Standard & Poors (S&P) has downgraded Telstras long-term and short-term credit ratings to A+/A-1 from AA/A1+, primarily on the back of the companys plans to invest in and form mobile phone and IP backbone joint-ventures with Pacific Century CyberWorks (PCCW). The move also reflects increasing competition in the Australian telecoms market, S&P says.
The tone of the press release from S&P this morning would suggest that greater rating emphasis has been placed on the heightened business risk associated with its Asian joint-venture with PCCW, says ANZ Investment Bank credit research analyst Siong Ooi.
Whats interesting is that the downgrade, which at two notches was fairly severe, has come at a time of intense speculation that Telstra is trying to renegotiate the terms of its planned investment in the joint-ventures with PCCW and may even walk away from the deal altogether. The two parties have been locked in talks for months and are trying to sew up a deal by year-end after failing to meet initial expectations that a binding agreement would be signed in September.
Still, the S&P move had no discernible impact on Telstra debt in the market in fact the yield on the companys March 2010 bond fell 3 basis points to 7.43% during the day.
As articulated in our research dated 5 September 2000, our view was that the forecast financial ratios for Telstra supports it as an AA- credit (long-term). In S&Ps own press release, the forecast interest cover and funds from operations to debt is not materially weaker than current levels, says Ooi.
S&P predicts Telstras interest cover will fall to 9.0 times to 10.0 times in the next two years from 10.7 times in 2000 and its lease-adjusted funds from operations-to-total debt ratio will decline to 55% to 60% from 70% over the period. In part, this reflects the fact Telstra will be forced to debt finance major capital expenditure and strategic investments as it cannot dilute the Australian governments shareholding to below 50.1%.
Since Telstra first announced plans to do a deal with PCCW, S&P has dropped its credit rating by three notches, affecting its A$8 billion ($4.41 billion) of long-term borrowings and A$4 billion of short-term debt. The companys net debt is in the region of A$9.5 billion, though this could rise to A$13 billion or more in the next couple of years if the company does agree a deal with PCCW.
Certainly one area PCCW wont be keen to give ground on in their negotiations is Telstras commitment to invest $3 billion cash - $1.5 billion for its stake in the joint-ventures and $1.5 billion in a PCCW convertible, the strike price of which has already dropped once to reflect PCCW share price weakness. PCCW needs the Telstra cash to help pay down a $12 billion loan it took out to finance its takeover of Cable & Wireless HKT.
Telstra, however, knows that PCCW management are under a lot of pressure to get a deal done. Two planned joint-ventures have already fallen through, contributing to negative investor sentiment which has been a key factor in PCCWs share price having dropped by two-thirds since the Cable & Wireless HKT bid was unveiled. PCCW cant afford to lose a third.