October 23, 2017 / 5:42 AM / in a month

Fitch Affirms SK Telecom, SK Broadband at 'A-'; Outlook Stable

(The following statement was released by the rating agency) SEOUL, October 23 (Fitch) Fitch Ratings has affirmed South Korea-based SK Telecom Co., Ltd.'s (SKT) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) and its senior unsecured rating at 'A-'. The agency has also affirmed its subsidiary SK Broadband Co., Ltd.'s (SKB) Long-Term Foreign- and Local-Currency IDRs and senior unsecured rating at 'A-'. The Outlook on both companies' IDRs is Stable. SKT's rating and Stable Outlook reflect Fitch's view that the company's financial profile will remain commensurate with the current rating level over the next 12 to 18 months despite lower operating cash flow generation as a result of a government-driven monthly tariff discount. SKB's ratings and Outlook reflect the strong operational and strategic linkages with SKT. KEY RATING DRIVERS Short-Lived Margin Improvement: Fitch expects SKT's operating EBITDAR margin to improve temporarily in 2017 before deteriorating gradually from 2018 due to the impact of an unfavourable regulatory change. Margin will expand mainly due to a sizeable reduction in operating losses in its e-commerce business and improvement in the internet-protocol television (IPTV) and media businesses. However, this margin improvement is likely to be offset by the government's plan to lower households' telecom bills by increasing the discount on monthly tariffs to 25% from the current 20%, and support the low-income population by cutting KRW11,000 from their telecom bills. Fitch estimates this tariff cut will reduce SKT's revenue and operating profit by 1%-2% and 10%-13%, respectively, during 2018-2020, and decrease SKT's operating EBITDAR margin gradually to 27% by 2020 from 28.6% in 2017. Solid Non-Telecom Growth: Contraction in fixed-line voice revenue is likely to be sufficiently offset by robust growth in the IPTV and media businesses. Revenue from SKB's IPTV and broadband businesses rose by 24% in 2016 while fixed-line telephony service revenue continued to decline by 18%. We believe that SKB continues to expand its share in the pay-TV market by bundling its IPTV offering with SKT's telecoms services. Revenue from pay-per view television, home shopping and advertising should also rise in tandem with the increase in IPTV subscribers, which will accelerate margin expansion for the non-telecom businesses. Increasing Capex: We think the probably increase in SKT's capex, due mainly to 5G investment, is likely to be manageable within the current rating as long as operating cash flows remain solid, although there is still a high level of uncertainty over the amount of capex after 2018. We believe that SKT's operating cash generation will remain solid with CFO of around KRW3.8 trillion- 4.0 trillion despite of negative impact from the tariff cut. We expect SKT's FFO adjusted net leverage ratio to stay around 1.4x until 2020 (2016:1.4x). We forecast SKB's capex to remain high at around KRW800 billion (2016: KRW714 billion) during 2018-2019 due to the expansion of high-speed internet coverage. We forecast SKB's FFO adjusted net leverage to deteriorate to 2.5x by 2019 from 2.4x in 2016. Weakening Wireless Operation: A decline in SKT's mobile average revenue per user (ARPU) is likely to accelerate with the implementation of the bigger discount for monthly telecom bills and tariff cuts for low-income earners. ARPU has been falling since early 2016 with an increasing number of subscribers taking monthly discounts on telecom bills over one-off subsidies. In addition, the share of long-term evolution (LTE) subscribers in the company's total mobile subscriber base is due to reach 80% (2Q17: 74%) by year-end, which will limit further growth in upselling of more expensive plans. We do not expect the decline in ARPU to be reversed over the medium term. SKB Equalised with SKT: The relationship between SKB and its parent SKT is close enough to align the ratings, under Fitch's Parent and Subsidiary Rating Linkage criteria. SKB's fixed-line operation is of great importance to SKT's market position, particularly with respect to its ability to compete with other integrated operators, such as KT Corporation (A/Stable) and LG Uplus Corporation. In addition, SKT would face reputational risk should SKB fail. Therefore, Fitch believes that SKT is highly likely to provide financial assistance to SKB, if required. DERIVATION SUMMARY SKT's market position is strong. It is the largest wireless operator in Korea with around 49% share of industry subscribers and the second-largest fixed-line operator after KT Corporation (A/Stable) in the oligopoly Korean telecom market. KT Corporation's debt reduction through the sale of non-core businesses led us to upgrade it to 'A' as we expect its FFO-adjusted net leverage to remain below 1.5x in the next five years. Our rating guideline for SKT's upgrade to 'A' is slightly tighter at 1.3x, reflecting SKT's exposure to SK Hynix Co., Ltd, which has lower credit quality due to its cyclical and capital-intensive semiconductor business. This difference in rating guidelines, and our expectation that SKT's financial leverage is likely to be slightly higher than KT's over the medium term because SKT has a larger wireless segment and will be more affected by a tariff cut, give rise to the one notch rating differential between the two. Compared with other telecom peers rated 'A' in the APAC region, such as Singapore Telecommunications Limited (A+/Stable, standalone rating A) and China Telecom Corporation Limited (A+/Stable, standalone rating A), SKT's financial leverage is lower, but it operates in a market with greater competition, higher regulatory risk and has exposure to the lower-rated semiconductor segment. SKT also has narrower operating EBITDAR margins due to higher marketing costs, tougher competition and declining fixed-line telephony services. KEY ASSUMPTIONS SKT (Based on consolidated financials) - Revenue to stay largely flat in 2017 and decrease from 2018, reflecting the negative impact from the tariff cut. However this is partly offset by higher revenue from non-telecom operations, such as media and IPTV - Operating EBITDAR margin to increase in 2017 and decline from 2018 due to the impact of tariff cut - Capex to decrease slightly to around KRW2.9 trillion (cash basis) in 2017 (2016: KRW3.1 trillion) - Free cash flow to be positive in 2017 - Dividend to remain largely stable between 2017 and 2019. SKB - Revenue to increase in the low single digits in 2017 - EBITAR margin to improve with expansion in IPTV business - Capex to increase to around KRW800 billion in 2017 due to investment in infrastructure for the broadband business - Free cash flow to remain at negative in 2017 RATING SENSITIVITIES SKT Developments That May, Individually or Collectively, Lead to Positive Rating Action - FFO-adjusted net leverage below 1.3x on a sustained basis (2016: 1.4x) - No sustained decline in core telecom operating EBITDAR - Positive pre-dividend free cash flow on a sustained basis Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO-adjusted net leverage over 1.8x on a sustained basis - Sustained decline in core telecom operating EBITDAR - Negative pre-dividend free cash flow on a sustained basis SKB Developments that may, individually or collectively, lead to negative rating action include: - An indication of weaker ties or a negative rating action on SKT Developments that may, individually or collectively, lead to positive rating action include: - A positive rating action on SKT LIQUIDITY Solid Liquidity: SKT's liquidity has been improved slightly. Cash and cash equivalents, including short-term investments, of KRW1.9 trillion were sufficient to cover short-term obligations of KRW1.5 trillion, including short-term debt and the current portion of long-term debt at end-June 2017. The company has unused credit lines of KRW440 billion from mostly domestic banks at end-June 2017. We also believe SKT's liquidity profile is aided by its ready access to capital markets when in need of external financing. Contact: Primary Analyst Shelley Jang Director +82 2 3278 8370 Fitch Ratings Australia Pty., Korea Branch 9F Kyobo Securities Building 97, Uisadang-daero, Yeoungdeungpo-Gu Seoul, Korea Secondary Analyst Jeong Min Pak Senior Director +82 2 3278 8360 Committee Chairperson Steve Durose Managing Director +61 2 8256 0307 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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