OREANDA-NEWS. Fitch Ratings has assigned Denmark-based telecoms group TDC A/S's (TDC, BBB/Negative) proposed EUR500m callable subordinated capital securities (hybrids) an expected rating of 'BB+(EXP)'. The final rating is contingent upon the receipt of final documentation confirming materially to the preliminary documentation reviewed.

The proposed hybrid securities have a 1,000 year maturity and are structured to be deeply subordinated and senior only to TDC's ordinary shares. The coupon payments can be deferred at the option of the issuer with a compounding of interest. As a result of these features, the proposed securities are rated two notches below TDC's 'BBB' Long-term IDR to reflect increased loss severity and heightened risk of non-performance relative to senior obligations. The approach is in accordance with Fitch's criteria, "Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis".

The hybrid securities qualify for 50% equity credit as they meet Fitch's criteria with regard to subordination, effective maturity of at least five years, full discretion to defer coupons for at least five years and limited events of default, as well as the absence of material covenants and look-back provisions.

TDC has an option to redeem the notes at its first call date and then on every annual interest payment date thereafter. The coupon will be reset every five years with a step-up of 25bp at the first step-up date and an additional 75bps at the second step-up date. Early call options are also permitted for tax, accounting, rating agency and change-of-control reasons.

There is no look-back provision in the securities' documentation that would remove the issuer's full discretion to unilaterally defer coupon payments. Deferrals of coupon payments are cumulative and the company will be obliged to make a mandatory settlement of deferred interest payments under certain circumstances, including a declaration or payment of a dividend to shareholders.

The issue of hybrid securities forms part of the company's funding strategy for its acquisition of Norwegian cable operator GET for EUR1.69bn in October 2014.

KEY RATING DRIVERS
Strong Domestic Position
TDC owns both the Danish incumbent copper network and the majority of the cable infrastructure in the country. This gives the company a strong fixed line position compared with all other European incumbents and helps the company to generate best-in-class EBITDA margins of 49% in 2014 excluding the company's operations in Norway and Sweden. This is reflected in Fitch-calculated funds from operations (FFO)-adjusted net leverage downgrade guidance of 3.75x, which is at the higher end of the rating category.

Increasing Competition and Regulation
Competition and regulation are expected to have a significant negative impact on TDC's domestic business over the next three years. The main points of pressure are likely to be driven by a loss of mobile virtual network operator (MVNO) contacts, continued losses in fixed line telephony and competitive pressure in the B2B segment. Regulatory pressure on broadband wholesale prices, retail roaming and cable TV is expected to amount to a gross profit loss of DKK100m-DKK150m by 2015 or approximately 0.5% of 2014 group revenues.

GET Acquisition
In September 2014, TDC announced the acquisition of the Norwegian cable operator GET for EUR1.69bn. The acquisition is to be funded through a combination of debt, hybrid securities and a reduction in dividend payments. The transaction aims to improve TDC's growth profile, increase diversification and gain greater exposure to cable. TDC also aims to generate revenue and cost synergies of EUR22m per annum by 2017.

Managing a Leverage Spike
The partially debt-funded nature of the GET transaction removed any headroom TDC had within its 'BBB' rating. The acquisition increased leverage; lifting the group's FFO adjusted net debt to 3.9x from 3.4x in 2014. Fitch expects TDC's leverage will decline to 3.7x by 2017 and further thereafter. The deleveraging is expected to be achieved with a combination of operating cash flow, reduced dividends and the planned issue of hybrid bonds. Given limited headroom within TDC's ratings, the execution of both the company's operational and financial strategy, including the planned hybrid bond issue, is key to meeting its deleveraging trajectory.

KEY ASSUMPTIONS
Fitch's key assumptions within our ratings case include:
- An improvement in the rate of revenue decline within TDC Denmark from 4% YoY in 2014 to 1% by 2016.
- A contraction of approximately 1.5 percentage points in EBITDA margin in 2015 reflecting the loss of MVNO contracts, regulatory and competitive pressure in Denmark.
- Capex of DKK4.3bn in 2015 excluding spectrum costs and gradually reducing capital intensity from 18% to 17% over three years.
- FFO adjusted net leverage declining from 4.0x in 2015 to 3.7x in 2017.
- A reduction in dividends in line with the company's new dividend policy of approximately 60% of equity free cash flow.
- We do not assume any improvement in operating performance as a result of potential market consolidation.

RATING SENSITIVITIES
Negative: Future developments that could lead to a downgrade include:
- FFO-adjusted net leverage exceeding 3.75x on a sustained basis.
- A lack of progress in deleveraging during 2015, as a result of lower operational cash flow or a change in the funding strategy for the GET acquisition.
- A marked deterioration in TDC's operating environment and/or unfavourable regulatory decisions.

Positive: Future developments that could lead to positive rating action include:
- FFO-adjusted net leverage sustainably below 3.0x, together with evidence of improved operational and financial performance could lead to an upgrade to 'BBB+'.
- The Outlook could be revised to Stable upon expectations that FFO-adjusted net leverage will fall to below 3.75x on a sustainable basis combined with stabilising EBITDA trends and no further deterioration in competitive and regulatory environments.