OREANDA-NEWS. Fitch Ratings will incorporate AT&T Inc.'s (AT&T) (NYSE: T) spending on spectrum under its review of the existing Negative Rating Watch. AT&T and its subsidiaries 'A' Issuer Default Rating and senior unsecured debt ratings were placed on Negative Rating Watch following the announcement on May 29, 2014 that AT&T had an agreement to acquire DIRECTV. The company's 'F1' short-term IDR and commercial paper ratings also remain on Negative Watch.

On Jan. 30, 2015, the Federal Communications Commission (FCC) announced the winning bids in the AWS-3 spectrum action. In the auction, AT&T bid approximately \$18.2 billion to acquire contiguous 10x10 MHz blocks of AWS-3 spectrum covering approximately 96% of the U.S. population. AT&T's total net remaining payment is \$17.3 billion?net of a \$0.9 billion upfront down payment made prior to the start of the auction in November 2014?with \$2.7 billion due February 13 and the final balance due March 2.

Fitch has anticipated that the DIRECTV transaction would lead to a one notch downgrade around the time of the closing of the transaction. Given the level of spending on spectrum, Fitch anticipates acting shortly on AT&T's Rating Watch status. Fitch currently anticipates that AT&T will be downgraded one-notch and a Stable Rating Outlook assigned but that the Outlook will be subject to a review of AT&T's financial policies. AT&T has stated that following the acquisition of spectrum, the close of the DIRECTV transaction, and investments in wireless in Mexico, that its net leverage will be in the 2.0x to 2.5x range and that it would seek to reduce net leverage to 1.8x within a three year period. Fitch believes gross leverage of 2.0x would be appropriate for the 'A-' rating level, and that based on the company's initial commentary, it would likely attain this level at the outer edge of Fitch's rating horizon.

Alternatively, should AT&T and DIRECTV terminate their agreement due to the lack of regulatory approval, Fitch believes that the company's metrics would return to a level appropriate for an
'A-' rating within a three year period. Without DIRECTV, AT&T delevers at a slower pace, but Fitch believes the company can still get gross leverage to 2.0x within three years as leverage following the spectrum investment peaks at a lower level.

Fitch anticipates that AT&T will use \$11.155 billion in term loan facilities entered into in January 2015 and a portion of its cash balances to fund the spectrum purchases. At Dec. 31, 2014, cash and cash equivalents, pro forma for a recent \$2.6 billion debt offering and the \$2.5 billion acquisition of Iusacell, amounted to approximately \$8.7 billion and highly liquid certificates of deposit and time deposits amounted to approximately \$1.9 billion.

KEY RATING DRIVERS

Fitch believes AT&T's acquisition of DIRECTV will improve its financial flexibility owing to DIRECTV's strong free cash flows (FCF) and the significant equity component in the transaction financing. The acquisition is expected to be completed in the first half of 2015, following the necessary regulatory approvals.

For 2014, AT&T's net leverage as calculated by Fitch approximated 1.8x, an increase from the 1.7x at year-end 2013. EBITDA has been under some pressure due to wireless subscribers converting to no-device subsidy plans, which provide for discounted service on the company's data sharing plans. Other factors contributing to EBITDA pressure include rising content costs for its U-verse video services, and expenses related to the March 2014 Leap Wireless acquisition and the pending DIRECTV transaction.

At Dec. 31, 2014, the company did not have any drawings on either its \$5 billion RCF due 2018 or its \$3 billion RCF due 2017, and in January 2015 entered into \$11.155 billion in term loan facilities. The principal financial covenant for all facilities other than a new \$2 billion 18-month term loan facility requires debt-to-EBITDA, as defined, to be no more than 3x.

For 2014, FCF (net cash provided by operating activities less capital expenditures and dividends) was modestly positive at \$353 million, and capital spending was \$21.4 billion.

Recently, AT&T completed wireless and wireline initiatives focused on its 4G LTE and IP broadband networks, respectively, leading to a moderation of spending going forward. Following the completion of these initiatives, AT&T has indicated 2015 capital spending will approximate \$18 billion.

At Dec. 31, 2014, total debt outstanding was approximately \$82.1 billion. Relative to the company's cash, RCF availability, and modest expected FCF, Fitch believes upcoming debt maturities are manageable. Debt maturities are approximately \$6.5 billion in 2015 and include approximately \$1.7 billion of debt putable to the company on an annual basis that Fitch believes is unlikely to be put.

RATING SENSITIVITIES

Negative: The DIRECTV acquisition, spectrum spending, plus the additional investments in Mexico in 2015, will likely lead to a one-notch downgrade of AT&T's rating to 'A-'. The Outlook will depend on an evaluation of AT&T's financial policies, including the time horizon expected to get gross leverage to approximately 2.0x.

Positive: To achieve an 'A' rating, the company's financial policies would need to target sustained gross leverage of around 1.7x or below.