These weaknesses are partly offset by the group's pan-European fiber optic network, which enables it to provide its business customers with end-to-end services over a single integrated network covering most of the major metropolitan cities in Western Europe; an improving business mix due to focused investment in higher-margin value-added services, including managed services and data center services, which entail longer-term contracts and have solid medium-term growth prospects; and track record of solid profitability.
The "intermediate" financial risk profile primarily reflects the group's solid credit metrics due to its debt-free balance sheet. We also factor into our assessment the fact that Colt's major shareholders--FMR LLC (A+/Stable/A-1), FIL Ltd. (BBB+/Negative/A-2), and other Fidelity entities--have provided significant financial support in the past. In addition, since repaying its debt in April 2009, Colt has been able to redeploy its cash on internal and external growth-oriented investments, as it has not had to pay dividends. However, these strengths are offset by projected negative free operating cash flow over at least the next couple of years due to an overall increase in capital expenditures related to data center expansion, product and service development, and network expansion and upgrades.
S&P base-case operating scenario
We forecast mid-to-low single-digit growth in reported revenues for 2012 and 2013, which is consistent with the group's guidance of mid-single-digit compounded annual growth for 2012-2016. Fiscal weakening (or outright contraction) across Colt's geographic footprint (consisting primarily of Germany, U.K., France, Spain, and Italy) could lead to further pressure on both public- and private-sector spending on IT-related services. As a result, we forecast that the group's voice-related revenues will continue to decline by low-to-mid single digits, with the mid-single-digit growth in the carrier voice segment not fully offsetting the continued double-digit decline in the group's legacy corporate and reseller voice segment. However, we believe the group will be able to achieve group revenue growth on the back of double-digit growth in the managed services and data center business, along with contributions from the data business.
In the first half ending June 30, 2012, Colt reported group revenue growth of 4.1% (2.6% at constant currency), managed services growth (including data centers) of 15.4%, data growth of 1.8%, and voice revenue growth of 4.1% as a result of carrier voice growth of 38.1% far exceeding the decline in corporate and reseller voice of 11.7%.
In terms of the group's reported EBITDA margin evolution, we are a bit more cautious and assume that it will remain relatively flat for 2012 and 2013 (21.4% in 2011), although growing roughly in line with revenues on an absolute basis. Although the group has experienced an improvement in its gross profit margins, incrementally higher operating costs related to the group's growth and investment initiatives translate, in our view, to relatively limited scope for EBITDA margin expansion over the near term. However, given the higher EBITDA margin profile associated with the data center business, stronger than anticipated growth could result in an improvement due to the margin mix of the business over the medium term.
S&P base-case cash flow and capital-structure scenario
Over the next 12-18 months we anticipate that Colt's Standard & Poor's-adjusted gross debt-to-EBITDA will remain relatively unchanged at around 0.5x, well within the bounds of the 2.0x limit we view as commensurate with the current rating. At June 30, 2012, we calculate the group's adjusted gross debt-to-EBITDA as 0.5x, unchanged from Dec. 31, 2011. Our adjusted gross debt (EUR147.6 million) primarily reflects capitalized operating leases. Our operating lease adjustments assumes an 8% discount rate, reflecting the implied interest expense in 2008, the last full year for which Colt had outstanding reported debt.
Our forecast for 2012 and 2013 is supported by our assumption of continued solid underlying generation of funds from operations (FFO) of around EUR300 million. However, we currently anticipate that free operating cash flow (FOCF) will be negative in 2012 and 2013 due to our forecast of increased capital expenditures over the near-to-medium term related to data center expansion, product and service development, and network capacity expansion and upgrades. In our view, Colt also has flexibility to tap capital markets at such point as the group needs further capital given the existing headroom under the leverage target for the current rating (0.5x vs. 2.0x).
We assess Colt's liquidity as "adequate" under our criteria. This reflects our assessment that the group's sources of liquidity will cover uses by at least 1.2x in the next 12 months, even in the event of a moderate unforeseen EBITDA decline.
As of June 30, 2012, we estimate Colt's main liquidity sources over the next 12 months to be about EUR505 million. These sources include:
-- Cash and cash equivalents of EUR195 million; and
-- Our forecast of relatively flat funds from operations (FFO) of around EUR300 million.
We estimate Colt's liquidity needs over the same period of about EUR420 million, including:
-- Our assumption that a minimum of about EUR100 million in cash balances is necessary to cover both ongoing operations and fund seasonal peaks in working capital given the absence of uncommitted bank credit lines; and
-- Forecast annual capital expenditure of about EUR320 million.
The stable outlook reflects our view that Colt will achieve mid-to-low single-digit growth in reported revenues and maintain stable EBITDA margins of around 21% for 2012 and 2013. Furthermore, the outlook reflects our view that Colt will take a prudent approach to shareholder returns or business expansion.
There is capacity for debt incurrence at the current rating, in our view, provided that any leveraging of the group's balance sheet is controlled and implemented relatively gradually, and that adjusted gross debt to EBITDA remains less than 2.0x. However, a rapid increase in leverage to 2.0x, in particular for shareholder distributions, could put pressure on the rating.
The rating could also come under pressure if the forecasted negative FOCF over the next 12-18 months becomes a persistent phenomenon rather than a temporary growth-related event. This could be a result of more aggressive capital investment, or a failure to realize the projected continued revenue growth and at least stable EBITDA margins.
We could consider the possibility of rating upside if Colt is able to demonstrate a track record of continued revenue growth, stable to improving EBITDA margins, and the maintenance of an intermediate financial risk profile. An intermediate financial risk profile is characterized by adjusted gross debt to EBITDA comfortably less than 2.0x, a clear path towards positive FOCF, and maintenance of adequate liquidity.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009