DBRS Downgrades Bell Canada to BBB (high) and BCE to BBB, Stable Trends

DBRS Limited (DBRS) has today downgraded Bell Canada’s (Bell Canada or the Company) Issuer Rating and Debentures and MTN Debentures rating to BBB (high) from A (low), its Subordinated Debentures rating to BBB (low) from BBB as well as its Commercial Paper (CP) rating to R-2 (high) from R-1 (low). With Bell Canada’s Issuer Rating at BBB (high), DBRS has also downgraded BCE Inc.’s (BCE; Bell Canada’s parent company) Issuer Rating and Unsecured Debentures rating to BBB from BBB (high), its CP rating to R-2 (middle) from R-1 (low) as well as its All Classes Preferred Shares rating to Pfd-3 from Pfd-3 (high). All trends are Stable.

The rating actions remove BCE’s and Bell Canada’s ratings from Under Review with Negative Implications. These reviews were initiated on May 2, 2016, following the announcement of BCE’s proposed acquisition of Manitoba Telecom Services Inc. (MTS). The rating downgrades reflect DBRS’s view that the MTS transaction will likely be completed as previously contemplated and follow BCE’s announcement that it will acquire complete control of Toronto-based data center operator, Q9 Networks Inc. (Q9).

DBRS notes that, since its May 2, 2016, press release, MTS shareholders have voted to approve BCE’s acquisition of MTS and MTS has received the approval of the Manitoba Court of Queen’s Bench to proceed with the transaction. The MTS transaction remains subject to regulatory approvals from the Canadian Radio-television and Telecommunications Commission, Competition Bureau and the Ministry of Innovation, Science and Economic Development Canada, which are expected in Fall 2016.

Successive, largely debt-financed acquisitions in recent years have caused the Company’s financial leverage to remain above its stated target (net debt-to-EBITDA of 1.75 times (x) to 2.25x) and have repeatedly delayed the Company’s deleveraging plans. DBRS believes that this, coupled with mounting risks in the sector, leaves the Company better situated at the revised rating categories. Most recently, BCE announced today that it will acquire the remaining (65.6%) equity interest that it does not already own in Q9 for approximately $675 million (including Q9 net debt). DBRS expects the Company to finance this transaction with incremental debt. Given the modest EBITDA contribution expected from full integration of the Q9 business, the transaction is expected to result in a further increase in financial leverage, albeit a modest one.

Incorporating both the MTS acquisition as well as the Q9 transaction, DBRS does not see a clear path for Bell Canada to reduce gross debt-to-EBITDA toward 2.0x by mid-2017. Additionally, DBRS estimates that the Company’s pro forma free cash flow (after dividends)-to-total debt will remain below 5% over the near to medium term because of high capital intensity and dividend payouts, which could limit management’s ability to deleverage adequately. Further exacerbating this is an increasingly challenging operating climate marked by intensifying competition in the wireless market; increased risks in the media business, including structural (cord shaving/cord cutting and over-the-top video streaming) and regulatory changes (pick and pay) affecting television broadcasting, coupled with weakness in advertising.

That said, DBRS considers Bell Canada to now be at the high end of the BBB (high) rating category. DBRS views the Company as a best-in-class telecommunications operator, exemplified by a track record of consistent EBITDA growth, industry-leading wireless average revenue per user and post-paid subscriber growth as well as sound wireline performance. Furthermore, Bell Canada has a well-entrenched market position, strong operating cash flows and coverage ratios. DBRS expects that the Company will continue to perform well operationally, and will grow pro forma EBITDA steadily above $9.0 billion over the near term to medium term, through both organic growth and the above-noted acquisitions. In terms of financial leverage, DBRS believes that debt-to-EBITDA of up to 2.75x would be commensurate with the current rating categories while continuing to consider evolving free cash flow (after dividends) levels and business risks.

DBRS has revised Bell Canada’s and BCE’s CP ratings consistent with its methodology for determining short-term ratings (See “Short-Term and Long-Term Rating Relationships” under the Rating Scales section of the DBRS website). DBRS believes that BCE no longer qualifies for the exceptional status with respect to the mapping of its short-term rating to its long-term rating and, as such, has reverted to the standard mapping relationship.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Companies in the Communications Industry, Rating Companies in the Television Broadcasting Industry, Rating Companies in the Radio Broadcasting Industry, DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Financial Issuers, DBRS Criteria: Preferred Share and Hybrid Criteria for Corporate Issuers and DBRS Criteria: Rating Holding Companies and Their Subsidiaries, which can be found on our website under Methodologies.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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