Credit analyst sees little upside in AT&T and considerable event risk

By Ronda Fears

Nashville, Tenn., June 3 - Assuming all goes well with AT&T's deal with Comcast, the remaining AT&T is still probably a weak BBB credit with little upside and considerable event risk, said Carol Levenson, director of research at Gimme Credit.

Late last week, AT&T (Baa2/BBB+) confirmed rumors it would soon be issuing equity, to the tune of $2.25 billion - but it was not all good news for AT&T bondholders.

"This is undoubtedly the first piece of good news bond investors have heard from this name in many a moon," Levenson said in a report Monday.

"The bad news is the cash raised by this equity offering will essentially be wasted, from a bondholder's point of view - satisfying most, but not all, of AT&T's requirement to purchase the rest of the faltering AT&T Canada. But using stock to fund this onerous requirement is far preferable to borrowing the cash."

She noted the recent Moody's downgrade and negative outlook assumes the Comcast deal will go through as currently structured and equity will be used to buy the AT&T Canada stake.

"This leaves little margin for error," Levenson said.

"It seems a brave notion to attempt to float this amount of telecom stock in the current environment, especially as what will remain of AT&T after the cable sale is not immune to the sector's overall distress."

The shunting off of the consumer long distance business into a tracking stock entity seems less likely as time goes by, she said, so investors will be forced to view AT&T as one languishing whole.

However, the analyst added, one thing the new AT&T will have going for it is strong debt protection measures relative to most of its competition.

"Indeed, management has spoken of, if not quantified, the benefits of a 'flight to quality' by corporate accounts," Levenson said.

"Oddly enough, neither WorldCom nor Qwest has yet detected a flight from low quality."

The analyst estimates pro forma debt/annualized EBITDA for AT&T's communications business initially will be less than 2 times, with EBITDA coverage of 7 times.

She added that annualizing first quarter EBITDA, down nearly 20%, could prove overly optimistic.

"One of the positive aspects of the cable sale is it should reduce AT&T's short-term debt, long a concern of ours, to zero," Levenson said.

"Although the company has made great strides in lowering its short-term debt - $5.2 billion at the end of March - it principally has drained its cash balance to do so. At the moment AT&T throws off almost no free cash flow, although the remaining communications business is expected to perform much better in this regard."

But in the first quarter, she said, net debt excluding "monetizations" didn't budge.

Fortunately, after the cable sale, assuming current credit facilities remain in place, the company would have an undrawn $8 billion revolver and a $2.7 billion accounts receivable facility, as well as $2 billion in cash, the analyst noted.

"We scarcely need remind you the competition has nowhere near this kind of financial flexibility," Levenson said.

"The major uncertainty, besides when things might turn around in the communications businesses, surrounds what AT&T will do next and how it will be financed."

Disturbingly, AT&T has been mentioned as a possible buyer of network assets of bankrupt service providers, most recently KPNQwest.

This would no doubt involve cash, and there's certainly no guarantee AT&T can wring profit from these assets where others have failed.

"Bondholders would prefer to see the company sit tight while continuing to cut costs and preserve cash," she said.

"Being bought by a Baby Bell for stock wouldn't be such a bad thing either, but we would not recommend AT&T bonds based on this regulatory-challenged happy ending."

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