Overview

We expect U.K.-based telecom company BT Group to post revenues and EBITDA 
that are weaker than we previously anticipated over the next couple of 
years. This is due to the effects of fiber regulation, continued fierce 
competition in the enterprise and public sectors, a maturing consumer 
broadband market, and cost inflation.
These operating risks, along with Brexit-related uncertainties, currently 
weaken our view of BT's business risk compared with some of its peers.
The resulting combination of lower EBITDA, partly due to significant 
restructuring costs, and higher network investments significantly weakens 
BT's free operating cash flow (FOCF). This, along with stable dividend 
payouts, limits BT's ability to offset operating pressures with 
discretionary cash flow.
We are therefore lowering our long-term issuer credit rating on BT to 
'BBB' from 'BBB+'.
The stable outlook reflects our view that cost reductions will largely 
offset revenue pressures and inherent cost inflation, enabling BT to 
maintain adjusted debt to EBITDA of 2.8x-3.0x and adjusted FOCF to debt 
of about 5%-6% over the next 24 months.

Rating Action

On June 12, 2018, S&P Global Ratings lowered its long-term issuer credit 
rating on U.K.-based telecommunications group BT Group PLC (BT) and its fully 
owned subsidiary EE Ltd. to 'BBB' from 'BBB+'. The outlook is stable. We 
affirmed the short-term rating at 'A-2'.

Rationale

The downgrade reflects our view that BT's credit quality has weakened compared 
with 'BBB+' rated telecom peers. This is mainly due to:

Ofcom's very strong regulatory oversight of Openreach, including the 
recent regulation of fiber under 40 megabits per second (MBps);
Increased competition in the consumer broadband market, notably for fiber 
at speeds of up to 76 MBps;
Continued fierce competition in the enterprise and public sectors, 
especially from TalkTalk;
Maturing consumer broadband and TV markets while BT continues to face 
high football content costs; and
Uncertainties regarding the medium-term impact of Brexit on consumer 
spending choices.

These pressures drive our expectation of weaker than previously anticipated 
revenues and EBITDA generation, and materially lower free operating cash flow 
generation in the current and next fiscal year. This is only partly offset by 
a lower pension deficit. As a result, we expect adjusted FOCF to debt to 
decline to about 5%-6% in fiscal 2019 (ending March 31) and 2020, from 13% in 
fiscal 2017 and 9% in fiscal 2018, well below our upgrade trigger of 12%. We 
only expect a return to EBITDA growth from 2021, and for it to be highly 
reliant on BT's execution of its consumer value-focused convergence plan and 
the significant cost-cutting plan, which includes the removal of 13,000 
employees (mainly back office and middle management roles), somewhat offset by 
6,000 new hires to support network deployment and customer service. 

Due to BT facing significant restructuring charges (of about £800 million), a 
step-up in capital expenditure (capex), and some additional spectrum 
acquisition, we forecast a meaningful decline in its free cash flow generation 
(before contributions to the pension deficit) to less than £1.5 billion in 
fiscals 2019 and 2020, from £1.9 billion in fiscal 2018. For BT, not reducing 
dividend payouts means breakeven to negative discretionary cash flows in 
fiscals 2019 and 2020, resulting in a further increase in adjusted debt and 
limiting BT's ability to offset operating pressures through debt reduction. At 
the same time, we understand BT is targeting a 'BBB+' rating over the cycle.

On the back of the recent wholesale local access market review, Openreach 
faces significant revenue pressures. Most of this relates to the new caps on 
access to fiber of up to 40 MBps, which cuts the fees it charges other 
carriers by about 33% over three years, with about two-thirds of the effect of 
this being felt in fiscal 2019. In our view, this may have a knock-on effect 
on the pricing of access to higher speeds, which will otherwise become 
disproportionately expensive. The lower access fees could also drive even more 
pricing competition from Vodafone and TalkTalk, who are looking to grow their 
broadband subscriber base, thereby potentially limiting BT's ability to 
increase prices for its installed base.

In our view, the recently announced convergence strategy of cross-selling 
value-added fixed and mobile products is positive and leverages BT's unique 
advantage in the U.K. through the ownership of both networks, creating 
meaningful cost advantages over peers. This network advantage as well as BT's 
dominance and brand are key strengths for our view of BT's business risk. We 
think this convergence strategy can be particularly successful when selling 
mobiles to existing BT customers. At the same time, given the potential impact 
of Brexit on consumer choices and BT's premium prices for its main brand 
compared to some of the other carriers, cross-selling products without any 
discount may be challenging.

Despite our view that BT's credit quality has somewhat weakened, we view 
favorably the recent resolution of the pension review--notably the closure for 
further accrual of the defined benefit scheme. This not only limits the 
increase in the plan's future liabilities (meaning we currently forecast an 
ongoing decline in the deficit through contributions), but also reduces the 
ongoing cost inflation related to the pension scheme.

In our base-case operating scenario for BT, we assume:

About 2% revenue decline in fiscal 2019 and an additional drop of 1%-2% 
in 2020, from -1.4% in fiscal 2018, driven by the negative impact on 
Openreach of the expected reduction in fiber wholesale fees, weaknesses 
in wholesale and business; this is somewhat offset by about 1%-2% growth 
in BT's fixed consumer revenues (including EE).
EBITDA margins of 30%-32% in fiscals 2019 and 2020 (before specific 
items) from 31.6% in financial 2018, on continual cost-cutting as well as 
the benefits of cost synergies from the integration of EE. These cost 
benefits are expected to largely offset increases in regulatory costs and 
cost inflation. 
Adjusted EBITDA margins of about 28.0% in fiscal 2019, down from 29.8% in 
fiscal 2018, improving to about 31.0% in 2020 due to lower restructuring 
charges and benefits of the planned cost reduction.
Capex of about 15%-16% of sales excluding spectrum acquisition payments 
on increased investments related to FTTP and capacity, compared with 
about 14% in fiscal 2017-2018.
Stable annual dividends of about £1.5 billion.

Based on these assumptions, we arrive at the following credit measures:

Debt to EBITDA of about 3.0x in 2019 and 2.8x in 2020 (similar to 2018);
Funds from operations (FFO; before pension recovery contributions) to 
debt of about 24% in 2019 and 25%-26% in 2020, from 27% in 2018; and
FOCF (adjusted for pension recovery contributions) to debt of about 5%-6% 
in fiscals 2019 and 2020, down from 9% in 2018 and about 13% in 2017.

Liquidity

The short-term rating on BT is 'A-2'. We assess the group's liquidity as 
adequate. We estimate that BT's available liquidity sources will exceed uses 
by about 1.4x over the 12 months from March 31, 2018, comfortably above the 
minimum 1.2x threshold for our adequate liquidity category.

For the 12 months started March 31, 2018, we calculate the following principal 
liquidity sources:

Cash and liquid investments of about £3.55 billion;
Our forecast of about £5.3 billion-£5.4 billion of FFO; and
Undrawn committed revolving credit facility of £2.1 billion due in 2021. 
The facility has no financial covenants.

For the same period, we calculate the following principal liquidity uses:

Debt amortizations of about £2.3 billion;
Our forecast of annual capex of about £4.0 billion-£4.2 billion, 
including assumed spectrum acquisition; and
Estimated shareholder returns of about £1.5 billion.

Outlook

The stable outlook reflects our view that execution of cost reduction will 
largely offset revenue pressures and inherent cost inflation, enabling BT to 
maintain adjusted debt to EBITDA of 2.8x-3.0x and adjusted FOCF to debt of 
about 5%-6% over the next 24 months.

Upside scenario

We could raise the rating if BT reduces its adjusted leverage to 2.5x and 
adjusted FOCF to debt to about 12% through a more conservative financial 
policy, for example, if it significantly reduces its cash paying dividends 
over the medium term. That said, we do not expect this over the next 12 
months. We could also raise the rating over the longer term if we see 
operating risks significantly reducing, enabling BT to return to sustainable 
revenue growth and adjusted EBITDA margins approaching mid-30%.

Downside scenario

We see short-term downside risks as remote because we currently see BT's 
business as well established in the U.K., and given BT's track record of 
maintaining a prudent balance sheet profile with unadjusted net debt to EBITDA 
kept well below 2x.

We could lower the rating if adjusted debt to EBITDA increases to about 3.5x 
and FOCF generation were to weaken further, which would likely be on the back 
of significantly stronger than anticipated operating pressures in its consumer 
divisions.

Ratings Score Snapshot

Issuer Credit Rating: BBB/Stable/A-2

Business risk: Satisfactory

Country risk: Low
Industry risk: Intermediate
Competitive position: Satisfactory

Financial risk: Intermediate

Cash flow/Leverage: Intermediate

Anchor: bbb

Modifiers

Diversification/Portfolio effect: Neutral (no impact)
Capital structure: Neutral (no impact)
Financial policy: Neutral (no impact)
Liquidity: Adequate (no impact)
Management and governance: fair (no impact)
Comparable ratings analysis: Neutral (no impact)

Issue Ratings--Subordination Risk Analysis

We rate the group's senior unsecured debt at the same level as the issuer 
credit rating. This is because the majority of BT's debt ranks pari passu. The 
only priority liabilities we consider for BT are the notes at EE, which 
comprise less than 10% of the group total debt--significantly below our 50% 
threshold for notching down. We therefore do not estimate any material 
subordination risk for BT's rated debt instruments.

Related Criteria

Criteria - Corporates - General: Reflecting Subordination Risk In 
Corporate Issue Ratings, March 28, 2018
General Criteria: Methodology For Linking Long-Term And Short-Term Ratings
, April 7, 2017
Criteria - Corporates - General: Methodology And Assumptions: Liquidity 
Descriptors For Global Corporate Issuers, Dec. 16, 2014
Criteria - Corporates - Industrials: Key Credit Factors For The 
Telecommunications And Cable Industry, June 22, 2014
General Criteria: Group Rating Methodology, Nov. 19, 2013
Criteria - Corporates - General: Corporate Methodology: Ratios And 
Adjustments, Nov. 19, 2013
Criteria - Corporates - General: Corporate Methodology, Nov. 19, 2013
General Criteria: Country Risk Assessment Methodology And Assumptions, 
Nov. 19, 2013
General Criteria: Methodology: Industry Risk, Nov. 19, 2013
General Criteria: Methodology: Management And Governance Credit Factors 
For Corporate Entities And Insurers, Nov. 13, 2012
General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009

Ratings List

Downgraded; Outlook Action; Ratings Affirmed
                                        To                 From
BT Group PLC
EE Ltd.
EE Finance PLC
British Telecommunications PLC
 Issuer Credit Rating                   BBB/Stable/A-2     BBB+/Negative/A-2

British Telecommunications PLC
EE Finance PLC
 Senior Unsecured                       BBB                BBB+


Ratings Affirmed

British Telecommunications PLC
 Commercial Paper                       A-2                

Certain terms used in this report, particularly certain adjectives used to 
express our view on rating relevant factors, have specific meanings ascribed 
to them in our criteria, and should therefore be read in conjunction with such 
criteria. Please see Ratings Criteria at www.standardandpoors.com for further 
information. Complete ratings information is available to subscribers of 
RatingsDirect at www.capitaliq.com. All ratings affected by this rating action 
can be found on S&P Global Ratings' public website at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.  Alternatively, call one of the following S&P Global Ratings numbers: 
Client Support Europe (44) 20-7176-7176; London Press Office (44) 
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