Fitch Affirms CenturyLink's Ratings; Assigns Stable Outlook

CHICAGO--([ BUSINESS WIRE ])--Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of CenturyLink, Inc. (CenturyLink) (NYSE: CTL) at 'BBB-', removed the rating from Rating Watch Negative and assigned a Stable Outlook. In addition, once the transaction closes, Fitch will upgrade Qwest Communications International Inc.'s (QC) IDR to 'BBB-' from 'BB', remove the rating from Rating Watch Positive and assign it a Stable Outlook. A full list of other rating actions is shown below.

The actions reflect Fitch's review of the Rating Watch status following the placement of the companies' ratings on Rating Watch on April 22, 2010. CenturyLink and Qwest Communications International, Inc. (Qwest) have an agreement to merge in an all-stock transaction. The Federal Communications Commission (FCC) approved the transaction on March 18, 2011 and the Public Utility Commission of Oregon is the only remaining approval needed. The transaction is expected to close on April 1, 2011.

Fitch notes that as a result of the higher business risk, in order to maintain an investment-grade rating, CenturyLink would have to demonstrate the ability to maintain leverage materially below Fitch's investment-grade rating threshold of 3.0 times (x) for a traditional rural local exchange carrier (RLEC) and, to sustain financial flexibility, its dividend payout as a percentage of free cash flow (FCF) would have to be no greater than 55%. Fitch believes that to maintain an investment grade rating as the company has transitioned away from being an RLEC, its revenue profile would have to return to growth, and leverage would need to be maintained at a level of 2.5x or below. In addition, Fitch believes CenturyLink would need to display a dividend payout of 55% or less in order to maintain financial flexibility. Fitch would evaluate the payout in the context of growth initiatives.

The rating recommendation is based on the expectations that CenturyLink will demonstrate a very gradual improvement in its revenue profile in combination with solid leverage for the rating category, strong free cash flows and strong liquidity. Low cash tax payments arising from bonus depreciation and Qwest's net operating loss payments contribute to FCF levels remaining strong while the company incurs front-end-loaded integration costs even before material synergies are captured. These supporting factors are balanced against the decline of traditional voice and long distance revenues, primarily in the consumer sector, from wireless substitution and moderate levels of continuing cable telephony substitution.

Eventual revenue stability: Fitch expects CenturyLink's revenue to reach a level of stability in the 2014-2015 timeframe through the continued growth of high-speed data and certain advanced business services. Fitch expects a modest but growing level of revenues from facilities-based video to contribute stability to the consumer revenue base. Fitch notes that higher penetration of advanced data services and facilities-based video services have gradually stabilized the wireline revenue streams of other large incumbent local exchange carriers. In total, Fitch expects these revenues and new product offerings will grow in the mid- to high-single digits, and reach a point where they offset the declines in the traditional legacy voice services. In the aggregate, Fitch expects revenue declines to be in the low single digits by 2012, as the most exposed revenue stream--consumer voice--is declining in importance. Fitch would re-evaluate the Rating Outlook if revenues were not making progress to stability.

Financial performance: Pro forma for the acquisition of Qwest, net leverage for 2010 as well as 2009 net leverage (Embarq pro forma for the whole year), excluding synergies, was relatively strong and stable at approximately 2.3x and 2.4x, respectively. On a stand-alone basis, CenturyLink's gross leverage was 2.1x for 2010 even after Embarq merger integration costs and the M&A costs for the Qwest transaction.

Fitch expects gross debt/EBITDA to approximate 2.5x or less in 2011, and gradually decline thereafter as debt is reduced. Fitch's expectations exclude integration and merger-related costs, which would be at their peak levels in the first year after the merger, and any noncash, mark-to-market write-up of Qwest's debt. On a net leverage basis, Fitch believes by 2012 leverage could reach 2.2x. At year-end 2010, on a pro forma basis the company had $18.73 billion in net debt. By 2012, Fitch's expectations call for a decline in net debt to slightly more than $16 billion.

Operating environment: Secular issues are having a great impact on voice revenues which have become a commodity in the residential market and substitutable by wireless services or cable telephony providers. However, in Fitch's view, these issues are likely to have a lessening effect on overall results given they are becoming a smaller proportion of the revenue base. Pro forma, residential lines are less than 61% of the total, down from 73% for CenturyLink in 2008 (before Embarq and Qwest).

CenturyLink indicates 35% of 2010 pro forma revenue came from consumer services, of which a material proportion consists of high-speed data services. Fitch believes that as CenturyLink's high-speed data product continues to grow at a moderate pace, in combination with the deployment of facilities-based video in its own and legacy Qwest service areas, consumer revenue can be stabilized. In 2010, the consumer wireline businesses of AT&T, Inc. and Verizon Communications, Inc. reached a relatively stable point as revenues from high-speed data and facilities-based video have grown beyond 40%.

In Fitch's view secular issues are not having the impact on the provision of business services as in providing services to consumers, as the level of wireless substitution is lower and there is growth in demand for data and IP services in the business sector. A portion of the reduction in business lines is recaptured in data revenues due to technology shifts. In addition, wireline carriers are experiencing growth in demand for fiber-to-the-cell tower backhaul services given the rapid demand growth for wireless data services.

Proposed synergies: CenturyLink estimates operating cost synergies approximating $575 million will be realized over a three- to five-year time period and that capital expense savings approximating $50 million will be achieved within two years. In Fitch's view, CenturyLink's estimate is reasonable, approximating 8% of Qwest's 2010 cash operating expenses, which is a bit less than the original expectations for the Embarq transaction and is much lower than expectations in other recent rural local exchange carrier transactions. In developing its view of CenturyLink's potential synergy realization, Fitch has assumed the majority of the synergies will not be attained until early 2013.

Integration expenses: Fitch expects integration costs to be in line with CenturyLink's announced $650 million-$800 million in terms of operating costs and $150 million-$200 million in terms of capital costs, with such amounts front-end loaded.

Regulatory approval process: In Fitch's assessment, the conditions placed on the merger by the regulatory approval process are manageable. Such conditions were largely as anticipated based on previous acquisitions in the industry. Such conditions include the expansion of broadband services into underserved areas as well as the implementation of increased broadband speeds. The commitment with the FCC, which could exceed $1 billion in total over a seven-year period, is manageable in the company's normal mid-$2 billion annual capital budget and a substantial portion likely reflects the continuation of past broadband spending. In addition, the companies reached agreements with competitive local exchange carriers (CLECs) where they agreed to continue to maintain wholesale operating systems (the systems CLECs interface with), and interconnection agreements for certain minimum periods of time. Notice would be provided to competitors before transitioning wholesale interfaces.

Aspects of the transaction supporting the recommendation:

--Increased scale allowing for increased investment in areas that support stronger revenue growth. Such areas include facilities-based video (IPTV), data hosting, wireless services, and potentially a broader range of strategic acquisitions. Also the scale should provide for increased business opportunities where, on a combined basis they will be in a stronger bidding position than on a standalone basis.

--Free cash flows likely to be relatively strong, based on expected capital spending levels and reduced cash taxes, enabling the company to reduce debt and retain stable credit metrics. Strong FCF is critical as the company transitions to intermediate-term revenue growth.

--After the acquisition, CenturyLink's exposure to the federal universal service funding program will decline to approximately 2% of revenue from 4%, and switched access revenues from 8% to 4%, both of which have been under considerable pressure.

Pro forma CenturyLink's total debt was $19.3 billion at Dec. 31, 2010, and cash and equivalents amounted to approximately $545 million. Financial flexibility will be provided through a revolving credit facility that will be expanded to $1.7 billion from $1 billion upon the close of the transaction. The revolving credit facility matures in January 2015. The principal financial covenants in CenturyLink's facility limit debt to EBITDA for the past four quarters to no more than 4.0x and EBITDA to interest plus preferred dividends (with the terms as defined in the agreement) to no less than 1.5x. QC has a maintenance covenant of 2.85x and an incurrence covenant of 2.35x. The new facility is guaranteed by Embarq, and upon the close of the transaction, will be guaranteed by QCII and QSC.

Fitch believes pro forma CenturyLink has the financial flexibility to manage upcoming maturities due to its FCF and credit facilities. For the remainder of 2011, debt maturities total $825 million (excluding the $280 million on CenturyLink's credit facility as of Feb. 28, 2011), in 2012 a total of $1.8 billion matures, and in 2013 nearly $1.5 billion matures. Going forward, Fitch expects CenturyLink to refinance debt at QC, and will also issue debt at the CenturyLink level. Similar to its financing strategy with Embarq, CenturyLink will no longer issue debt at QCII or QCF. CenturyLink has a universal shelf registration available for the issuance of debt and equity securities, as well as a $1.5 billion authorized commercial paper program. The company effectively limits borrowing under the program to the amount available under the credit facility. There was no commercial paper outstanding as of Dec. 31, 2010.

Fitch estimates pro forma FCF in 2011 will be in the $1.1 billion to $1.3 billion range, after dividends, capital spending, and the after-tax effect of modest contributions to the pension plan.

Fitch affirms the following CenturyLink ratings with a Stable Outlook:

CenturyLink

--Long-Term IDR at 'BBB-';

--Senior Unsecured revolving credit facility at 'BBB-';

--Senior Unsecured debt at 'BBB-';

--Short-Term IDR at 'F3';

--Commercial paper at 'F3'.

Embarq Corp.

--Long-Term IDR at 'BBB-';

--Sr. unsecured notes at 'BBB-'.

Carolina Telephone & Telegraph (CT&T)

--IDR at 'BBB-';

--Debentures at 'BBB-'.

Embarq - Florida, Inc. (EFL)

--IDR ' at BBB-';

--First mortgage bonds at 'BBB'.

Fitch maintains the following ratings on Rating Watch Positive:

Qwest Communications International, Inc.

--IDR 'BB';

--Senior Unsecured Notes (guaranteed by QSC 'BB+').

Qwest Corporation

--IDR 'BB'.

Qwest Services Corporation (QSC)

--IDR 'BB'.

Qwest Capital Funding

--IDR 'BB';

--Senior unsecured notes 'BB'.

Fitch affirms the following ratings with a Stable Outlook:

Qwest Communications International, Inc.

--Senior Secured Credit Facility at 'BBB-'.

Qwest Corporation

--Senior unsecured notes at 'BBB-'.

Additional information is available at '[ www.fitchratings.com ]'

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 16, 2010);

--'Rating Global Telecoms Companies' (Sept. 16, 2010).

Applicable Criteria and Related Research:

Corporate Rating Methodology

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646 ]

Rating Global Telecoms Companies - Sector Credit Factors

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=550205 ]

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Fitch Affirms CenturyLink's Ratings; Assigns Stable Outlook