March 28, 2017 / 4:27 PM / 5 months ago

Fitch Upgrades P4 to 'BB-'; Assigns Play Topco PIK Notes Final 'B-'/RR6

(The following statement was released by the rating agency) LONDON, March 28 (Fitch) Fitch Ratings has upgraded Polish telecom group P4 Sp. z o.o.'s (P4 or Play) Long-Term Issuer Default Rating (IDR) to 'BB-' from 'B+' and affirmed the company's National Long-Term Rating at 'BBB-(pol)'/Stable. At the same time, the agency has assigned a final rating of 'B-'/'RR6' to Play Topco S.A.'s PIK Toggle notes. A full list of rating actions is available at the end of this commentary. The upgrade takes into account P4's consistently strong market performance, having steadily transformed itself from market challenger to the market number-two by subscriber numbers. Operational strength has been accompanied by solid financial results, including double-digit revenue growth, solid margin expansion and strong underlying free cash flow (FCF). Fitch views the PIK Toggle instrument as sufficiently ring-fenced from the senior restricted group to be excluded from P4's consolidated metrics for IDR purposes. The leverage policy adopted by management at Play is consistent with a 'BB-' rating while taking into account the dividend policy likely to be adopted in order to service the PIK note. We have assigned Play Topco an IDR of 'B+' based on our parent subsidiary linkage, reflecting the subordination of the cash flow streams used to service its debt to those of the P4 restricted group. KEY RATING DRIVERS Play Topco PIK Note Rating: The Play Topco PIK exhibits sufficient ring-fenced features to be treated outside the senior debt restricted group. However, Fitch considers management's intention to cash-pay the coupon and the willingness of the shareholders to refinance this type of instrument within the senior group as having some bearing on Play's IDR. Fitch believes the deleveraging capacity of the business and an assumption that Play will manage overall net debt/EBITDA leverage (including the PIK) below 4x are consistent with a 'BB-' rating. Recovery analysis on the PIK Toggle notes results in an 'RR6' recovery rating and the notes are assigned 'B-'. Challenger to Market Leader: While the company operates in a competitive four-player market, it has shown consistent subscriber growth and a strong track record in taking the leading share of mobile number ports, and a solid improvement in the subscriber mix. At end-2016, the company is estimated to have had a more than 26% subscriber market share, up from 16% at end-2012, having transformed itself from market challenger to the market number-two behind Orange. Contract share of Play's subscriber base had reached 58% by end-2016, from 47% at end-2014. The changing subscriber mix has been instrumental in driving financial performance. Evolving Network Strategy: Play has developed a strong market position using a hybrid or asset-light approach to its network. At end-2016, its network provided voice coverage of 86% and LTE coverage of 92%, with in-fill coverage made possible by national roaming agreements with each of the other Polish network operators. With subscriber market share at 26%, management has decided to reduce dependence on its roaming partners and build out a nationwide network. This will raise the capex/sales ratio over the coming years, but avoid potential difficulties when renewing roaming agreements which however remain in place for the next four years. Limited Quad-Play Threat: Quad-play or the convergence of fixed and mobile services can help drive data traffic, improve per customer revenues and manage churn. So far, Play's lack of a fixed-line offer has not affected its growth or financial performance. Its focus on network quality, customer experience and value-for-money bundles including access to a range of content continues to support customer growth. Fitch does not regard Play's lack of a fixed offer as a major risk given the limited appetite for quad-play in the market. Evidence from incumbent telco Orange supports this view; its broadband customer base has fallen in recent quarters despite its quad-play capability. Deleveraging Capacity, Leverage Policy: Play's underlying cash flow generation is strong, providing an inherent ability to deleverage. The company's underlying 2016 FCF margin (FCF before spectrum payments/sales) of 14% underlines this strength. Our rating case is for this metric to remain in double digits over the next four years despite a period of higher capex. This cash flow strength provides Play with an ability to deleverage and financial flexibility consistent with a 'BB-' rating. The willingness of its shareholders to re-leverage the business when the balance sheet shows sufficient capacity acts as a constraint on the rating. DERIVATION SUMMARY Play compares favourably with a peer group that includes smaller, single-country telecom operators such as Telefonica Deutschland, Sunrise Communications, WIND and eir, as well as the leveraged cable sector. Compared to its peer group, Play exhibits strongly improving operating metrics and solid financials - particularly in terms of revenue growth and underlying cash flow strength. The business exhibits a deleveraging capacity that is not present in some of its telecom peers and is more analogous to its cable sector peers in this regard. A view that the shareholders are likely to re-capitalise the balance sheet and manage net debt/EBITDA leverage towards 4x acts as a constraint on the rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue growth of 5.6% in FY17, reducing to 2.2% by FY20 - EBITDA margins of 34.6% in FY17, increasing to 36.0% by 2019 - Capex of around 10% of revenue across the rating horizon - Increased cash taxes across the rating period as tax losses are fully utilised RATING SENSITIVITIES For P4 Sp Z.o.o Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - A change in the shareholders' intentions with respect to long-term financial policy. The shareholders have guided an intention to target net debt/EBITDA leverage of 4x. The following metrics would be important for an upgrade to be considered: - Continued strong subscriber metrics and an ongoing shift in the subscriber mix to post-paid, with subscriber acquisition cost and post-paid churn close to management's expectations. - Sustained EBITDA margin in the low to mid 30s and EBITDA-less capex margin in the low to mid 20s. - A financial policy that is likely to result in FFO-adjusted net leverage (excluding the Play Topco PIK) managed at or below 3.5x, a level consistent with net debt/EBITDA of around 2.7x. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - A more intense competitive environment, pressuring revenue and profitability. An expectation that convergent services are deemed by the market to be a more important offering could also create negative rating pressure. - A financial policy or weakened financial performance leading to FFO-adjusted net leverage (excluding the Play Topco PIK) consistently above 4.5x, which would result in a downgrade to 'B+'. - Fixed charge cover (excluding cash pay interest on the Play Topco PIK note), consistently below 3.0x, would result in a downgrade. - Post dividend free cash flow margin consistently below mid-single digits LIQUIDITY Play had cash and cash equivalents of PLN341 million as at 31 December 2016 along with an undrawn revolving credit facility of PLN400 million and other undrawn facilities of PLN200 million. The company is expected to generate positive FCF across the rating horizon with no significant debt maturities in the medium term. FULL LIST OF RATING ACTIONS P4 Sp. z o.o. -- Long-Term Issuer Default Rating upgraded to 'BB-' from 'B+'; Outlook Stable -- National Long-Term Rating: affirmed at 'BBB-(pol)'; Outlook Stable Play Finance 2 S.A. -- Senior secured notes: 'BB-'/'RR3'/'BBB(pol)' withdrawn Play Finance 1 S.A. -- Senior notes: 'B-'/'RR6' withdrawn Play Topco S.A. -- Long-Term Issuer Default Rating of 'B+' assigned with Stable Outlook -- Senior PIK Toggle notes due 2022: 'B-'/'RR6' assigned Criteria Variance Fitch notes that Play has chosen the early adoption of IRFS16 "Leases" resulting in the company's capitalisation of leases. Fitch has not made any adjustments to the value of reported finance leases relative to our standard criteria approach, which is to gross up associated operating lease expense by a factor of eight. Any variance is not considered material to the rating, while the adoption of the standard will become mandatory from 2019. Contact: Principal Analyst James Hollamby Associate Director +44 20 3530 1656 Supervisory Analyst Stuart Reid Senior Director +44 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Nikolai Lukashevich, CFA Senior Director +7 495 956 9968 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. 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