Debt-Heavy Telecoms Won't Escape the Credit Crunch

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While credit analysts believe that the carriers' huge cash flows make them solid credit risks that are highly unlikely to default, the analysts say higher borrowing costs will reduce earnings and force the carriers to scale back on their ambitious plans. "If you had to place debt you'd have to pay a high rate," says Mike Weaver, managing director with Fitch Ratings. "There will be less profitability."

AT"T sounded the first warning signal in late September, when CEO Randall Stephenson said the telecom giant was unable to sell commercial paper for terms longer than overnight. AT"T is the industry's biggest user of commercial paper, with about $8.5 billion in paper outstanding at the end of June. Since then, AT"T says it has regained access to the market and is "getting reasonable rates."

Although Verizon is not a big player in the commercial paper market, it does have $7 billion of debt coming up for renewal in 2009. The company also needs to borrow another $22 billion to pay for its acquisition of wireless carrier Alltel Wireless, which the company hopes to close by year-end. Bernstein analyst Moffett expects the interest rates that Verizon pays to increase soon by a percentage point, which he says could wipe out 35% of the anticipated $1 billion in cost savings from the Alltel deal.

Moreover, should Verizon's free cash flow drop by more than 5%, Moffett says the company could not afford to pay for its dividend and capital spending without additional borrowing. Todd Rosenbluth, an analyst with Standard " Poor's, says Verizon will be "inclined to pull back on their capital spending modestly." He expects to see a reduction by a single-digit percentage.

Eyes on leveraged Sprint

Of all the U.S. carriers, Sprint faces the greatest risk. This summer, Sprint said it wanted to sell the iDen network it acquired as part of its merger with Nextel. But tight credit and the sagging economy mean the struggling operator will be unlikely to find a buyer for the iDen network at an attractive price.

Sprint is the most leveraged carrier. It holds a junk bond rating and its ratio of debt to earnings before interest, taxes, depreciation, and amortization (or EBITDA) is expected to reach 3.2, Bernstein's Moffett says. With Sprint's declining profit, some analysts worry that the company could move past that ratio. If Sprint breaches 3.5, it will default on its credit agreements. While most analysts say creditors would be reluctant to push Sprint into bankruptcy, a default likely would mean higher borrowing terms and bank fees. "They would have to work out some waiver or amendment that would cost them," says Fitch managing director Weaver.

Thanks to years of consolidation and rational investment, the telecom industry is in relatively good shape. But the financial contagion is so strong that even companies with strong credit will find it hard to avoid some level of infection.

—With Olga Kharif

Ante is an associate editor for BusinessWeek.