Fitch Affirms TDS and U. S. Cellular IDRs at 'BB+'; Outlook Stable
KEY RATING DRIVERS
Wireless Market Position: Fitch's ratings for TDS incorporate the smaller size of its main operating unit - United States Cellular (USM) - in a market dominated by four national wireless operators. This concern is mitigated by TDS's financial flexibility arising from its healthy liquidity position. USM posted relatively solid net post-paid subscriber additions in the first half of 2016 and in 2015; while gross additions were moderate given the maturity and competitiveness of the market, lower post-paid churn has been aiding net additions.
Leverage: TDS's gross leverage was 2.4x at June 30, 2016, including a portion of partnership distributions received from noncontrolled entities (2.5x without). Partnership distributions have been temporarily lower beginning in 2015 and into 2016 due to a one-time charge at the Los Angeles partnership related to a capital lease for AWS-3 spectrum covering the partnership's market. Distributions from the Los Angeles partnership resumed in July 2016, when USM received $10 million.
Solid Financial Profile: The ratings at TDS and USM reflect the current strong liquidity position owing to substantial cash balances, conservative balance sheet, undrawn revolving credit facilities and long-dated maturities.
Spectrum: USM is participating in the Federal Communications Commission's (FCC) incentive spectrum auction which began in March 2016. In 2015, USM participated in the FCC's spectrum auction for AWS-3 spectrum through its limited partnership interest in Advantage Spectrum. Advantage Spectrum won 124 licenses with a total value of $338 million, net of the 25% designated entity discount.
Cable Strategy: TDS has targeted the cable industry as an avenue of growth. The company acquired BendBroadband in September 2014 for $261 million in cash. BendBroadband was the second major cable acquisition for TDS, following the acquisition of Baja Broadband for $267 million in August 2013.
Noncore Assets: The sale of noncore assets mitigated the effect of negative free cash flow (FCF) on USM and TDS in 2015, as $343 million of noncore assets were divested. While Fitch believes TDS considers USM's 5.5% stake in the Los Angeles partnership and its tower portfolio as core assets, Fitch also recognizes these assets provide the company with financial flexibility should the need arise as it pursues growth in the cable industry.
FCF Expectations Improved: Fitch expects TDS's consolidated FCF levels to be around break-even on average over 2016 and 2017. Capital spending in 2016 is expected to decline to approximately $695 million (per company guidance) from $759 million in 2015. FCF was negative in 2015, at $78 million.
--Fitch assumes a mid-single digit decline in wireless service ARPUs during 2016 and 2017, which is offset by moderate gross subscriber additions. Post-paid churn is expected to remain around 1.2% to 1.3%, in line with levels seen in the first half of 2016 and slightly below the 1.4% rate during 2015.
--Wireless EBITDA margins comparable to the 16.9% recorded in 2015 are forecast for 2016-2018.
--TDS Telecom demonstrates revenue growth due to cable acquisitions and growth in Hosting and Managed services. Fitch expects EBITDA to decline in the mid-single digit range in 2016, and is relatively flat thereafter.
--Capital spending during the forecast period is in the 13% to 14% range.
--Fitch's forecast assumes spending in the FCC's TV broadcast auction similar to the USM's AWS-3 auction spending.
Positive Rating Action: Fitch believes that competitive factors and TDS's relative position in the wireless industry would not likely allow a positive rating action in the near term.
Negative Rating Action: Longer term, Fitch believes TDS's and USM's ability to grow revenues and cash flows while competing effectively against much larger national operators is key to maintaining their 'BB+' Issuer Default Ratings (IDRs). In addition, if gross leverage -- calculated including partial credit for material wireless partnership distributions in EBITDA -- approaches 3.5x, a negative action could be contemplated.
Strong Liquidity Profile: In relation to its total outstanding debt of $2.53 billion at June 30, 2016, TDS has relatively high balances of cash, which amounted to $899 million. The ratings at TDS and USM reflect the current strong liquidity position owing to substantial cash balances, a conservative balance sheet, available revolving credit facility capacity and generally long-dated maturities.
TDS and USM entered into new senior unsecured revolving credit agreements in June 2016, extending the maturity from December 2017 to June 2021. The total amounts of the facilities remained unchanged at $400 million and $300 million for TDS and USM, respectively. TDS's facility is jointly and severally unconditionally guaranteed by TDS's first-tier subsidiaries (with one small exception) and the USM facility is jointly and severally unconditionally guaranteed by USM's first-tier subsidiaries. USM also amended and restated the $225 million CoBank loan to put in place a similar guarantee.
The main financial covenants in the TDS revolving facility and USM's revolving and term loan facilities require total consolidated interest coverage to be no less than 3.0x and the total consolidated leverage ratio to be no more than 3.25x through June 30, 2019. On July 1, 2019, the required leverage ratio steps down to 3.0x.
The only material near-term maturity is the $225 million CoBank loan, which matures in 2022. The loan was drawn in July 2015. The earliest notes at TDS are due in 2045 ($116 million) and at USM the earliest note maturity is in 2033 ($544 million face value).