Fitch Downgrades TDS and U.S. Cellular to 'BBB+'.

CHICAGO -- Fitch Ratings has downgraded Telephone and Data Systems, Inc.'s (TDS) unsecured debt rating to 'BBB+' from 'A-'. United States Cellular Corp.'s (USM) senior debt rating has also been downgraded to 'BBB+' from 'A-'. The 'BBB+' rating on the 6% zero coupon convertible liquid yield option notes (LYONs) due 2015 has been withdrawn due to the full redemption of these notes. The Rating Outlook for these credits is revised to Stable from Negative by Fitch.

The rating downgrade primarily reflects the risks associated with the company's relatively high leverage and lack of free cash flow generation, which are not reflective of an 'A-' rated credit profile. Gross debt-to-EBITDA has remained outside the level reflective of the 'A-' range since the company's acquisition of the PrimeCo operations in 2002. Fitch's expected level of leverage improvement from that time has not been achieved primarily due to USM's strategic realignment of its operations. While USM used proceeds from asset divestures to offset costs with the footprint expansion, Fitch believes the company does not produce sufficient free cash flow to make up for the operating losses and higher capital expenditures associated with the developing markets. Fitch expects that TDS will be unable to materially reduce debt and improve free cash flow prior to 2006. The company does have a strong liquidity position with approximately $1 billion of cash as of second quarter 2004, but this benefit is muted with a large future tax liability associated with the prepaid forward contracts. In addition, USM will likely continue investment and footprint expansion in USM's Midwest cluster to remain competitive against the larger nationwide operators.

For 2004, expectations are for consolidated debt-to-EBITDA in the range of 3.8 times (x)-3.9x, higher than Fitch's initial expectations. As a result of faster customer growth, the costs of new market launches and the divestiture of cash flow generating properties to AT&T Wireless, management expects minimal EBITDA growth in 2004, which marks the third consecutive year for muted EBITDA growth. Given a light maturity schedule over the next year, debt levels are expected to remain relatively stable during 2005. Leverage in 2005 should improve slightly due to EBTIDA growth in USM's operations, resulting from the increase in mobile subscribers offsetting average revenue per user (ARPU) pressure from aggressive market launch plans. However, Fitch had believed USM would be generating sufficiently higher cash flows in 2005 than now currently expected.

Several positive factors offer support for the rating at 'BBB+' with a Stable Outlook. Fitch agrees with USM's strategic repositioning of divesting noncore wireless assets and building out of several greenfield PCS deployments that are adjacent to existing operations, thereby strengthening its competitive position. Nevertheless, it is important to note that a substantial portion of USM's POPs could be characterized as a developing market, which indicates that the developing market operations generate minimal cash flow at this time. Accordingly, USM has shown good financial discipline of gaiting the PCS deployments by using the cash flows associated with its mature markets to fully fund the developing operations. With the successful launches in several new markets during the third quarter, USM has made considerable progress on this initiative while reducing the execution risk related to this strategy. In 2005, USM only has plans to launch the St. Louis market, which is critical to strengthening USM's footprint. Beyond 2005, in our opinion, USM will explore similar strategies and likely consider other sizable footprint expansions, which depending on the scale of the deployment, could continue to pressure cash generation.

Fitch also believes the business risk profile has improved for USM over the past year when considering the overhang from wireless number portability, concern over wireless industry growth, uncertain timing of wireless consolidation, and greater execution risk in its PCS market build-outs. USM remains very competitive in its markets as evidenced by its low churn and the forecasted increase in net additions for 2004. Considering all the above factors, the underlying credit quality of USM assets appear to have stabilized, and USM should be better positioned to generate profitable growth for the future.

TDS/USM has substantial liquidity provided by cash, committed credit lines, and other assets, as well as enjoying a relatively light maturity schedule over the next several years due to past refinancings. TDS consolidated cash balance as of June 30, 2004 was approximately $1 billion when adjusted for the redemption of USM's 7.25% $250 million senior notes and USM's 6% $163 million LYONs. TDS and USM maintain $1.4 billion of undrawn revolver capacity principally through TDS' $600 million revolving credit facility, which matures in 2007 and USM's $700 million revolver that also expires in 2007. Other sources of potential liquidity include USM's tower portfolio and interests in several minority-owned markets.

TDS' only material near-term maturity is in 2006 with $200 million of notes coming due. Fitch believes TDS intends to use existing cash to retire the debt. However, the company has an approximate $550 million cash tax liability in 2007 and 2008 arising from the prepaid forward contracts. Given the current market pricing for the underlying equity securities, the company retains a substantial value over the prepaid forward contract obligations. Nevertheless, due to the lengthy timeframe until these obligations are settled, there are no assurances the company retains this value when the liabilities mature.

For the company to return to the 'A-' rating level, Fitch would need to see improvement in adjusted debt-to-EBITDA leverage to below 2x, sustainable free cash flow generation (before minority distributions) of $150 to $200 million, and a committed cash offset to the future tax liability, as well as stable operating trends in its wireless operations.