DBRS Confirms Bell Aliant at BBB (high) and R-1 (low)

DBRS has today confirmed the Senior Unsecured Debt rating of Bell Aliant Regional Communications, Limited Partnership (Bell Aliant or the Company) at BBB (high) and its Commercial Paper rating at R-1 (low); the trends are Stable. The confirmation reflects a business risk profile that remains manageable and a stable financial risk profile that, while higher than its Canadian peers, could improve modestly with its conversion to a corporation.

In terms of assessing the business risk profile of a communications company such as Bell Aliant, DBRS considers three predominant factors: the competitive landscape, technology (evolution, substitution, etc.) and regulation. DBRS notes that competition and technology substitution remain ongoing drivers of continued access-line erosion for Bell Aliant, particularly in residential services, where, unlike most telcos, Bell Aliant does not benefit from wireless growth as it largely resells Bell Mobility wireless services throughout most of its territory. At the same time, cable operators continue to expand their competitive footprint in Bell Aliant’s territories, now covering nearly 70% of its households.

Bell Aliant has been deploying fibre into its neighbourhoods (fibre to the node (FTTN)) and launched its fibre-to-the-home (FTTH) plans in 2009 to cover two entire cities. In 2010, the Company announced a major expansion of its FTTH initiative, with plans to pass over 600,000 homes by the end of 2012. DBRS believes Bell Aliant’s collective fibre investment will give it a competitive advantage in roughly one-quarter of its roughly 2.5 million homes and businesses by the end of 2012, while roughly 20% of its households are not expected to be covered by cable over the medium term. This fibre investment is expected to better position Bell Aliant by lowering its network operating costs and giving it industry-leading high-speed Internet services, allowing it to offer an advanced video service and bundle up to four services, thereby driving up average revenue per user (ARPU) while decreasing subscriber turnover (churn).

Although DBRS expects competition and technology substitution to remain ongoing contributors to access-line erosion, Bell Aliant’s efforts to reset its cost structure are expected to continue, while the growth areas of high-speed Internet, video and wireless (in certain territories) should help stem most but not all of the pressure on EBITDA over the next couple of years as new services, such as Internet and video, carry acquisition costs and generally have lower EBITDA margins in the near term. DBRS notes that Bell Aliant recently struck a new collective agreement with its unionized workforce in Atlantic Canada that should help in resetting its cost structure. DBRS believes Bell Aliant can maintain EBITDA margins that are healthy for a telco in the mid-40% range over the next couple of years despite the competitive environment and growth areas (high-speed Internet and video), which will incur incremental costs as subscribers are acquired. DBRS believes that a new competitive equilibrium will be found over the next couple of years once the Company’s fibre investment has been completed.

From a regulatory perspective, Bell Aliant has received forbearance from local regulation in a significant part of its coverage territory, while cable competition has continued to expand. However, DBRS believes that given the nature of its coverage territory, Bell Aliant is not likely to receive this relief in 20% to 25% of it territory as this high-cost service area is not expected to be passed by cable over the next few years. Achieving forbearance in 75% to 80% of its territory while not having competition in the remainder should let Bell Aliant adjust to the increasing competition. DBRS notes that other regulatory changes are possible as the Canadian Radio-television and Telecommunications Commission (CRTC) is currently studying the obligation to serve high-cost service areas, along with whether to include broadband services in this obligation. Depending on the outcome, these regulatory changes could affect Bell Aliant given its high-cost service areas. Additionally, DBRS notes that one major change from a regulatory perspective that could affect not only Bell Aliant but the entire communications industry in Canada is the possibility of the government moving forward on liberalizing foreign ownership restrictions over the near to medium term. However, such changes could have less impact on Bell Aliant, which remains controlled by BCE Inc. and Bell Canada.

From a financial risk perspective, in addition to key credit metrics, DBRS focuses on free cash flow generation, debt maturities and liquidity in assessing a communications company. DBRS expects free cash flow to remain positive for Bell Aliant in 2010 and likely to be near break-even over the next couple of years (on a fully taxed basis). Despite Bell Aliant becoming taxable in 2011 after its corporate conversion and higher capex levels associated with its expanded fibre deployment, lower dividends and the benefit of cash tax savings (at least for the first couple of years) should give the Company additional flexibility to cover pension deficit payments, undertake possible acquisitions and reduce its leverage.

DBRS notes that while Bell Aliant has a reasonable debt maturity schedule until the end of 2014, a sizable portion of its current debt, credit facilities and accounts receivable (A/R) securitization matures in 2011. While Bell Aliant redeemed $345 million of its 2011 debt early, in Q3 2010, the remaining debt, as well as the renewal of its facilities, will need to be addressed in the near term, likely after its corporate conversion. Although Bell Aliant’s leverage is currently modestly above its Canadian peers, with EBITDA interest coverage just below 9.0 times, cash flow-to-debt less than 0.4 times and debt in the capital structure healthy at 34%, the Company’s metrics are expected to improve incrementally over the next couple of years despite some modest pressure on EBITDA and cash flow from operations.

While DBRS believes that Bell Aliant’s business risk profile is manageable, there is no certainty that its fibre investment and ongoing cost reductions will enhance its competitive position, stem access-line erosion and reverse the resulting modest EBITDA pressure. DBRS notes that any significant changes in Bell Aliant’s business risk profile or financial risk profile could result in pressure on its ratings.

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

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