Vodafone risks downgrade

Vodafone appeared to confirm that it is willing to risk a credit rating downgrade after it made a preliminary approach for German cable TV and telecoms group Kabel Deutschland (KDG).

The UK telecoms group said the two companies are in talks over a possible deal, though there is no certainty of a formal offer being made. An acquisition of KDG would fit in with Vodafone's "unified communications" strategy, which involves bundling broadband and television services with its mobile telecoms products.

Germany is one of Vodafone's key markets and it only recently signed a deal with Deutsche Telekom - its main competitor - to use its broadband services. Combining with KDG would give it greater independence.

From a credit perspective, however, the benefits of the deal are more ambiguous. Vodafone currently has net leverage of 2.1x, and an acquisition of KDG financed by cash would probably push leverage above 2.5x, depending on the price paid.

This could threaten Vodafone's 'A-' rating, which it has maintained for some time. However, the UK firm's CFO said recently that for "the right asset with the right value opportunity"we could go to BBB+". If the reports are to be believed, then KDG could be the desired deal.

The reaction in the credit markets was muted. Vodafone's spreads widened 1bp to 82bps, still 9bps tighter than where it was trading in late February and in line with its peers. Indeed, Vodafone already trades with an implied rating of 'BBB', according to Markit data, suggesting the market may have already priced in a one-notch downgrade.

The UK company's balance sheet is set to remain strong and could be bolstered by the sale of its stake in Verizon Wireless, a saga that may come to an end before the year is out.

If the effect on Vodafone's credit standing was uncertain, the same couldn't be said of KDG. Its spreads tightened by 52bps to 150bps, reflecting the potential benefits of a junk-rated company combining with a solid investment grade credit. The move brought KDG's spreads back down to the level they reached in February, when interest from Vodafone emerged.

Elsewhere, the broader market gave back earlier gains and continued on its correcting trend. The Markit iTraxx Europe was over 2bps wider at 113bps, while the Markit iTraxx Crossover was 9.5bps wider at 472.5bps. Emerging market credits, though, stabilised after a torrid two days.

It is unlikely we will get spreads moving in a firm direction until we get clarity from the Federal Reserve on tapering QE.

Download full article