OREANDA-NEWS. Fitch Ratings has revised Orange S.A.'s Outlook to Stable from Negative, while affirming its Long-term Issuer Default Rating (IDR) at 'BBB+'. Fitch has also assigned a rating of 'BBB-' to Orange's deeply subordinated fixed-rate notes (hybrid securities). A full list of rating actions is available below.

The revision of the Outlook to Stable is driven by our expectations of stabilising operational trends within Orange's domestic market in France and lower leverage as a result of improved operational cash flows and asset sales.

Opportunities for cost reduction across the group are likely to help the company absorb increases in capital expenditure and loss of domestic wholesale revenues in France from competitors Iliad and SFR over the next three to four years. However, higher capital expenditure should restrain free cashflow (FCF) generation over the medium-term.

KEY RATING DRIVERS

French Market Remains Competitive
Fitch expects that competitive pressures in the French telecoms market to persist in the short- to medium-term, which will impact tariffs and keep commercial costs and investment spending elevated for Orange. It is however, unlikely that the French telecoms market will deteriorate significantly further from its current levels as mobile tariff plans have now generally been rebased at lower levels following Iliad's launch of mobile services in January 2012.

Competitive pressures will be driven by Iliad's desire to gain scale in mobile, Bouygues Telecom's counter moves to maintain mobile market share and expand in fixed line and Numericable-SFR's aim to achieve integration synergies and enhance cash flows.

French Operational Trends to Stabilise
The rate of revenue decline for Orange France, which accounts for 64% of Group operating FCF (restated EBITDA less capex excluding spectrum costs) has improved to 1.8% YoY in 1Q15 from a peak of 6.6% in FY13. We expect this positive trend to continue over the next 18 to 24 months, potentially leading to revenue stabilisation. The trend is driven by increasing uptake of fibre and 4G mobile services in the consumer segment and growth from Orange's fibre co-investment programme and increases in regulated Local Loop Unbundled prices within fixed line wholesale.

In Fitch's opinion, the company's faster rate of fibre and 4G network deployment relative to its competitors could provide a point of differentiation in the short-term that should help to stabilise Orange's market share. Due to the competitive dynamics of the market Fitch anticipates that increases in average revenue per user (ARPU) could be limited.

Loss of Wholesale in France
Fitch estimates that Orange will have to absorb the loss of around EUR1bn in high-margin wholesale revenues equal to 2.5% of total 2014 group revenues by the next four years. The loss is due to the migration of Iliad's mobile customers onto its own network and SFR's migration of LLU lines to Numericable's cable network. We expect, however, that Orange will be able to offset much of the loss with cost reductions over time. The company targets gross cost savings of EUR3bn from its transformation programme over 2015-2018. With a significant proportion of these savings covered by headcount reductions notably in France, we believe Orange should be able to absorb this loss.

Capital Expenditure to Remain Elevated
Capital expenditure is likely to remain at high levels over the next three to four years, driven by spectrum auctions, lower fibre co-investment (following SFR's acquisition by Numericable) and Orange's commercial strategy to have robust and market leading broadband networks. Fitch estimates that Orange's capex spend in 2014 of EUR5.6bn or 14% of revenues (15% including spectrum) is likely to increase in the next two years before declining. The increase will weigh on FCF generation and pre-dividend FCF margins are unlikely to expand significantly above 5% over the next two to three years.

Spanish Consolidation Supportive
The acquisition of Jazztel in Spain in 2Q15 would enable Orange to build scale in fixed line and operationally strengthens its convergent product offering while gaining synergies in network and distribution. The acquisition is in our opinion, credit-supportive. It has been financed by the issue of hybrid securities and the Group balance sheet should benefit further from the forthcoming sale of EE. While integration and network expansion costs will weigh on cash flows in the next two years, the release of synergies thereafter combined with recent Spanish market consolidation is likely to improve the economics of Orange Spain in the long run.

Risk of Leverage Increase Abated
Orange's funds from operations (FFO) adjusted net leverage at end-2013 and -2014 remained around 3.3x while domestic operating FCF declined by 18% in 2014 compared to 2012. We now expect FFO adjusted net leverage to gradually trend to 3.0x by end-2016. The improvement in leverage is driven by the stabilisation of operating FCF and the prospective sale of Orange's 50% stake in its UK mobile joint venture EE where Orange expects to receive around GBP3.4bn in cash plus a 4% stake in the acquiring party, BT Group plc (BBB/Positive).

Hybrid Ratings
Orange issued EUR5.8bn of hybrid securities during 2014. Fitch rates these securities two notches below Orange's Long-term IDR of 'BBB+'. The differential reflects greater loss severity and risk of non-performance relative to senior obligations. 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 and full discretion to defer coupons for at least five years, as well as the absence of material covenants and look-back provisions. The approach is in accordance with Fitch's criteria, "Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis".

KEY ASSUMPTIONS
- Limited (less than 1%) further loss of mobile and broadband market subscriber share in France.
- Continued decline in mobile ARPUs over the next two years of 2% to 5% per year.
- Group revenue declines stabilise from 2016, including the impact of Jazztel.
- Group restated EBITDA margin of 30% to 31% over the next three years.
- Capex to sales ratio (including spectrum) to increase to over 18% in 2016 from 15% in 2014 before declining thereafter.
- Orange acquires 100% of Jazztel shares for EUR3.4bn with consolidation from 2H15.
- Sale of EE at end-1Q16. Orange continues to receive dividends until then.

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, result in negative rating action include:
- FFO adjusted net leverage trending sustainably above 3.5x, which would lead to a downgrade.
- Pressure on FCF, driven by continued EBITDA erosion, higher capex and shareholder distribution, or significant underperformance in the core domestic market and at other key subsidiaries

Positive: Future developments that may, individually or collectively, result in positive rating action include:
- Expectations of FFO adjusted net leverage trending sustainably below 2.5x
- Improved competitive position in Orange's domestic and other key international markets combined with growth in pre-dividend FCF.

FULL LIST OF RATING ACTIONS

Orange S.A.
- Long-term IDR: affirmed at 'BBB+'; Outlook revised to Stable from Negative
- Senior unsecured: affirmed at 'BBB+'/'F2'
- Short-term IDR: affirmed at 'F2'
- Commercial paper programme: affirmed at 'F2'
- Subordinated undated notes: assigned at 'BBB-'