issuer: EE Finance Plc

....Backed Senior Unsecured Medium-Term Note Program, Affirmed (P)Baa1

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed Baa1

..Issuer: EE Limited

....LT Issuer Rating, Affirmed Baa1

Outlook Actions:

..Issuer: British Telecom Finance B.V.

....Outlook, Changed To Negative From Stable

..Issuer: British Telecommunications Plc

....Outlook, Changed To Negative From Stable

..Issuer: EE Finance Plc

....Outlook, Changed To Negative From Stable

..Issuer: EE Limited

....Outlook, Changed To Negative From Stable

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Global Telecommunications Industry published in December 2010. Please see the Rating Methodologies 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 more than 170 countries. Following the completion of its GBP12.5 billion acquisition of EE Limited in January 2016, BT is also one of the largest mobile network operators in the UK.

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 credit rating action on the support provider and in relation to each particular credit 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 credit rating action, and whose ratings may change as a result of this credit 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.

Laura Perez Martinez
Vice President - Senior Analyst
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

Ivan Palacios
Associate Managing Director
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

No Related Data.
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