Despite solid industry fundamentals, driven by demand for wired and mobile connectivity, ratings among U.S. telecom and cable speculative-grade issuers ('BB+' or below) were pressured in 2023. We expect this trend will continue in 2024 in the face of high interest rates and elevated debt.

U.S. wireline companies are trying to build out fiber-to-the-home (FTTH) to better compete with cable broadband providers. However, they are constrained by rising interest costs and inflation, which make it more challenging to earn an adequate return on investment. At the same time, small and midsize cable operators face greater competition from FTTH and fixed wireless access (FWA). Unlike larger peers (Comcast Corp. and Charter Communications Inc.) that can absorb the high costs from offering wireless service using mobile virtual network operator (MVNO) agreements, smaller cable providers do not have the same financial flexibility. Larger speculative-grade issuers, including Lumen Technologies Inc. (CC/Negative) and Dish Network Corp. (CC/Negative), recently initiated distressed exchanges to extend debt maturities and give themselves runway to execute on their strategies. Dish's proposed transaction was unsuccessful, and as a result, it pulled the offer.

Given the number of companies rated in the 'CCC' category, we expect defaults over the next 12 months will increase. While a potential easing of interest rates and improving credit market conditions could support the issuance of new debt to refinance maturities, many must contend with substantially higher interest costs, elevated debt, and capital spending requirements.

U.S. Telecom And Cable Snapshot: We Rate More Issuers In The 'CCC' Category

The U.S. telecom and cable rated portfolio consists of 59 companies as of Feb. 26, 2024. Just 10 companies (17% of the total) have investment-grade ratings ('BBB-' or better), while 49 (83% of the total) have speculative-grade ratings.

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Of the 49 speculative-grade companies, 31 (63%) are at the low end of the rating spectrum ('B' or lower). This is not surprising since U.S. corporate issuers overall skew toward the 'B' category.

What has changed is that we rate 29% of these speculative-grade companies 'CCC+' or below, and 51% are in the 'B' category. This trend seems somewhat counterintuitive given the recurring, subscription-based revenue model and utility-like nature of the sector. A year ago, we rated only 9% of these companies 'CCC+' or below and 64% in the 'B' category. We believe this is primarily because of the elevated debt they carried amid a prolonged period of low interest rates and elevated capital spending requirements associated with network upgrades.

With higher interest rates and substantial exposure to floating-rate debt, many of these issuers are simply weighed down by rather large debt burdens. We typically lower an issuer credit rating to the 'CCC' category when we believe the capital structure is unsustainable or that liquidity could be pressured over the near term. An unsustainable capital structure is one in which the debt burden is high enough such that we believe successful refinancing is unlikely absent financial improvement. In these cases, we believe an eventual debt restructuring is necessary in order for the company to service its debt longer term. We typically consider whether the company can generate positive free operating cash flow (FOCF) on a sustained basis after considering current yields on the debt and the elevated cost of capital when the debt will need to be refinanced.

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Speculative-Grade Ratings By Subsector

Speculative-grade ratings in the U.S. cable and satellite television sector are pretty evenly split between the 'BB' and 'B' categories, although there have some notable downgrades: Altice USA Inc. to 'B-' with a stable outlook from 'B', Radiate Holdco LLC to 'CCC+' with a negative outlook from 'B', and WideOpenWest Finance LLC to 'B+' with a negative outlook from 'BB-'. Cable operators once had a monopoly on the high-margin broadband market, but over the past couple of years have faced increasing competition from FWA and FTTH providers.

We believe small and midsized operators in more competitive markets with less scale to absorb losses from a wireless MVNO, which could help churn metrics, could be at risk for broadband losses, margin degradation, and potentially higher leverage.

In contrast, most wireless and wireline telcos are rated in the 'B' category given their exposure to legacy products such as digital subscriber line (DSL) broadband service, significant capital spending requirements to build out their fiber networks, elevated leverage, high interest costs, and ongoing FOCF deficits. Some, including Frontier Communications Holdings LLC and Windstream Holdings II LLC, actually emerged from bankruptcy over the last couple of years with less debt. However, to better compete with cable, they are aggressively deploying FTTH, which is costly to build and has resulted in a return to higher leverage.

Lumen derives about 80% of its revenue from the business segment, which is in secular decline as customers transition to software-defined and cloud-based technology solutions that are less expensive than legacy products and services. Weighed down by its massive debt burden and a large maturity wall in 2027 that includes almost half of its debt, Lumen has offered to exchange debt that comes due over the next few years for new debt with longer-dated maturities. We believe Lumen's capital structure is unsustainable given our expectation for earnings declines and negative FOCF, which will hinder its ability to reduce leverage.

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Outlook Distribution

Our outlook bias for the industry is mostly negative: 19 companies (32% of the total) have negative outlooks, 37 (63%) have stable outlooks, and only one has a positive outlook. This represents a sharp deterioration from a year ago when only 19% had negative outlooks or were on CreditWatch with negative implications and 78% had stable outlooks. Among speculative-grade issuers, the bias is even more negative: about 39% have negative outlooks.

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The sector ratings distribution is a culmination of two years of net negative rating actions, although the bulk occurred in 2023. In 2022, there were 27 negative rating actions and 12 net positive rating actions. Negative rating actions include downgrades, outlook revisions to negative, and CreditWatch negative listings. This trend worsened in 2023 when we had 31 negative rating actions and only six positive rating actions. Year to date in 2024, we have taken five negative rating actions and no positive actions. We had 14 downgrades and eight upgrades in 2022, and 21 downgrades and only four upgrades in 2023, as speculative-grade capital structures became stressed from higher interest rates and inflationary pressures, which hurt FOCF.

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More Issuers Rated 'CCC+' And Below

We were somewhat surprised by the increasing number of U.S. telecom and cable issuers that we downgraded to 'CCC+' and below in 2023 given the general stability of sector earnings and cash flow. We looked for some commonality among these companies and came up with these themes:

• Significant exposure to legacy products and services that are in secular decline. Companies such as Lumen and Dish derive much of their revenue from products such as linear television, multiprotocol label switching, and DSL broadband service.
• Inflation. Most U.S. telecom and cable issuers were hurt by cost inflation, which contributed to rising labor and other expenses. Smaller companies that dominate the low speculative-grade universe are more vulnerable because they lack the leverage of bigger firms to pass higher costs along to customers.
• Elevated leverage and a large amount of floating-rate debt. Typically, issuers in the 'B' category do not have access to the public debt markets and, therefore, look to bank lending facilities, which carry floating rates. As interest rates rose in 2023, free cash flow deficits accelerated due to the weight of higher interest costs, contributing to unsustainable capital structures.
• Near-term maturities and limited access to the credit markets.

U.S. Telecom And Cable Has Sufficient Breathing Room To Address A Maturity Wall In 2027

We estimate total outstanding debt in the speculative-grade U.S. telecom and cable sector is about $275.4 billion. Most of these issuers took advantage of historically low interest rates in 2020 and 2021 to refinance their capital structures and push out maturities until 2026 and 2027.

We estimate that, in aggregate, about $6.5 billion of speculative-grade telecom and cable debt will come due in 2024, increasing to $14.9 billion in 2025. We estimate total debt maturities for these issuers will be $26.9 billion in 2026 and $66.5 billion in 2027.

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Our review identified a handful of companies that have financing needs in 2024 and 2025 and several with greater financing needs in 2026. We rate some issuers that need to address maturities in 2024 and 2025 'CCC+' or lower, although we believe the higher-rated issuers can refinance or pay down upcoming obligations through cash balances, free cash flow, or well-earned access to the capital markets. Below is a selected list of companies with significant upcoming maturities (one to two years), which may result in refinancing challenges or ratings pressure (table 1), and companies with significant 2026 maturities (table 2).

Table 1

Table 2

Ratings Outlook By Subsector

Telecom

The near-term rating outlook for the U.S. speculative-grade telecom sector is negative, although we have a more favorable view longer term. While these companies continue to expand their FTTH footprints, we expect headwinds will persist in 2024, resulting in weaker liquidity as they try to reverse their earnings trajectories. Inflation, high interest rates, and exposure to legacy revenues will continue to weigh on credit quality as they transition to newer technologies and fiber.

We expect overall top-line pressures to continue in 2024, with revenues declining 4%-5%, although results will vary by provider depending on how far along they are with their fiber builds. At the same time, we expect revenue from business services will continue to fall in the high-single-digit percent area due to reduced information technology spending and exposure to legacy products and services.

Cable/satellite TV

The rating outlook for speculative-grade cable providers is increasingly negative due to competition from FWA and FTTH. FWA, in particular, is taking almost all industry broadband net adds each quarter while low move activity is also hurting subscriber growth. That said, the impact from competitive pressures will vary among small and midsize cable providers, depending on population density and existing high speed data penetration. Increasingly, they need to bundle mobile service with their broadband product to better compete.

However, these companies lack the size and scale to absorb operating losses from their wireless services. We believe cable overbuilders including WideOpenWest and Radiate--which tend to skew to the younger, urban demographic more likely to adopt more affordable FWA service--are at greater risk.

Direct broadcast satellite providers are not well positioned without a broadband service given the sharp declines in linear TV subscribers and a crowded virtual multichannel video programming distributor market. In addition to losing video subscribers, Dish is trying to build out its own 5G wireless network but lacks the financial capacity given its elevated leverage and large cash burn. While DirecTV Entertainment Holdings LLC is subject to the same industry dynamics, its credit quality benefits from low leverage, about 1.5x, and cost-cutting initiatives, which has enabled it to generate solid FOCF.