In 1998 there were several developments in Europe leading to the liberalization of the European telecommunication industry. In October 1998, Moody's Investors Service published a report ("Rating Methodology: European Telecoms") addressing the issues in the rating of European telecommunication companies. Below are quotes from the report followed by questions that should be answered.
A. "We look carefully at a company's general funding strategy-the debt and equity markets the company accesses, and the sources of bank financing it arranges. . . This becomes more important the lower down the rating scale, particularly in the case of high yield issuers . . ." Why is the funding strategy of high-yield issuers of particular concern to Moody's analysts?
B. "As a very general rule of thumb, the larger the company's cushion of cash and assets above fixed payments due, the more able it will be to meet maturing debt obligations in potentially adverse conditions, and the higher the rating. In many cases, the size of this cushion may be less important than its predictability or sustainability. Moody's views the telecom industry as having generally very predictable revenue streams, which accounts for the relatively high level of ratings of the telecom industry compared to other industries." Explain why "predictability and sustainability" may be more important than size of a coverage ratio.
C. In discussing the financial measures it uses, the report explains the importance of "cash flow to debt figures." The report stated, "We also look at adjusted retained cash flow which includes any items which we view as non-discretionary to gauge the financial flexibility of a company, . . " What is meant by "financial flexibility of a company"?
D. The quote in the previous part ends with "as well as adjusted debt figures which include unfunded pension liabilities and guarantees." Why would Moody's adjust debt figures for these items?
E. In the report, Moody's looks at various measures considered in ratings such as coverage ratios and capitalization ratios, and shows these ratios for a sample of European telecom companies. In each case when discussing ratios, Moody's notes the "loose correlation" between ratings and ratios; that is, it is not necessarily the case that companies with the best ratios will always receive a better rating. Moody's noted that "inconsistencies underscore the limitations of ratio analysis." Explain why one might expect a loose correlation between ratios and ratings.