CANADIAN COMMUNICATIONS and TELEPHONY

[Kitskid]

http://www.dbrs.com/web/sentry?COMP=1400&DocId=110161
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The full text of the press release:




Paul Holman, Peter Schroeder / 416-593-5577 ext.2234, ext.2279 / [e-mail]



DBRS is downgrading the TELUS group to BBB from BBB (high), with the trend remaining Negative. The downgrade reflects the fact that even if the plans announced on May 3 to grow revenues, cut costs, and improve efficiencies are successful, TELUS will face similar debt levels by the end of next year. Moreover, the recent CRTC decision on price caps removed the prospect of additional local revenue, as it effectively prevents local rate increases on about 75% of local voice revenue. Accordingly, the Negative trend remains in place to reflect the execution risk associated with the successful implementation of the cost-cutting plan to be in rolled out by year-end. TELUS has indicated that it expects to improve productivity, while reducing operating costs. With this action, it intends to improve earnings and cash flow during 2003, while reducing debt to EBITDA to 3.0 times. Thereafter, it expects to be in a position to start reducing debt levels. Despite the downgrade, however, the TELUS group remains firmly in the investment grade category at this time.
The downgrade applies to the entire TELUS group as it is considered to have a consolidated credit profile. This results from the inter-company debt that was put in place to help with the acquisition of Clearnet Communications Inc. The internal debt effectively places the creditors at the corporate level (TELUS Corporation debtholders) on par with those at the operating level (pari passu with TELUS Communications Inc. debtholders).
The downgrade takes into account a number of specific issues:
(1) High debt levels, with financial ratios under pressure. Even with a successful execution of the revised business plan, debt levels will remain high next year.
(2) Regulatory decisions that are expected to reduce EBITDA by up $300 million annually. The CRTC decision concerning contribution rates last year will reduce EBITDA by about $230 million, while the CRTC decision this year concerning price caps will reduce EBITDA by up to $45 million this year and $75 million each year thereafter. While TELUS expects to more than cover this with lower operating costs and reduced dividend payout, the net improvements are uncertain.
(3) Cost cutting that has been slow to materialize since the merger of TELUS and BC TEL, and the acquisition of Clearnet. At the time of the merger, there was pressure from local governments and unions to resist downsizing the work force. The differing operating cultures in all these companies have made it challenging to streamline the businesses. As TELUS addresses these issues, with employee reductions later this year, it will incur sizeable cash charges.
(4) Intense wireless competition. TELUS’s wireless operations in western Canada are under increasing competitive pressure from Bell Mobility. As well, TELUS continues to face intense competition in Central Canada from its three main competitors. While TELUS expects to see some easing in price competition and improving cash flow, wireless revenue and customer growth rates could slow, as they have done in the U.S., despite the significant subsidies still provided to new customers.
(5) Costly data network strategy facing intense competition in central Canada. TELUS plans to fund a sizeable capital expenditure program to complete the roll-out of its competitive carrier operations in Toronto and Montreal. This business competes directly with the incumbent, Bell Canada, and the local CLECs. In Canada, as elsewhere, growing revenue by gaining market share from the incumbent telcos represents a significant challenge.
Even with the aforementioned, DBRS is maintaining TELUS’s investment grade status due to:
(1) Significant incumbent telco franchises in B.C. and Alberta that generate stable cash flow.
(2) Reasonable liquidity and minimal debt refinancing requirements. The first major debt maturity is not until 2006.
(3) Easing pressure on internal funding requirements and free cash flow, with lower capex and lower cash dividends.
(4) Revised business plan to reduce costs appears reasonable and management appears determined to achieve the targets. This includes ambitious cost-cutting initiatives leading to cash flow break-even for 2003. As well, tax shelters from Clearnet will reduce TELUS taxes through 2004.
(5) Verizon Communications Inc. owns 24% of TELUS.
While TELUS is investment grade at this time, this could be at risk if operating performance during this period shows no signs of improving and free cash flow remains negative. Conversely, this position would be further supported as performance improves and financial strength grows.
Dominion Bond Rating Service Limited (DBRS) will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, please contact us at: [e-mail] <mailto:[e-mail]>.


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