June 22, 2017 / 11:19 AM / a month ago

Fitch Rates Liquid Telecom IDR 'B+ (EXP)'; Outlook Stable

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(The following statement was released by the rating agency) LONDON, June 22 (Fitch) Fitch Ratings has assigned Liquid Telecommunications Holdings Limited a Long-Term Issuer Default Rating (IDR) of 'B+ (EXP)'/Stable Outlook. Fitch has also assigned an instrument rating of 'B+ (EXP)'/'RR4' to the company's proposed new senior secured bond and term loans. Proceeds from the issuance will be used to refinance the current capital structure. The final IDR and debt instrument ratings will be contingent upon the completion of the proposed refinancing and the receipt of final bond and loan documentation conforming materially to information provided to Fitch. KEY RATING DRIVERS Liquid Telecom's 'B+ (EXP)' rating reflects its robust business model with its unique fibre footprint offering cross-border telecommunication connectivity in Southern, Eastern and Central Africa. Higher demand for data, storage and bandwidth represents future growth opportunities for Liquid Telecom's enterprises and wholesale data divisions. The addition of Neotel's network in South Africa has enhanced Liquid Telecom's competitive position. However, some unhedged FX exposure may lead to volatility in key credit metrics. Commitment to infrastructure investment as well as dividend distribution could weigh on its already weak free cash flow (FCF) profile over the next three years. We believe there is moderate execution risk in turning around Neotel and generating sustainable enterprise revenue growth in a competitive operating environment. Robust Business Model: Liquid Telecom's market-leading position is underpinned by its unique cross-border fibre network spanning 13 countries in Africa, with limited substitution threat from alternative network operators. The company benefits from operating leverage where additional customers can be added at low marginal costs once network capacity has been put in place. The business model is supported by long-term contracts with global and regional enterprises and telecoms operators where we see a history of low customer churn rates. We believe the acquisition of Neotel should accelerate sales opportunities with the combined group's new and existing customers. Favourable Market Trend: The African telecommunications market is growing on the back of an increase in data traffic from an increasing number of connected devices and higher broadband speeds as internet penetration and mobile network coverage improve. Expansion of IT applications in end-markets such as finance, healthcare and media should support this growth. We believe Liquid Telecom is well placed to benefit from this favourable market trend and we do not foresee any sharp reversal as long as the overall African economic backdrop remains stable. Neotel Turnaround Strategy: Before its acquisition by Liquid Telecom, Neotel's operating performance had suffered due to uncertainty about its future ownership. As part of the turnaround strategy, Liquid Telecom has already reduced Neotel's indebtedness and is in the process of restructuring the businesses. The Neotel acquisition has moderately diluted the group's margins and increased leverage. Management has a track record in turning around distressed telecoms operations in East Africa, but the timing and the magnitude of improving operations at Neotel remain uncertain. High Capex Weakens FCF: High capex in FY18 and FY19 (financial year ending February) is part of the company's plan to turn around Neotel and to expand Liquid Telecom's network to support continued revenue growth. We expect these investments to be funded by upfront payments from anchor customers as well as external financing, with the payback period likely to be over four years, leading to short-term FCF pressures. The potential to increase dividend distribution may also weaken the liquidity profile. In the case of slower top-line growth, we believe the company has the flexibility to hold back expansionary capex to maintain a more neutral FCF profile. Emerging-Market Risks: A large portion of the group's revenue (48% in FY17) is generated in South Africa (BB+/Stable), which has been subject to weak GDP growth. The rest of the group's revenue is generated in countries such as Zimbabwe, Kenya (B+/Negative) and Zambia (B/Negative), which exhibit relatively weak operating environments. Regulatory uncertainty in these jurisdictions can have a negative impact on Liquid Telecom's business profile. Our sensitivity guidance for Liquid Telecom has been set tighter than for peers operating in developed markets to reflect these emerging-market risks. A majority of USD revenue is collected in the UK and Mauritius, reducing currency transfer and convertibility risks. Exposure to FX Volatility: Liquid Telecom's cash flow profile is subject to some FX volatility, with revenue derived in South Africa (representing 48% of total revenue) denominated in ZAR and a large proportion of the remaining revenue denominated in USD. We estimate that the majority of costs are denominated in local currency, leaving almost 80% of EBITDA linked to the USD. Overall, we estimate that a 25% adverse move of the USD/ZAR would only increase our FFO adjusted net leverage metric by 0.1x. DERIVATION SUMMARY Liquid Telecommunications Holdings Limited's business profile compares best with US peers Level 3 Communications, Inc. (BB/Stable) and Zayo Group, LLC. Liquid Telecom benefits from long-term customer relationships, strong network coverage and favourable industry trends. While the growth opportunity is greater in Africa than in developed markets, Liquid Telecom operates in countries in which the economic and regulatory environment can be unstable. Liquid Telecom's FX mismatch between cash flow and debt could lead to some volatility in credit metrics should there be material changes in its key currency pair (USD/ZAR). The company's FCF profile is constrained by high levels of capex over the next two years, which will be only partially funded by upfront payments from anchor customers as well as external financing. Following the Neotel acquisition and taking into account the proposed refinancing, we expect Liquid Telecom's credit metrics to be weaker than those of Level 3 Communications but stronger than those of Zayo Group. We highlight the company's exposure to emerging markets as the key differentiating factor relative to the sector peers. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Moderate compound annual growth in revenue of over 5% in FY17-FY20 (pro forma for Neotel), supported by growth in enterprises and wholesale data mitigated by wholesale voice, which is subject to pricing as well as volume pressures; - An operating EBITDA (before income from associates) margin of 28% in FY17 (pro forma for Neotel), improving to 32% in FY20; - Capex as a percentage of revenue of 25%-30% in FY18 and FY19, declining to below 20% in FY20; - Dividends paid of around USD13 million per year in FY18 and beyond; and - A bespoke recovery analysis based on a going concern approach assumes a post-restructuring EBITDA of USD122milion and distressed EV/EBITDA multiple of 5.0x. However, the Recovery Rating for the USD700m of expected senior secured debt (including RCF) is limited to 'RR4' due to country considerations. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action Successful implementation of the business strategy, including a turnaround of Neotel, with an improvement in operating performance leading to: - FFO adjusted net leverage sustainably below 3.0x; and - A FCF margin of 3%. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action A material deterioration in operating performance leading to: - FFO adjusted net leverage sustainably above 4.0x; and - A negative FCF margin leading to liquidity pressure. LIQUIDITY Satisfactory Liquidity: As of closing of the proposed refinancing, we expect Liquid Telecom to have access to a revolving credit facility of USD50 million (undrawn) and readily available cash of USD85 million on the balance sheet by FYE18. There are operating challenges with the company's subsidiary in Zimbabwe (around 15% of revenue), in which cash is subject to transfer and convertibility risks. We treat Liquid Telecom's cash in Zimbabwe as restricted and exclude it from our net leverage calculations. As FYE17, Liquid Telecom has access to readily available cash of USD106 million (net of USD12 million held as bank guarantees and USD35 million as restricted cash in Zimbabwe), which is sufficient to cover its short-term liabilities as well as other operating requirements. FULL LIST OF RATING ACTIONS Liquid Telecommunications Holdings Limited: Long-Term IDR: assigned at 'B+ (EXP)'; Outlook Stable Senior secured rating: assigned at 'B+ (EXP)'/'RR4' Liquid Telecommunications Financing plc: Senior secured rating: assigned at 'B+ (EXP)'/'RR4' Neotel Proprietary Limited Senior secured rating: assigned at 'B+ (EXP)'/'RR4' Contact: Principal Analyst Joe Howes Analyst +44 20 3530 1382 Supervisory Analyst Timothy Li Director +44 20 3530 1386 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Damien Chew, CFA Senior Director +44 20 3530 1424 Date of Relevant Rating Committee: 20/06/2017 Summary of Financial Statement Adjustments - 1. Lease-equivalent debt was calculated using an operating lease multiple of 6.0x for property and 4.3x for network equipment. The blended operating lease multiple was 5x. 2. Cash of USD35 million held in Zimbabwe and bank guarantees of USD12 million were treated as restricted. 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