Date of Release: 2005-04-22

SBC Communications Inc.

Ratings Under Review – Developing at Ap, Confirms at R-1 (low)p

Dominion Bond Rating Service (“DBRS”) has today maintained the ratings of SBC Communications Inc. (“SBC” or the “Company”) “Under Review with Developing Implications”. In addition, DBRS has extended its ratings to SBC’s legacy debt issuers, which due to limited financial disclosure and the support of SBC’s guarantee, effectively carry the same rating as SBC.

SBC’s rating has remained stable following its downgrade (November 2004), as debt levels increased and as pressure on its core fixed-line business persisted. On January 31, 2005, SBC’s rating was placed “Under Review with Developing Implications” after it announced its intentions to acquire AT&T Corporation (“AT&T”) (for US$15 billion in equity and assume roughly US$7 billion in AT&T debt), subject to customary regulatory approvals.

While SBC’s ultimate rating with respect to its plan to acquire AT&T has not currently been finalized, DBRS’s final rating determination on both SBC and AT&T are expected to be based on two factors. Firstly, the impact on SBC’s financial risk profile pertaining to whether SBC guarantees AT&T’s debt obligations. Secondly, and more importantly, the degree to which SBC’s business risk profile has changed by adding AT&T and it emphasis on long-haul data and IP services. This segment of the communications market continues to remain fundamentally challenged.

While further pressure is expected in SBC’s core wireline business, DBRS notes that the Company continues to maintain a relatively strong balance sheet (debt-to-capital at 40%), and generate significant cash flow from operations through its long-standing telephone and directory franchises.

With competitive pressure from new technologies, and a shift in its product mix, SBC is expected to continue to experience pressure on its wireline EBITDA margins (currently below its peers in the mid-30% range). While competition for local telephone service has come from other carriers like AT&T and MCI, Inc. reselling SBC’s telephone lines, this form of competition is expected to unwind with recent favourable regulatory changes. However, SBC’s competition is now expected to come from attractively-priced voice services [Voice over Internet Protocol (VoIP)] provided by cable operators coupled with further wireless substitution.

SBC has responded to these competitive threats in three ways. Firstly, it is aggressively bundling its wireline services with new services [including wireless with Cingular Wireless LLC (“Cingular”)] in order to grow average revenue per customer and reduce customer turnover. SBC has led the industry in implementing this strategy and successfully reversed a trend of increasing wholesale lines in 2004. Additionally, SBC increased its exposure to wireless by supporting Cingular’s purchase of AT&T Wireless. Secondly, SBC is undertaking a network transformation to a more efficient Internet Protocol (IP)-based network. This will allow it to offer higher data speeds and video services, with a lower cost base. However, the new services, while helping to preserve revenue, will have lower EBITDA margins while the costs savings will likely take three to five years to achieve and will require a sizeable capital investment. Finally, SBC continues to aggressively pursue regulatory reform with the Federal Communications Commission and state regulators. As such, unbundling rules have generally been overturned and left SBC to pursue its IP network transition to deploy fibre further into its customers’ neighbourhoods.

Free cash flow is expected to decline in 2005 as a result of higher capex levels and the above pressure on cash flow from operations. Debt levels will likely be modestly lowered in 2005 and going forward after leverage increased by US$9 billion last year to inject US$21.6 billion into Cingular. DBRS believes that this will be achieved mainly through Cingular’s return of capital as SBC’s free cash flow is expecting to be modest. (SBC could accelerate debt reduction should it choose to monetize its Mexican telco and wireless interests – currently approximately US$4 billion.) As the integration at Cingular continues, Cingular could provide more regular cash flow to its parents.

Note: p – This rating is based on public information.

The full report providing additional analytical detail is available by clicking on the link below or by contacting us at info@dbrs.com.

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