AT&T (T) Downgraded to 'BBB+' by S&P Following AWS-3 Purchase

Standard & Poor's Ratings Services said it lowered its corporate credit rating on Dallas-based AT&T Inc. (NYSE: T) to 'BBB+' from 'A-'. At the same time, we affirmed the 'A-2' short term rating. The outlook is stable. We also lowered the rating on AT&T's senior unsecured debt to 'BBB+' from 'A-'.

"The rating downgrade is primarily based on the company's recent announcement that it will spend $18.2 billion, or about $2.88 per MHz-POP, on its winning bids in the recently concluded AWS-3 spectrum auction, which we expect it will fund primarily with debt," said Standard & Poor's credit analyst Allyn Arden.

Although we view the acquisition of spectrum as a positive for AT&T's wireless business, the amount was higher than our expectations of around $15 billion-$16 billion. Because of this and an increase in pensions and post-retirement liabilities due to a lower discount rate, we expect that adjusted leverage will be in the 3x area in 2015 and will not meaningfully improve thereafter. Moreover, we expect FFO to debt will be in the low- to mid-20% area over the next few years. We still view the financial risk profile as "intermediate" although we believe that credit metrics will remain on the weak side of the financial risk assessment over the next few years.

The rating downgrade is also based on the following factors:

• AT&T has slowly increased its leverage target over the last few years to accommodate growth initiatives, acquisition activity, and share repurchases. The company recently indicated that its net leverage would likely be 2.0x-.2.5x over the next year, although it expected leverage to improve thereafter. We estimate that AT&T's reported leverage range translates to about 2.8x-3.3x on an S&P adjusted basis, above our 3x threshold for an 'A-' or at the upper end of the range. In addition, with the potential for further acquisitions and spending for the broadcast incentive auctions in 2016, we believe it will be difficult for the company to improve key credit metrics over the next few years.
• We expect discretionary cash flow (DCF) to debt to remain low, at less than 5%, which will not support an 'A-' rating.
• While the acquisitions of Iusacell and NII's assets in Mexico will not have a meaningful impact on credit measures, we still believe they could signal the potential for additional investments or acquisitions in Mexico or other markets, which could be funded with debt. Moreover, we believe that AT&T may face challenges to successfully integrate multiple acquisitions.
• We believe that intense competition in the U.S. wireless market and promotional activity could lead to weaker profitability for AT&T over the next few years.

The outlook is stable. As a result of the significant debt financing requirement for the spectrum auction as well as smaller acquisitions, we expect AT&T's leverage to be around 3x for the next couple of years. Additionally, we expect FFO to debt and DCF to debt to be in the mid-20% area and less than 5%, respectively.

While not likely, we could lower the rating if leverage were to rise to the mid-3x area or FFO to debt were to decline to the 20% area with no expectation for improvement. Based on the company's strong competitive position, we believe a potential downgrade would most likely result from a more aggressive financial policy that included material debt funding of stock repurchases or additional acquisitions.

We could raise the rating if AT&T were to achieve leverage of less than 2.75x or FFO to debt of around 30%, both on a sustained basis. Given the company's current leverage target, we believe this could take several years to achieve.

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