DBRS Changes Bell Canada’s Ratings to A (low), BCE to BBB (high), Stable Trends

DBRS has today changed Bell Canada’s senior and subordinated debt ratings to A (low) and BBB, respectively, and assigned Bell Canada a short-term rating of R-1 (low). DBRS has also discontinued its Issuer Rating on Bell Canada. Additionally, with Bell Canada at A (low), DBRS has also changed its ratings on BCE Inc. (BCE or the Company) to BBB (high) and Pfd-3 (high) and assigned BCE Inc. a short-term rating of R-1 (low). All trends are Stable.

This rating action removes BCE and Bell Canada’s ratings from Under Review Developing and Positive implications, respectively. These reviews were initiated on December 11, 2008 following the termination of the privatization of BCE. DBRS had previously adjusted Bell Canada’s ratings in October 2008 under the assumption at that point that the privatization would close as planned.

DBRS’s ratings are driven by the credit profile of Bell Canada which is directly supported by the wireline, wireless and video operations of Bell Canada and its subsidiaries. BCE’s ratings reflect the structural subordination of its debt and preferred obligations relative to Bell Canada who supports these obligations. Bell Canada’s ratings are below its ratings prior to the privatization given a highly competitive operating environment for all of its services and execution risks centered on investing and repositioning Bell Canada to a more solid competitive footing. Despite this, Bell Canada’s A (low) rating reflects: (a) a good business risk profile; and (b) a reasonable financial risk profile which could improve incrementally over the next two years.

While Bell Canada continues to generate modest levels of EBITDA growth, it also continues to experience pressure on its legacy residential voice services as a result of competition and technology substitution. This pressure impacts Bell Canada more than its peers given its higher exposure to wireline services and lesser exposure to growth areas such as wireless and broadband. Additionally, DBRS expects these growth areas to be more competitive going forward as broadband growth slows and as new carriers enter the wireless market.

Additionally, while DBRS notes that Bell Canada has been able to slow the pace of its access line erosion, there are risks associated with increasing Bell Canada’s competitive footing. This is something that George Cope has just begun to address with his appointment as CEO in July 2008. These initiatives include re-branding Bell, streamlining operations to be more efficient, introducing service initiatives and undertaking initiatives to change Bell Canada’s operating culture.

DBRS believes that Bell Canada, unlike many of its peers, continues to benefit from the ownership of Bell ExpressVu (now branded Bell TV). The ability to bundle up to four services along with deregulation in local residential services in recent years has allowed Bell Canada to compete more effectively for all four services with cable competitors and other competitors. However, DBRS believes that Bell Canada will have to continue to invest in its wireline and wireless networks to close the gap with its competitors. This is in terms of the network advantage that cable operators enjoy with most about to deploy DOCSIS 3.0 this year and other wireless carriers who operate on the GSM standard. While Bell Canada continues to focus its broadband investment on deploying fibre closer to its customers to enhance its data speeds and capacity, DBRS ultimately believes that deploying a terrestrial video service is inevitable for Bell Canada in its urban Ontario and Québec markets despite the costs and execution risks.

In wireless, Bell Canada has repositioned itself in recent years to close the gap between itself and its peers in terms of operating metrics such as net subscriber additions, churn and ARPU improvement. These factors have driven better levels of EBITDA growth and generally stronger EBITDA margins. DBRS notes that Bell Canada is jointly deploying a national HSPA-based network overlay on its existing CDMA-based network. This investment will put Bell Mobility on the GSM-based standard and give it a well-defined path for its 4G network upgrade (Long Term Evolution or LTE) thereafter. Additionally, DBRS notes that new entrants are likely to enter the Canadian wireless market beginning in the second half of 2009. This will likely include carriers attempting to gain share with lower prices and flat rate plans. DBRS believes that the more credible threat is likely to come from cable operators who can bundle wireless service to their existing customers. However, DBRS notes that the success of these new wireless entrants remains to be seen with these new entrants not likely to have a large impact on the Canadian wireless market in 2009.

Finally, while DBRS notes that Bell Canada maintains a strong position in business services that includes small, medium and large enterprise customers. This segment remains highly competitive and possibly more susceptible to pressure as a result of the current economic downturn. This could be prevalent should the downturn remain protracted as a portion of Bell Canada’s contracts could be re-priced or susceptible to competitors as they mature.

From a financial perspective, DBRS believes BCE/Bell Canada’s financial risk profile could improve further in 2009 after it today established fairly conservative leverage targets. Additionally, by continuing to generate modest EBITDA growth and with its roughly $300 million distribution from Bell Aliant this should allow BCE/Bell Canada to: (a) invest capital in growth areas such as broadband and wireless at an overall healthy level (mid teens as a percentage of total revenue); (b) pay a dividend that is tied to earnings growth; and (c) cover higher near-term pension contributions. However, DBRS notes that there will likely be constant pressure for increasing shareholder returns going forward.

While BCE/Bell Canada has a sizable portion of debt maturing over the next two years, the Company has indicated that it plans to use its current cash balance ($3.0 billion) and free cash flow to repay the $1.5 billion of debt that matures in 2009 and has the ability to repay its nearly $1 billion of 2010 maturities. Additionally, BCE is likely to complete its share repurchase program that was authorized in mid-December 2008 to repurchase up to 40 million of BCE Inc. shares.

DBRS expects leverage to be healthy for an incumbent telco with gross debt-to-EBITDA (including A/R securitization) expected to remain below 2.0 times with EBITDA interest coverage and cash flow-to-debt to likely improve should BCE/Bell Canada reduce the majority of its maturing debt over the next two years as planned. This would lead to EBITDA interest coverage improving to above 8.0 times and cash flow-to-debt above 0.40 times.

DBRS believes that Bell Canada is ideally placed at the A (low) level as it operates in a highly competitive environment and faces a number of execution risks. However, should Bell Canada appreciably execute on: (a) repositioning itself to better compete in a highly competitive environment; (b) upgrading its networks to close the gap with its competitors; and (c) further improving its customer retention rates; DBRS could, in conjunction with reduced leverage and balanced shareholder returns, reconsider Bell Canada’s ratings.

DBRS notes that its ratings of Bell Aliant (BBB (high) and R-1 (low)), Télébec, Limited Partnership (BBB (high) and NorthernTel, Limited Partnership (BBB (high), remain unaffected following this rating action. Given BCE/Bell Canada’s control of Bell Aliant, DBRS expects stable EBITDA due to growth areas and recent operating savings offsetting wireline pressure. This should benefit of all of Bell Aliant’s unitholders, including BCE/Bell Canada and its 44% stake.

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Telecommunications, which can be found on our website under Methodologies.

This is a Corporate (Telecommunications) rating.