DBRS Confirms AT&T Inc., BellSouth Corp & Affiliates Ratings

Dominion Bond Rating Service (“DBRS”) has today confirmed the ratings of AT&T Inc. (“AT&T Inc.” or the “Company”) and its affiliated companies, AT&T Corporation (“AT&T Corp.”), BellSouth Corporation (“BellSouth”), and Cingular Wireless II, LLC (“Cingular”) following the announcement that AT&T Inc. plans to acquire BellSouth in an all-stock deal totalling US$67 billion. All trends remain Stable, except for that of Cingular, which remains Negative, reflecting integration issues with its acquisition of AT&T Wireless Services Inc. As part of the transaction, AT&T Inc. will issue 1.325 shares for each BellSouth share and will assume roughly US$17 billion in net debt from BellSouth along with US$5 billion of BellSouth’s proportionate external net debt. This transaction places the enterprise value of BellSouth at roughly US$89 billion.

DBRS notes that this acquisition, which is subject to customary regulatory approvals, will create a massive telecommunications operator with significant scale (over 70 million access lines and nearly ten million DSL subscribers); as well as give it significant last-mile access and strong market presence in the residential and enterprise communications markets in the United States. The new company, which will also wholly own the largest wireless carrier in the U.S., Cingular, with over 54 million subscribers, is expected to carry the AT&T name and brand – one of the most respected brands in the world. The Company has estimated the total synergies that can be attained from this transaction to be significant at roughly US$18 billion (on a net present value basis).

From a financial perspective, DBRS notes that the new company will have a strong balance sheet that will generate sizeable free cash flow (over US$4 billion on a pro forma basis after dividends in 2005, with the Company forecasting free cash flow in excess of US$4 billion in 2007 and US$6 billion in 2008) partially supported by strong balance sheets at AT&T Inc., BellSouth, and Cingular and the all-equity nature of this transaction. However, as a result, the Company has significantly increased its share repurchase program over the next 22 months, allowing it to repurchase up to 400 million of its shares and expects to buy back over US$10 billion of its shares as part of this program to effectively cash fund the equity premium involved with the acquisition of BellSouth.

First, DBRS notes that this transaction is being implemented between two companies that have significant knowledge of one another through their existing joint ownership of Cingular. Therefore, DBRS believes that the projected synergies outlined, with more than 90% of the expected synergies coming from cost reductions, have a high degree of certainty in being ascertained. Key elements of the cost reductions include an incremental 10,000 headcount reduction over the next three years, consolidation of network and IT functions that facilitate moving more traffic onto AT&T Inc.’s or BellSouth’s networks, thus improving margins, along with an expectation of reduced advertising spending as the Company moves from three brands to one.

Secondly, DBRS also acknowledges that the simplification of Cingular’s ownership and operating structure that results as part of this transaction will likely accelerate further operating margin improvements that were not achievable when Cingular was under joint ownership. Furthermore, the new company will likely be able to further capitalize on the trend of wireless/wireline convergence as both Cingular and AT&T Inc.’s networks move further towards IP-based technologies. Finally, the movement to a single brand should also benefit Cingular through improved efficiencies and unified branding across all AT&T Inc. product lines.

Finally, although revenue synergies are not projected to be a significant part of this transaction, AT&T Corp. could potentially benefit through gaining further reach into the BellSouth territory with an integrated product offer, along with the ability to sell services to BellSouth’s small- and medium-size customer base.

The confirmation of the above ratings also assumes that the business risk profile of the combined company will not change significantly and the new entity will need to defend its core business and customer base against increasing competition (in the residential segment) and fundamental challenges continuing in the enterprise segment despite its strong position in this market. This will include its bundling capabilities and its rollout of video (IPTV) services across its legacy territory (now along with BellSouth’s) in order to increase the stickiness of its customers and attempt to mitigate accelerated access line erosion. However, DBRS does acknowledge that through this transaction, AT&T Inc.’s pro forma revenue mix for 2007 will see revenue exposure to the increasingly competitive consumer segment at only 23%, while exposure to the growing wireless segment will be at 34%.

DBRS believes that the added execution risk placed on the Company – in addition to executing on two sizeable transitions over the past 18 months including its recent acquisition of AT&T Corp. and Cingular’s acquisition of AT&T Wireless Services, Inc. – appears to be manageable given that this transaction is a horizontal merger involving two companies that have past working knowledge of one another. Integration costs are expected to be most substantial in 2007 at a projected US$2 billion.

However, DBRS expects the current strong financial metrics of the Company can be maintained in this increasingly competitive communications environment, which is a competitive advantage especially against cable operators that typically have weaker credit profiles. Although free cash flow in the near term will be used for substantial share repurchases in 2007 and reduced by the above indicated integration costs, it is DBRS’s expectation that the considerable free cash flow generated in future years would partly be used to further reduce the Company’s debt levels.

DBRS’s rating confirmation also assumes that no significant regulatory or divestiture conditions will result as the transaction is reviewed by the Department of Justice, the Federal Communications Commission, and at least five states in BellSouth’s region. This transaction could benefit from the fact that a significant portion of BellSouth’s operations and AT&T Inc.’s do not have an overlap, along with the recent review that was conducted when AT&T Inc. acquired AT&T Corp. in late 2005.

AT&T Inc. and BellSouth expect to close this transaction within the next 12 months, with the ability to extend the closing for an additional six months by either company for needed regulatory approvals.

Note:
These ratings are based on public information.