DBRS Morningstar Confirms TELUS Corporation at BBB (high) with a Stable Trend Post-Acquisition Announcement

DBRS Limited (DBRS Morningstar) confirmed TELUS Corporation’s (TELUS or the Company) Issuer Rating and the rating of the Company’s Notes at BBB (high) and confirmed the Commercial Paper rating at R-2 (high). DBRS Morningstar also confirmed the rating of TELUS Communications Inc.’s Senior Debentures at BBB (high). All trends are Stable. The confirmations follow TELUS’s announcement that, through TELUS International, it has entered into an agreement to acquire privately owned Competence Call Center (CCC) for EUR 915 million or approximately $1.3 billion. DBRS Morningstar expects the acquisition to be financed through a combination of (1) approximately $900 million drawn on TELUS International’s non-recourse credit facility, and (2) equity capital from TELUS, Baring Private Equity Asia, and CCC senior management. The transaction is expected to close in Q1 2020, and TELUS is expected to retain a 62% ownership of TELUS International.

Founded in 1998, CCC is a customer lifecycle business service provider with a focus on customer relationship management and content moderation. CCC offers a comprehensive service suite including pre-sale, after-sale, business process outsourcing, digitization, loyalty services, and social media monitoring, which are provided in a channel agnostic manner. CCC services numerous industries including technology, media, telecommunications, retail, travel, and hospitality and employs approximately 8,500 employees. CCC is headquartered in Berlin, Germany, and operates from 22 locations in 11 European countries.

In April 2019, DBRS Morningstar confirmed TELUS’s Issuer Rating at BBB (high) with a Stable trend. The Issuer Rating is supported by the Company’s well-entrenched market position and proven track record of profitable growth, while also reflecting intensifying competition, risks associated with regulatory and technological change, as well as the industry’s capital-intensive nature. At that time, DBRS Morningstar noted that should TELUS’s operating performance deteriorate and/or financial management become more aggressive such that gross debt-to EBITDA increases materially above 3.0 times (x) for a sustained period, a negative rating action may result. DBRS Morningstar is confirming TELUS’s ratings despite the fact that the Company’s consolidated gross debt-to-EBITDA will increase to about 3.25x at the time of close. These confirmations are based on several factors, including (1) the attractiveness of the CCC acquisition with regard to the long-term strategic growth of TELUS International; (2) a complementary operating footprint that provides customer, service, and geographic diversification benefits; (3) an attractive free cash flow (FCF) profile at CCC and management’s intention to use FCF to delever at TELUS International post-transaction close; (4) TELUS has maintained its stated long-term leverage target; and (5) the potential financial flexibility of a future liquidity event (such as an initial public offering at TELUS International) that could occur within a 24-month time horizon.

On a pro forma basis, DBRS Morningstar forecasts CCC 2020 revenue of approximately $500 million and an EBITDA margin of 30% to 35%. Capital intensity is expected to be in the mid-single-digit range and considerably below the level of TELUS’s wireline and wireless communications operations, leading to attractive FCF-generating ability. DBRS Morningstar forecasts debt to increase to about $16.8 billion at year end 2019 reflecting the close of CCC and the previously announced acquisition of ADT Security Services Canada, Inc. (ADT), which closed in November 2019. As a result, DBRS Morningstar expects 2019 year-end gross debt-to-EBITDA of approximately 3.25x.

Looking ahead, leverage is expected to decline primarily as a result of EBITDA growth, driven by mid-single-digit organic growth and incremental EBITDA related to the CCC and ADT acquisitions, which should outpace rising debt levels. Cash flow from operations is expected to track profit growth and increase to a range of $4.6 billion to $4.7 billion in 2020 and continue to grow in the mid-single digit range through our forecast horizon. With essentially flat capex and high-single digit growth in dividends through 2022, FCF (after dividends, but before working capital) is expected to be approximately $500 million in 2020 and should continue to grow through the forecast horizon. DBRS Morningstar believes that a portion of FCF will be directed toward reducing debt at TELUS International although total debt levels at TELUS are likely to rise on a net basis, in part related to future purchases of spectrum licenses in 2020 and 2021. The net result is that DBRS Morningstar believes that TELUS has the ability and willingness to delever meaningfully towards 3.0x over a 24-month time horizon despite future spectrum license auction activity.

DBRS Morningstar believes that the CCC transaction increases geographic, client, and services diversification as well as growth potential of TELUS International; however, in the near-term, the consolidated risk profile of the entire entity is modestly higher, thus pressuring the current rating toward the lower end of the current rating category. As a result, a negative rating action may occur if organic operating performance were to grow below expectations and/or leverage were to remain elevated over a multi-year period or if the Company were to continue to aggressively pursue additional debt-financed acquisition activity or debt-financed material distribution to shareholders. Furthermore, DBRS Morningstar believes a positive rating action is highly unlikely over the foreseeable future due to the competitive landscape, high level of capital intensity, the higher level of acquisition-driven leverage, and material distributions to shareholders.

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

The principal methodologies are Rating Companies in the Communications Industry, DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers, DBRS Criteria: Guarantees and Other Forms of Support, and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships, which can be found on dbrs.com under Methodologies & Criteria.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at [email protected].

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada