DBRS Assigns “A” Ratings to Cellco Partnership, Confirms Verizon Communications at “A” and R-1 (low), Trends Stable

DBRS has today assigned “A” ratings to the Bank Debt and Senior Unsecured Notes of Cellco Partnership/Verizon Wireless Capital LLC (Verizon Wireless Capital LLC is a wholly owned subsidiary of Cellco Partnership, which does business as Verizon Wireless). DBRS has also confirmed the ratings of Verizon Communications Inc. (Verizon or the Company) at “A” and R-1 (low). The trends are Stable.

Verizon Wireless’s ratings reflect its good business risk profile and its reasonable balance sheet and credit metrics. While leverage is expected to increase with the acquisition of ALLTEL Corporation (ALLTEL), giving it a more reasonable capital structure, DBRS believes that the additional scale benefits and five national competitors moving to four should benefit Verizon Wireless’s business risk profile in a market that continues to remain highly competitive. As such, Verizon Wireless is expected to continue to benefit from a number of factors that support its business risk profile and should lead to its generation of healthy EBITDA margins (of total revenue) in the upper 30% range.

These factors include (1) scale benefits, being the largest wireless carrier in the United States after the ALLTEL acquisition closes, with more than 80 million subscribers; (2) a high-quality subscriber base, with more than 92% postpaid subscribers, and low subscriber turnover, with blended churn at 1.21% per month for the nine months ended September 30, 2008; (3) an advanced wireless network that uses one platform, CDMA (code division multiple access), with strong national coverage; and (4) ownership by two strong telecom operators – Verizon, which is the second largest telco in the United States, and Vodafone Group plc (Vodafone), which has 280 million wireless subscribers (on a proportionate basis) in many markets around the world.

As a result, DBRS expects Verizon Wireless (including ALLTEL and a full year of Rural Cellular Corporation) to generate healthy levels of EBITDA in 2009 (between $23 billion and $25 billion) and generate greater than $7.5 billion in free cash flow (DBRS estimate on an after-tax basis) in 2009. Additionally, Verizon Wireless expects to realize synergies with a net present value of $9.0 billion, with annual savings expected to reach at least $1.0 billion after the second year following the close of the ALLTEL acquisition. This will only partially be offset by upfront integration costs and capital expenditures of roughly $1.7 billion.

DBRS expects Verizon Wireless to have a reasonable balance sheet and credit metrics following the close of its acquisition of ALLTEL. This is after Verizon Wireless exclusively borrowed from Verizon over the past couple of years to fund any acquisitions or spectrum investments. (DBRS notes that Verizon Wireless was a public debt issuer until it repaid its last note in Q4 2006.) Any inter-company debt that Verizon Wireless borrows from Verizon is repaid with free cash flow, with distributions to Verizon and Vodafone limited to amounts that offset the taxes on their respective share of Verizon Wireless’s income.

DBRS notes that Verizon Wireless’s $28.1 billion cash acquisition of ALLTEL, which is expected to close before the end of 2008, consists of purchasing ALLTEL’s equity of $5.9 billion and assuming ALLTEL’s net debt of roughly $22.2 billion. While Verizon Wireless has already (in June 2008) purchased $5.0 billion of ALLTEL debt for $4.8 billion, the remaining $20.9 billion is expected to be funded with a combination of bank debt, notes and cash, with Verizon Wireless assuming ALLTEL’s $2.3 billion of legacy notes. DBRS notes that as part of the acquisition, Verizon Wireless recently issued $3.5 billion of senior unsecured notes.

DBRS notes that as part of the U.S. regulatory approval (U.S. Department of Justice and the Federal Communications Commission), Verizon Wireless had agreed to divest some of its overlapping operations (105 markets in 22 states) and extend its current roaming agreements for up to four years. DBRS views these as fairly minor conditions, with proceeds from the sale of these markets ultimately helping to reduce the acquisition financing.

Following the close of the ALLTEL acquisition, DBRS expects Verizon Wireless will have reasonable leverage, with net debt-to-EBITDA below 2.0 times and cash flow-to-debt in the mid-0.30 times to 0.40 times range or above. Additionally, DBRS expects Verizon Wireless to continue to be a strong free cash flow generator, which will allow it to invest in its current and next-generation technology (Long-Term Evolution, or 4G) over the next couple of years, with an anticipated 2010 deployment. In addition, this free cash flow will continue to help Verizon’s credit profile as Verizon Wireless continues to repay inter-company debt with free cash flow after it services its own debt obligations.

The confirmation of Verizon’s ratings reflects its balanced business risk profile and healthy financial risk profile despite leverage increasing to fund a number of wireless acquisitions and spectrum investments in 2008. Verizon continues to benefit from a shift in its business mix toward growth areas such as wireless and data, while its legacy fixed-line operations continue to be pressured from competition and technology substitution. DBRS notes that following the acquisition of ALLTEL, roughly 60% of Verizon’s consolidated EBITDA will come from wireless in 2009.

This, along with relatively stable wireline EBITDA from data and video growth (bolstered by its FiOS data and video deployment) and cost reduction efforts, helps offset pressure on legacy residential and enterprise services, including ongoing pressure on MCI Inc.’s legacy consumer operations. The Company is aggressively upgrading its network with fibre optics to the customer’s premise (it has passed nearly two-thirds of its planned 18 million households) to support its market share push for data and video services for residential subscribers. These subscribers can purchase these services as part of a bundle, along with voice and wireless services. As a result, Verizon’s wireline operations continue to generate reasonable EBITDA margins for a telco, with large enterprise exposure of approximately 30%, with aspirations to improve this over time. DBRS believes that despite this sizable investment in fibre today, Verizon will benefit from significant operating efficiencies in running its advanced fibre network going forward.

From a financial perspective, both on a consolidated basis and on an ex-wireless basis, Verizon had a healthy financial risk profile, with sizable cash flow from operations generation, good levels of free cash flow and credit metrics and a fairly reasonable maturity schedule. DBRS expects consolidated cash flow from operations to approach $30 billion in 2009, with free cash flow approaching $5.0 billion. Additionally, DBRS does note that its stake in Vodafone Omnitel N.V. did pay a healthy net distribution ($1.2 billion in December 2007), with further distributions anticipated in the future.

This free cash flow should continue to give Verizon flexibility to make strategic investments, reduce its leverage, possibly increase its common dividend and continue to repurchase its shares. DBRS expects Verizon’s credit metrics to improve in 2009 after sizable wireless and spectrum investments were undertake in 2008. As a result, DBRS expects gross debt-to-EBITDA to remain below 1.5 times, with cash flow-to-debt expected to remain strong at above 0.45 times.

While DBRS notes that Verizon’s wireline leverage would be weaker excluding wireless (gross debt-to-EBITDA about 2.5 times), DBRS believes that the inter-company debt owed to Verizon, which should be paid off over time with Verizon Wireless’s free cash flow, could possibly reduce this to 1.0 times should all of this inter-company debt reduction be used to reduce Verizon’s debt. As a result, Verizon Wireless’s free cash flow (along with interest paid on its inter-company notes) continues to indirectly support Verizon’s credit profile.

Overall, while DBRS believes that Verizon Wireless’s ratings are well placed at the current levels given its good business risk and reasonable financial risk profile, Verizon’s long-term rating could experience pressure should the shift in its business mix begin to cause significant pressure on the EBITDA of its wireline business.

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