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Fitch Affirms TCNZ's Ratings; Outlook Negative

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Fuseworks Media
Fitch Affirms TCNZ's Ratings; Outlook Negative

Fitch Ratings has today affirmed Telecom Corporation of New Zealand Limited's (TCNZ) 'A' Long-term Issuer Default Rating (IDR) and 'F1' Short-term IDR. The Outlook remains Negative.

TCNZ's ratings reflect its strong domestic market position, solid cash generation, domestic earnings margins and a publicly articulated conservative financial profile. These strengths are counterbalanced by the multifaceted challenges facing TCNZ, these being: growing competition in all the segments it operates in, largely driven by regulatory change; a heightened risk of structural separation; and a competing government-funded fiber infrastructure.

A downgrade could be triggered by leverage (measured by lease adjusted net debt to funds from operations) being sustained above 2.0x, or a contraction in domestic EBITDA margins below 35%, and loss in market share. Other potentially negative factors include the structural separation of the group's assets and any regulatory determinations that weaken cash generation. Conversely, regulatory certainty in respect of structural separation and clarification of the government's broadband initiatives would be required before an upward revision of the rating outlook from negative to stable could take place.

TCNZ's government-enforced operational separation has increased competition in both fixed line and mobile products, with competitors able to expand their broadband offerings and a third player, 2Degress recently entering the mobile market. Furthermore, the company is currently experiencing revenue pressure due to the weakness of the New Zealand economy (where the unemployment rate is at 7.3%, its highest level since June 1999). The launch of TCNZ's 3G mobile network, XT, together with Gen-i and the Wholesale & International segments are the company's intended key growth drivers. Although the mobile segment achieved 1.4% revenue growth for the 6 months to December 2009 (6M09), both Gen-i and Wholesale & International recorded a decline in revenue. However, the recent XT network outages will negatively impact XT's brand value and de-rail the company's mobile growth aspirations. Achieving top-line revenue growth in order to meet the company's medium term earnings guidance in such an environment will be a challenge.

Although Fitch acknowledges the benefits of the company's transformation programme in defending its cash flow and strong business profile, the significant capex associated with the programme together with increased earnings pressure has limited the headroom in the rating. Notwithstanding the planned decline in capex from the current peak of NZD1.2bn to NZD750m by FY13, Fitch expects that leverage will remain broadly unchanged as relatively flat EBITDA and high dividends will restrict free cash flow generation.

The government's proposed fiber-to-the-premise investment programme, Ultra Fast Broadband (UFB), poses a significant threat for TCNZ. The proposal could potentially exclude TCNZ from participating, as the government's proposal is premised on avoiding a vertically integrated company, effectively forcing competition between UFB and TCNZ's NZD1.3bn national fiber network. Although not explicit, TCNZ's exclusion from UFB will mean the company risks having to undertake a voluntary structural separation in order to participate. The New Zealand government expects to enter into final binding offers for recommendation during the third calendar quarter of 2010 which should clarify the regulatory landscape.

TCNZ has a conservative financial policy, with a stated leverage target (defined by the company as net debt to EBITDA) of less than 1.7x (this metric stood at 1.5x at end 6M09). The company has recently carefully balanced its debt service/ratings protection with its significant transformation-related capex programme and a shareholder-friendly position in respect of distributions.

Liquidity is sound and there are no debt maturities, aside from maturing promissory notes/commercial paper, until December 2011. TCNZ has NZD296m cash which, together with undrawn credit lines of NZD800m (at 6M09) is sufficient to cover debt maturities over the next two years.

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