DBRS Confirms Bell Aliant’s Ratings at BBB (high), R-1 (low), Stable Trends

DBRS has today confirmed the short- and long-term ratings of Bell Aliant Regional Communications, Limited Partnership (Bell Aliant or the Company) at R-1 (low) and BBB (high), respectively, along with the preferred share rating at Pfd-3 (high). The trends are Stable. The confirmation reflects a business risk profile that, while undergoing a transition from legacy voice services to focusing on growth areas such as data and video, has to-date been manageable. The ratings also incorporate Bell Aliant’s relatively stable financial risk profile, which remains slightly higher than its Canadian peers but within an acceptable range. DBRS believes that for Bell Aliant, the successful transition to providing new services – both in terms of investment and execution – remains more acute than for other telcos that typically have wireless services throughout their territory to provide growth while this fixed-line transition occurs.

In terms of Bell Aliant’s short-term rating, DBRS notes that the R-1 (low) rating remains an exception to DBRS’s standard mapping to a BBB (high) rating, for which the equivalent would usually be R-2 (high). This exception, however, could be lost should the Company’s cash flow from operations come under accelerated pressure (potentially turning free cash flow to negative), management changes its philosophy to liquidity, or debt/leverage and the business risk profile become less manageable, therefore weakening the strength of its long-term rating. If Bell Aliant’s liquidity is not seen by DBRS to be more than adequate, the short-term rating would come under pressure and likely fall into the more usual mapping of R-2 (high).

In terms of assessing the business risk profile for Bell Aliant, DBRS considers five predominant factors: the competitive landscape, technology, networks, regulation and product diversification. DBRS notes that competition and technology substitution remain ongoing drivers behind access line erosion for Bell Aliant. In addition, cable operators have continued to expand their competitive footprint in Bell Aliant’s territories, and are now covering approximately 71% of its total 2.53 million households.

While DBRS expects competition and technology substitution to continue to contribute to access line erosion – especially in non-fibre markets – Bell Aliant has shown early signs that its fibre network deployment plans are stimulating revenue and subscriber growth. Furthermore, increased subscriber acquisition costs have mostly been offset by ongoing operating efficiencies.

At the end of Q3 2011, Bell Aliant’s fibre-to-the-home (FTTH) initiative has expanded to cover 398,000 homes, with plans to pass 450,000 homes and businesses by the end of 2011 and more than 600,000 by the end of 2012. The Company has been ahead of plan in its fibre deployment and this has had an immediate and sustained positive impact on revenue in markets where available – predominantly Atlantic Canada to date, which is roughly half of its overall territory. While approximately 20% of its total households are not expected to be covered by cable over the medium term, DBRS believes that Bell Aliant’s FTTH investment will give it a competitive advantage in just over one-quarter of its total homes and businesses by the end of 2012. However, the remaining half of its territory (especially Ontario and Quebec) is under greater threat from cable operators, which can offer triple-play services and faster high-speed Internet services than can Bell Aliant currently. DBRS notes that the Company has acknowledged that it will need to turn its attention to better equipping this territory following its 2012 FTTH deployment.

The FTTH investment is expected to better position the Company by enabling it to provide industry-leading high-speed Internet services, as well as an advanced Internet protocol television (IPTV) video service, and bundle three fixed-line services, thereby driving up average revenue per user (ARPU) while decreasing subscriber turnover (churn) and lower its network operating costs. While it is still early days for this investment and the transition overall, DBRS believes that a new competitive equilibrium for both Bell Aliant and its cable competitors will be found in its fibre markets over the medium term once the Company’s fibre deployment has been completed.

From a regulatory perspective, Bell Aliant has received forbearance from local regulation in a significant part of its coverage territory as 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 roughly 20% 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 facing competition in the remainder should allow Bell Aliant to adjust to the increase in competitive pressures.

From a financial risk perspective, in addition to key credit metrics, DBRS focuses on free cash flow generation, maturities and liquidity in assessing a communications company. Despite the benefits that will ultimately be realized from its fibre investment, DBRS expects Bell Aliant’s free cash flow (including cash tax savings) to decline for 2011 and further in 2012, with higher capex levels focused on its FTTH build and deployment. DBRS notes that the cash tax savings that Bell Aliant will realize in 2011 and 2012 should provide some cushion to cover this higher capex as the Company is expected to become a cash tax payer beginning in 2013. DBRS also notes that following the voluntary pension contribution in 2011, the Company’s pension deficit and contributions should be more manageable over the next couple of years, although they could continue to require funding thereafter should the environment of low interest rates and weak asset returns remain protracted.

In terms of Bell Aliant’s debt maturity schedule, it recently refinanced a large portion of its current debt coming due during 2011. DBRS notes that Bell Aliant has no maturities until the end of 2014, although there is a sizeable portion due in each of the three following years. Bell Aliant’s leverage is currently modestly above the levels seen among its Canadian peers, with debt in the capital structure at 46%, debt-to-EBITDA at 2.2 times and EBITDA coverage at 8.5 times. Cash flow-to-debt has held around the mid-0.30 times level. The Company’s credit metrics are expected to remain flat at best over the next couple of years, with continued 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, transition to growth services 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 (including not sufficiently executing on the transition from legacy voice services to growth areas such as data and video) or its financial risk profile could result in pressure on the ratings.

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

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