Credit analyst sees upside in BellSouth as event risk has eased

By Ronda Fears

Nashville, Tenn., Sept. 3 - BellSouth is under pressure from earnings revisions but there is less event risk and some upside in the credit, said Carol Levenson, director of research at Gimme Credit.

"This is not your father's Baby Bell. An industry formerly boringly predictable (which is just what a bondholder craves) has become wildly unpredictable.

"The fact that BellSouth (Aa3/A+) last week revised downward its 2002 earnings guidance for the fourth time in seven months (and with more than half of the year under its belt) is more significant symbolically than numerically," Levenson said in a report Tuesday.

"Granted, the company's business risk has increased, but when it was a triple-A credit, its numbers weren't materially better than [recent earnings]. We view BLS as no worse than a mid single-A credit.

"Although we expect further earnings disappointments, event risk has lessened and we believe there is upside in this name."

Levenson noted that BellSouth began the year projecting normalized EPS growth of 7% to 9%, so last week's revision implies EPS instead could fall by 9% to 12% and the impact on total earnings with stock buybacks could be even worse.

"Previous downward revisions to forecast EPS were accompanied by reductions in projected revenues, data sales growth, DSL customers, and capital spending, but this one addressed EPS only, and BellSouth offered little elaboration other than citing weaker wireless revenues and the economy," Levenson said.

"Clearly BellSouth is facing an environment it's simply not accustomed to dealing with."

The challenges, she said, include increased competition and product substitution for local access lines, pressure on wholesale margins because of regulatory mandates and a new economic sensitivity that could threaten the pursuit of data and broadband revenue.

"Although BellSouth's results have become less predictable, its debt protection measures remain quite strong and are unlikely to suffer materially from lower earnings projections," Levenson said.

Levenson worked up a worst case scenario for BellSouth.

The 10% earnings drop now forecast was doubled. Although the company has paid down more than $3 billion in net debt year-to-date from free cash flow and the sale of investments, she assumed free cash flow would henceforth be used to buy back stock instead.

Since the earnings forecast includes its portion of Cingular's earnings, a corresponding portion of Cingular's debt and interest expense was allocated to BellSouth.

Finally, even though we feel reasonably certain BellSouth can and will cut back its capital spending even more (it was already forecast to be down 40% from last year), she didn't assume additional free cash flow would be available to pay down debt.

"Even with such a dire outlook, we project BellSouth's net debt/EBITDA would remain below 2x, with EBITDA/interest coverage of more than 8x," Levenson said.

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