DBRS Confirms AT&T Inc. at “A” and R-1 (low), Upgrades A&T Mobility II, LLC to “A,” Stable Trends

DBRS has today confirmed the Senior Unsecured Notes of AT&T Inc. (the Company) at “A” and its Commercial Paper at R-1 (low) and confirmed the long-term ratings of its related wireline issuers and the Co-obliged Notes of AT&T Mobility II, LLC (AT&T Mobility, formerly Cingular Wireless II, LLC) at “A”; the trends are Stable. DBRS has also upgraded AT&T Mobility’s Senior Unsecured Notes to “A” from A (low) with a Stable trend.

The upgrade of AT&T Mobility’s Senior Unsecured Notes reflects (1) further unity with its parent, AT&T Inc.; (2) further operating improvement, along with an improving financial risk profile and strong EBITDA growth (currently nearly $17 billion and roughly double 2005 levels); and (3) lower external debt levels. While AT&T Mobility provides some financial disclosure, DBRS believes that its gross debt-to-EBITDA (both inter-company and external debt) below 1.5 times is strong for a wireless operator.

Given the significant amount of inter-dependence between AT&T Mobility and AT&T Inc., DBRS now views these more as integrated credits. While DBRS does not currently anticipate this level of inter-dependence to diminish going forward, it remains possible, albeit unlikely, that these credits (either through company-driven undertakings or external events) could return to being viewed separately by DBRS at some point in the future.

DBRS notes that since AT&T Mobility acquired AT&T Wireless Services Inc. in 2004, AT&T Mobility has made significant progress in integrating and consolidating its operations and has moved to a single GSM-based network (with the UMTS/HSPA advanced 3G platforms). This simplification, along with the operating benefits of the GSM platform and exclusivity on devices such as the Apple iPhone, has strengthened AT&T Mobility’s competitive and operating performance. Despite the U.S. wireless market remaining highly competitive and overall subscriber growth rates continuing to slow, with penetration levels above 85%, AT&T Mobility has improved its wireless operating metrics to a point where they are becoming much more comparable with its industry-leading peers such as Verizon Wireless Inc.

Specifically, AT&T Mobility has demonstrated healthy levels of subscriber growth (1.2 million or more net additions per quarter over the past two years), a steady improvement in monthly churn levels to 1.1% for its postpaid subscribers (1.6% on a blended basis) and healthy average revenue per user (ARPU) levels that, despite voice-pricing pressure, have grown with additional voice usage and a strong uptake of data services. All of these factors, along with reasonable subscriber acquisition costs (despite higher costs incurred for iPhone subscribers), have led to an improvement in AT&T Mobility’s EBITDA margins by more than 110 basis points since 2005 to 36.2% for the most recent 12-month period, which is good for a U.S wireless carrier. DBRS expects good levels of revenue and EBITDA growth to continue at AT&T Mobility over the next 12 months, along with further improvement in its wireless operating metrics and EBITDA margins.

The confirmation of AT&T Inc. is based on its well-diversified mix of communications services (fixed-line, wireless and advertising and publishing) that serve enterprises, small to medium-sized businesses and consumers. The Company’s mix of growth and legacy businesses supports this diversity, with growth in wireless, Internet protocol (IP) data and video services; synergies from past mergers; and additional cost-cutting initiatives able to – from a consolidated perspective – offset pressure in its legacy fixed-line services as the impact of competition and technology substitution remains ongoing. While the shift in the Company’s fixed-line business continues to move toward data services and its high-margin legacy voice services remain under pressure, AT&T Inc. is also investing heavily to deploy its U-verse video service (expected to pass 30 million households by the end of 2010), with a goal of retaining its subscribers while gaining a share of the video market. Despite the pressure on its Wireline segment as a result of these factors, DBRS believes this shift should be manageable for AT&T Inc. to maintain EBITDA margins in the 35% to 40% range, which is reasonable for a diversified telco with a large enterprise business.

DBRS notes that while AT&T Inc. benefits from both the growth from AT&T Mobility (as described above) and the addition of services to bundle and integrate with its fixed-line services, AT&T Inc. also continues to receive free cash flow from AT&T Mobility (from a variety of sources but mostly as it repays the inter-company debt that AT&T Mobility owes AT&T Inc.). This supports AT&T Inc.’s higher leverage, which increased in H1 2008 to fund spectrum and other acquisitions (more than $10 billion), and its share repurchase programs. DBRS expects AT&T Inc. to focus its free cash flow for the remainder of 2008 on reducing its leverage and intends to end 2008 with credit metrics similar to 2007. As such, DBRS expects AT&T to end 2008 within its targeted leverage range of 1.3 times to 1.5 times net debt-to-EBITDA. In 2009, DBRS believes that, barring any other acquisitions or investments beyond its current plans, AT&T Inc. will likely use its free cash flow to continue to repurchase its shares, with $7.5 billion remaining under its current program.

Although DBRS believes that the pressure on AT&T Inc.’s wireline business is manageable, with growth from other areas such as wireless and ongoing cost-cutting efforts being implemented, if this pressure accelerates and/or if further growth does not materialize or leverage is not reduced as expected, this could lead to pressure on AT&T Inc.’s long-term ratings.

Note:
All figures are in U.S. dollars unless otherwise noted.