Moody’s Investor’s Service placed AT&T’s Baa1 senior unsecured debt rating on review for downgrade following its announcement that it will purchase Time Warner Inc., adding that the buy will increase its leverage ratio.
In a statement, Moody’s said AT&T intends to finance the deal through equity and cash and estimated that its gross leverage ratio will rise to 3.5 times cash flow at the end of 2018.
AT&T has already said it has raised the cash portion of the deal already through a $40 billion bridge loan. It has also said it intends to bring leverage down to about 2.8 times cash flow by the end of 2018, a year after the deal is estimated to close.
In a statement, Moody's said its review will focus on AT&T's pro forma capital structure and its willingness and ability to reduce leverage back towards 3-times cash flow, AT&T's current limit for its Baa1 rating.
Moody’s said it has already affirmed AT&T's Prime-2 commercial paper rating has been affirmed, and at the present moment, any potential downgrade to its senior unsecured rating would be limited to one notch.
Moody’s added that the deal’s financing costs will take up most of acquired free cash flow because of an incremental $2.3 billion in annual dividends and $1.3 billion in additional after-tax annual interest expense.
“Moody's believes that given AT&T's limited excess cash after dividends and modest EBITDA growth potential, that organic leverage reduction is limited to around 0.1x to 0.2x annually,” the ratings agency said in a statement. “Asset sales could accelerate this trajectory, including segments of AT&T or Time Warner.”
Moody’s also pointed out the credit positives of the deal: it gives AT&T additional scale, more growth potential and lower capital intensity.
“Time Warner's broad content business will increase AT&T's revenue diversity and offer more control over content costs and distribution rights across pay TV and mobile networks,” Moody’s said. “Time Warner may better leverage AT&T's broad distribution capabilities and potentially improve ad monetization, although this was probably achievable through arms-length commercial negotiations. Slower content cost escalation will benefit AT&T's video business but reduce Time Warner's growth rate for that portion of content.”
Still, Moody’s expects the deal to be rigorously scrutinized, adding that the lengthy approval process and expected conditions on the deal could limit AT&T’s ability to use Time Warner content competitively.
“Regulatory conditions could ultimately undermine AT&T's objective to differentiate its mobile and pay TV platforms with exclusive content,” Moody’s said.
At the same time, Time Warner is facing pressure from new disruptive distribution models like Netflix, Hulu, Apple TV, Amazon Prime, You Tube and others.
“AT&T's plan to acquire Time Warner so soon after its purchase of DirecTV is a somewhat defensive strategy that gives more power to AT&T to mold the pay TV industry evolution in its own favor,” Moody’s said. “But, with both deals, AT&T has agreed to pay a full price for businesses facing disruptive change.”