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Rating Action:

Moody's places AT&T's ratings on review for downgrade following Time Warner acquisition announcement

Global Credit Research - 24 Oct 2016

New York, October 24, 2016 -- Moody's Investors Service, ("Moody's") has placed AT&T Inc.'s Baa1 senior unsecured rating on review for downgrade following its agreement to purchase Time Warner Inc. for $85.5 billion. AT&T's Prime-2 commercial paper rating has been affirmed, and, at this time, Moody's expects any potential downgrade of AT&T's senior unsecured rating to be limited to one notch. AT&T intends to finance the deal with a mix of 50% equity and 50% cash and Moody's estimates that AT&T's gross leverage will rise to around 3.5x (including Moody's standard adjustments, which add around 0.7x to reported leverage) at year end 2018, assuming the deal closes at year end 2017. Moody's estimates that AT&T and Time Warner could accumulate up to $10 billion in combined cash to offset the amount of potential new debt during the inevitably lengthy regulatory approval process.

RATINGS RATIONALE

Moody's review will focus on AT&T's pro forma capital structure and its willingness and ability to reduce leverage back towards 3x (Moody's adjusted), AT&T's current limit for its Baa1 rating. The deal's financing costs will consume the majority of acquired free cash flow due to an incremental $2.3 billion in annual dividends and $1.3 billion in additional after-tax annual interest expense. Moody's believes that given AT&T's limited excess cash after dividends and modest EBITDA growth potential, that organic leverage reduction is limited to around 0.1x to 0.2x annually. Asset sales could accelerate this trajectory, including segments of AT&T or Time Warner.

The deal will give AT&T additional scale and breadth, more growth potential and lower capital intensity, all credit positives. Time Warner's broad content business will increase AT&T's revenue diversity and offer more control over content costs and distribution rights across pay TV and mobile networks. Time Warner may better leverage AT&T's broad distribution capabilities and potentially improve ad monetization, although this was probably achievable through arms-length commercial negotiations. Slower content cost escalation will benefit AT&T's video business but reduce Time Warner's growth rate for that portion of content.

Moody's expects the deal to face a rigorous regulatory review and, if approved to include conditions that could limit AT&T's ability to use Time Warner's content as a competitive advantage. Regulatory conditions could ultimately undermine AT&T's objective to differentiate its mobile and pay TV platforms with exclusive content.

Moody's believes that Time Warner's current earnings and growth reflect both a late stage of an economic growth cycle and an especially strong political season. At the same time, Time Warner's business faces disruptive change from new distribution models including Netflix, Hulu (of which it owns 10%), YouTube, Amazon, Apple and others. AT&T's plan to acquire Time Warner so soon after its purchase of DirecTV is a somewhat defensive strategy that gives more power to AT&T to mold the pay TV industry evolution in its own favor. But, with both deals, AT&T has agreed to pay a full price for businesses facing disruptive change.

AT&T's funded debt balance could exceed $170 billion following the transaction close and average annual maturities will be greater than $9 billion starting in 2018. Moody's believes that many fixed income investors have limited capacity to buy more AT&T debt. The fixed income market's capacity will be further stressed following the acquisition of Time Warner, and possibly more so if AT&T's ratings are downgraded. This may cause AT&T's cost of debt to rise, especially in times of market stress. Rising benchmark rates, combined with wider credit spreads would put pressure on AT&T's free cash flow.

AT&T's common dividend will grow to around $14.5 billion annually from around $12 billion prior. This large, after-tax cash obligation reduces AT&T's financial flexibility and limits its ability to repay debt. To demonstrate the sustainability of its dividend, AT&T must maintain a reasonable payout ratio. From a credit perspective, the dividend is a cash flow cushion to bondholders and a dividend cut would allow for rapid de-levering if AT&T were to face pressure from weak fundamentals. Over a longer timeframe, Moody's continues to expect AT&T to reduce its cash dividends in order to remain competitive with its new peer group that includes other media and technology giants, many of which have very lean balance sheets.

We expect AT&T to maintain good liquidity over the next 12 to 18 months. The Time Warner transaction will be backstopped by a $40 billion 18-month unsecured bridge loan. AT&T's existing undrawn $12 billion bank facility remains in place and matures December 2020. We expect Time Warner will accumulate cash for the next 5 quarters, building up to $5 billion to offset the debt incurred or assumed in the deal. Moody's will assess AT&T's liquidity with increased scrutiny to ensure that refinance risk remains very low. After the deal closes, we would expect AT&T to enhance its liquidity by maintaining higher cash balances, expanding its committed bank line and addressing upcoming debt maturities as far ahead as possible. Any modest deterioration in liquidity would pressure AT&T's ratings, irrespective of its underlying business trajectory.

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.

AT&T Inc. ("AT&T" or the "Company"), the largest telecommunications company in the US, is headquartered in Dallas, Texas. In July of 2015, AT&T completed the acquisition of satellite provider DIRECTV and became the largest pay TV provider in the US and a major player in the Latin American market. We estimate AT&T's consolidated revenues will be approximately $165 billion for the full year 2016.

The following ratings were affected:

AT&T Corp.

- Senior unsecured rating, placed on review for downgrade, currently Baa1

AT&T Inc.

- Senior unsecured rating, placed on review for downgrade, currently Baa1

- Short-term commercial paper affirmed at P-2

- Senior unsecured shelf, placed on review for downgrade, currently (P)Baa1

BellSouth Corporation

- Senior unsecured rating, placed on review for downgrade, currently Baa1

Pacific Bell

- Senior unsecured rating, placed on review for downgrade, currently Baa1

SBC Communications Capital Corporation

- Senior unsecured MTN program rating, placed on review for downgrade, currently (P)Baa1

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.

Mark Stodden
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

John Diaz
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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