Fitch Affirms BSkyB at 'BBB+', Outlook Stable

Reuters

Dec 23 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has affirmed British Sky Broadcasting Group plc's (Sky) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+'. The Outlook is Stable.

Sky's pay-TV and communications business continues to be robust despite a weak macroeconomic environment and increased competitive pressures from other triple-play services operators in the UK. Fitch expects content costs in the UK to rise over the medium-term and Sky may have significant choices to make regarding the size and mix of its programming budget and the impact on profitability. Although Fitch expects revenue growth to slow and EBITDA margin to decline over the next three years, the Stable Outlook reflects Sky's sound financial flexibility and conservative approach to leverage. Sky should be able to adapt to intensifying competition and manage its free cashflow generation with a disciplined approach to shareholder remuneration.

KEY RATING DRIVERS

Intensifying Competition

The UK market for triple-play is one of the most competitive in Europe, and competition is intensifying. Built on the foundation of its leading pay-TV position, Sky has the largest triple-play subscriber base in the UK, with 36% of customers now using its triple-play services. BT Group plc's (BT, BBB/Stable) recent investment in sports broadcast rights shows it is willing to buy attractive content to monetise its ongoing GBP2.5bn investment in its fibre network, and to support its UK consumer business. Virgin Media (B+/Stable), the second largest triple-play services operator by subscribers, differentiates its offering with its high-speed broadband network and TiVo, its interactive TV service.

Rising Content Costs

Sky's content costs may continue to rise over the medium-term as it faces greater competition for broadcast rights to attractive content. In June 2012, Sky successfully bid GBP2.3bn for the rights to show English Premier League (EPL) football games for three years. These higher costs, a 40% increase on Sky's previous deal of GBP1.6bn, are now coming into effect. An important decision point will be when these rights come up for auction in 1H15, which could see further increases in costs if BT continues to aggressively push its pay-TV strategy. Sky may have major choices to make regarding the size and mix of its programming budget and the impact on profitability.

Over-The-Top Threat

Sky has launched and strengthened its IPTV services (NOW TV and Sky Store) in response to growing competition from over-the-top (OTT) content providers such as Netflix and Amazon's LoveFilm, which stream content over the internet at competitive prices, targeting the lower end of the pay-TV market. Sky can use NOW TV to tap a potential market of 13 million UK homes that currently do not take pay-TV services, but there is a balance to be struck in that it does not cannibalise its existing higher-value customer base. Fitch does not expect NOW TV to be a significant source of Sky's revenue in the next two years as it accounts for only a small proportion of Sky's current subscribers.

Financial Flexibility Remains Sound

Sky currently has sound financial flexibility and fairly low funds from operations (FFO)-adjusted net leverage of 1.05x for financial year to June 2013. Cash flow generation has been strong and in the last two financial years, Sky has repurchased GBP1.4bn of its own shares. Fitch expects post-dividend free cash flow (FCF) margin to weaken over the medium term as competition increases. However, with a disciplined approach to shareholder remuneration, Sky should be able to adapt to a more challenging environment and manage its free cash flow generation and leverage profile.

Liquidity Remains Healthy

The group's liquidity profile is robust. Sky had GBP1.41bn in cash and short-term deposits (as of 30 June 2013), an undrawn revolving credit facility of GBP743m which expires in October 2018, and does not have any bond repayments until October 2015.

RATING SENSITIVITIES

Future developments that may individually collectively result in negative ration action include:

- Adverse changes to industry dynamics including price erosion, increasing content costs and capital intensity and increasing regulatory pressure, leading to significant downward pressure on EBITDA and free cash flow

- FFO-adjusted net leverage sustained at over 2.0x. However, the rating can tolerate temporary increases in leverage above this level following events such as an acquisition, as long as there is a clear deleveraging path back to 2.0x. Positive action is unlikely given Sky's high concentration of business in a single country and sector.

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