MONTERREY, Mexico-- (BUSINESS WIRE) -- Fitch Ratings has assigned Telefonos de Mexico, S.A.B. de C.V.'s (Telmex) US$500 million 5.5% senior notes due 2019 'A-'. Fitch currently rates Telmex's local and foreign currency Issuer Default Ratings (IDRs) at 'A-' with a Stable Rating Outlook. Proceeds from the offering are expected to be used for general corporate uses.

Telmex's rating are supported by the company's leading position as a fixed line telecommunications provider in Mexico, robust multiservice network, strong cash flow generation and a sound financial profile. Conversely, the ratings are tempered by increased regulatory risk, heightened competition and traffic migration from fixed to mobile networks.

Fitch believes the company has strong free cash flow generation and enough financial flexibility to maintain its current credit profile. Investments over the past years has resulted in a multiservice network capable of offering simultaneous voice and data services to most of the lines in service, reducing future investments and underpinning growth in data and broadband services. Even with weak operating results, cash flow can be used for debt reductions to maintain a stable credit quality. During the past few quarters Telmex has posted weak operating results, driven by lower revenues in local, domestic long distance and interconnection revenues that have not been able to compensate with lower costs, resulting in lower EBITDA generation.

Fitch expects total debt to EBITDA ratio after considering hedges to remain stable during 2010, close to historical level of 1.5 times (x). For the 12 months ended Sept. 30, 2009, total gross debt to EBITDA was 1.8x. This ratio does not consider derivatives gains of MXN13.4 billion associated with debt hedges, which offsets debt increases for the past few quarters due to the MXN devaluation. Taking into account these derivative gains, the pro forma indicator is close to its historical average of 1.5x.

Heightened competition from CLECs, cable TV providers and mobile substitution has resulted in revenue declines, particularly in local service and to a lesser extent in interconnection revenues, which in turn have pressured operating margins. Telmex's strategy has focused on offering bundled services to different customer segments in order to gain loyalty as competition increases. In the residential segment, the company still awaits the authorization to offer video services and today has only a commercial agreement with Dish, where Telmex only does the collection of bills.

Regulatory risk continues to increase for Telmex, adding to weaker financial results. Among those regulatory issues, is the interconnection and interoperability plan that includes unbundling of the network. While implementation of this plan is still being defined, it may negatively affect Telmex if it becomes effective. Network unbundling should result in increased competition and most likely in lower network investments from Telmex.

The increase in taxes should put additional pressure to Telmex operating results and demand for its services. Mexican authorities are passing a tax bill for 2010 that among others set a special tax for telecommunication services. This tax of 3% should be applied to all fixed (other than rural and public telephony), mobile and pay TV services. This tax does not consider additional tax burden to broadband services as it was originally proposed. In addition, the bill increases value added tax to 16% from 15% and income tax to 30% from 28% affecting the purchasing power of customers.

Other regulatory issues encompass reduction of local service areas to 197 by 2010, from the existing 397; the investigation of substantial power in certain markets; delay in the authorization to offer pay TV services; and introduction of number portability. According to Cofetel, Telmex has experienced 183,000 LIS losses since number portability introduction in July 2008, which has not been able to compensate with fixed-line additions.

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