April 21, 2017 / 2:24 PM / 3 months ago

Fitch Rates Tele Columbus 'B'/Positive, Debt Instruments 'BB-'

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(The following statement was released by the rating agency) MOSCOW/LONDON, April 21 (Fitch) Fitch Ratings has assigned Tele Columbus AG a Long-Term IDR of 'B' with a Positive Outlook. Fitch also assigned a 'BB-'/'RR2'rating to Tele Columbus's senior secured debt instruments. Tele Columbus is the third-largest cable provider in Germany after Kabel Deutschland (a subsidiary of Vodafone) and Unitymedia (B+/Stable; a subsidiary of Liberty Global), with around 3.6 million connected homes. The Outlook is Positive as we expect the company to continue improving EBITDA and free cash flow generation due to wider take-up of additional services. This gives Tele Columbus strong deleveraging flexibility from the high estimated 5.4x funds from operations (FFO) adjusted net leverage at end-2016. However, deleveraging may be slowed by introduction of dividend payments in the medium term, in our view. KEY RATING DRIVERS Strong Regional Market Shares We expect Tele Columbus to maintain strong regional market shares, shielded by limited overlap with other cable companies in its key operating territories. The company holds above 50% cable market shares in the regions where 2.4 million of its 3.6 million connected homes are located. Rational Competition Peer cable competition is rational and primarily based on legacy cable infrastructure, with limited appetite for opportunistic new development. Cable operators typically have exclusive access to their client housing associations (HAs), with only incumbent Deutsche Telekom (BBB+/Stable) able to offer a full range of competing premium services such as broadband connection, premium TV and mobile service on own broadband infrastructure. We believe content is unlikely to become a key competitive driver as there is abundant quality content on free-to-air TV channels. Long-Term Contract Relationships Tele Columbus benefits from long-term contracts with HAs, which ensures stability of its core revenues, protects against excessive competition with other cable companies and helps reduce churn. About 95% of its subscribers live in homes that are part of HAs. Bulk contracts with these HAs for basic TV service have a typical duration of eight to 10 years. A relationship with the HA is likely maintained for a long time once it has been established. A switch to a new cable operator would require new equipment installation and/or network rewiring, which HAs are generally keen to avoid. Focused Strategy Reduces Execution Risks The company's strategy is to focus on upselling additional services to its existing connected homes taking its basic TV service, rather than expanding into new areas. This shields it from execution risks associated with entering new areas without established relationships. Therefore, most of its capex is success-driven, as network upgrades are typically only started after reaching an agreement with HAs. Positive Growth Outlook Relatively low revenue generating units (RGUs) per customer of 1.6x and a high 51% of existing customers on slow (below 30 MB/sec) broadband connections at end-3Q16 suggests that take-up of additional services will continue to increase. The company guided for mid-single-digit percentage yoy revenue and roughly 10% yoy normalised EBITDA growth in 2017. We expect low-single-digit revenue and EBITDA growth in the medium term. The core regions of operations are in eastern Germany, which has lower broadband penetration than western Germany, resulting in a stronger growth outlook. Integration Synergies Help EBITDA Generation We expect the enlarged Tele Columbus to achieve substantial integration synergies following the merger of Tele Columbus, Primacom and Pepcom in 2015. The company is targeting EUR40 million of synergies (both opex and capex) on a run-rate basis by end-2018, with moderate restructuring costs equal to around one time of the run-rate spread across the integration period. Strong Deleveraging Profile We expect Tele Columbus to keep reducing its leverage, driven by growing EBITDA and improving free cash flow (FCF) generation resulting from modest capex declines. We project FFO adjusted net leverage to decline to about 5x by end-2017 from the 5.4x estimated at end-2016, and to go to below 5x in 2018. Deleveraging may be slowed but is unlikely to be reversed by the introduction of dividend payments in the medium term. The company's debt covenants are consistent with moderate dividend distributions following the refinancing in March 2017. Moderate Acquisition Risks We view Tele Columbus's acquisition risks as moderate. Its strategy is to participate in further cable consolidation, but there are no large companies in the market, limiting potential M&A risks. We expect the company to take a prudent approach to further acquisitions. Robust Expected Recoveries Fitch rates the company's debt instruments at 'BB-', two notches above the IDR, due to strong, above 70%, expected recoveries. DERIVATION SUMMARY Tele Columbus has a significantly smaller operational scale than its closest domestic peer Unitymedia, the second-largest cable company in Germany. Unitymedia has similar leverage but its rating benefits from better infrastructure, a larger footprint and sustainably strong FCF. Liberty Global's cable subsidiaries Virgin Media, VodafoneZiggo and UPC Holding are rated 'BB-' due to lower leverage, solid financial profiles and stronger market positions. Cable companies typically have looser leverage thresholds than mobile and fixed-line operators due to the more sustainable nature of their business and stronger FCF. Strong Liquidity Tele Columbus does not face any significant refinancing exposure before 2025. Liquidity is strong, with EUR55 million cash at end-2016, and an untapped EUR75 million capex facility and a EUR50 million revolving facility, both maturing in 2020. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Stable homes connected at around 3.6 million in 2017-2020 - Low-single-digit percentage growth in total RGUs a year in 2017-2020 - Gradual increase in RGU per unique subscriber from 1.6x in 2016 to 1.8x by 2020 - Mid-single-digit revenue growth in 2017 slowing to low single digits in 2018-2020 - Normalised EBITDA margin of above 50% in 2017-2020 - Capex at 34% of revenue in 2017, gradually declining in 2018-2020 - Introduction of moderate dividends in the medium term RATING SENSITIVITIES Positive: Future developments that may, individually or collectively, lead to positive rating action include: - FFO-adjusted net leverage sustained below 5.0x and supported by robust free cash flow generation. Negative: Future developments that may, individually or collectively, lead to negative rating action include: - FFO adjusted net leverage rising and remaining above 6.0x - Significant shortening of the remaining contract life with housing associations Contact: Principal Analyst Slava Bunkov Director +7 495 956 9931 Supervisory Analyst Nikolai Lukashevich, CFA Senior Director +7 495 956 9968 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chair Damien Chew, CFA Senior Director +44 20 3530 1424 Media Relations: Athos Larkou, London, Tel: +44 203 530 1549, Email: athos.larkou@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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