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Fitch Affirms Sunrise Communications Holdings at 'BB+'; Outlook Stable
September 18, 2017 / 4:34 PM / a month ago

Fitch Affirms Sunrise Communications Holdings at 'BB+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, September 18 (Fitch) Fitch Ratings has affirmed Sunrise Communications Holdings S.A.'s (Sunrise) Long-Term Issuer Default Rating (IDR) at 'BB+' with a Stable Outlook. Fitch has also affirmed Sunrise's and Sunrise Communications AG's senior secured debt ratings at 'BBB-'. A full list of rating actions is at the end of this commentary. Sunrise's ratings reflect its sufficiently scaled and stable position in the Swiss mobile market. These underpin the company's cash flow generation, which is supported by a small but gradually increasing market share in the fixed line segment. A focus on cost control and improving sales mix are driving improvements in EBITDA. Combined with the sale of tower assets, this is leading to leverage improvements that are likely to build headroom within the company's rating. Given the competitive dynamics in the Swiss telecoms market, the improved headroom increases Sunrise's financial flexibility and ability to manage potential operational risks. KEY RATING DRIVERS Stable Position, Competitive Market: Sunrise has a stable, number two position in the Swiss telecoms market. Around two-thirds of total group revenues and a greater proportion of profits are driven by mobile services. We estimate Sunrise has gradually increased its mobile service revenue share to around 22.5% from 21.5% over the past five years. The company is likely to sustain its competitive position in mobile given its focus on network quality, convergent product and multi-brand strategy. However, we expect the market to remain competitive due to Swisscom's dominant position, turnaround plans at third operator Salt and footprint expansion plans by UPC. Fixed Line Improving: Sunrise has around a 10% share of the Swiss fixed broadband market. The unit, including voice services, accounted for 29% of revenues in 1H17 (excluding hubbing). Revenues in the fixed line unit have historically declined due to competition and structural decline in the sector. The introduction of wholesale fibre-based, multi-play products, a state of the art TV platform and end-to-end service focus is helping Sunrise grow its customer base and moderate the decline, which slowed to -2.4% YoY in 1H17 from -5.7% in 2016 (excluding hubbing). It is likely that ongoing improvements will continue albeit gradually due to a lack of customer liquidity in the market. EBITDA Profile Turning: Sunrise's EBITDA increased by 1% YoY in 1H17. The increase reversed a long period of decline that averaged 4% between 2014 and 2016. The improvement is a result of margin expansion driven by a combination of factors. These include cost reduction, improvements in customer mix, subscriber growth, the launch of convergent products and reducing incremental impact from structural factors in the sector such as OTT in mobile. Our base case forecast assumes gradual improvements in EBITDA are likely to continue. However, we remain cautious about the pace of growth ahead of any potential competitive reaction to Sunrise's recent success. Tower Sale Maintaining Comparability: Sunrise announced the sale of its passive tower infrastructure to a consortium led by Cellnex Telecom for an EV of CHF500 million. As part of the transaction, Sunrise has entered into a long-term service agreement with Cellnex for the provision of infrastructure services. The service nature of the contract with Cellnex means that operating lease rental obligations associated with the sold passive infrastructure will no longer be classified as such under IFRS, resulting in a decline in reported operating lease costs that affect Sunrise's adjusted gross debt. To maintain the comparability of ratings between issuers in the sector, Fitch has reclassified a proportion of the service cost paid to Cellnex for the use of the sold infrastructure as an equivalent to an operating lease expense. As a result of the reclassification, Fitch has increased Sunrise's pro-forma annual lease rental expense by around CHF18 million to CHF117 million. The adjustment is based on our estimate of the annual incremental cost of replicating the non-service elements of the sold assets (see below). As per Fitch's criteria for rating non-financial corporates, operating lease obligations in Switzerland are capitalised by a multiple of 9.0x. Tower Sale Improves Leverage: Sunrise has used CHF450 million of proceeds from the sale of its tower infrastructure to reduce debt. This has off-set a pro-forma increase in adjusted debt of CHF167 million compared with 2016 as a result of Fitch's adjustment to operating lease expense, as detailed above. The net result is an expected decrease in pro-forma total gross adjusted debt by around CHF280 million and an improvement in funds from operations (FFO) adjusted net leverage by a factor of 0.2x-0.3x. Combined with improvements in EBITDA and interest costs, we project Sunrise's FFO adjusted net leverage is likely to reduce to 3.3x in 2018 from 3.8x in 2016. Dividend Policy Retains FCF: Sunrise has a flexible dividend policy based on a 65% pay-out ratio of its equity free cashflow (FCF). The company is targeting a pay-out ratio of 85% once net debt to adjusted EBITDA below 2.0x. Our base case forecasts indicate that it is likely that this will be reached over the next 12 to 24 months, leading to a potential increase in dividend payments. Nonetheless, Sunrise is likely to improve its FCF margin to around 2% by 2018 and generate between CHF30 million-CHF40 million of retained FCF per year. The flexibility in the dividend payment is an important element of Sunrise's rating as it provides flexibility to manage operational risks. DERIVATION SUMMARY Sunrise's rating reflects its predominantly mobile-centric operating profile that drives a majority of the company's profits and its challenger position in a market that is dominated by incumbent Swisscom. Sunrise has demonstrated historic stability in service revenue market share, some flexibility in dividend policy and improving leverage headroom within the rating support the company's strong 'BB+' rating. Higher rated peers in the sector have stronger operating profiles as a result of greater mobile only in-market scale and lower adjusted net leverage metrics such as Telefonica Deutschland Holdings AG (BBB/Positive) or have strong domestic positions in both mobile and fixed with the ownership of local loop infrastructure such as Royal KPN N.V. (BBB/Stable) or TDC A/S (BBB-/Stable). Operators such as VodafoneZiggo Group B.V (BB-/Negative) and Wind Tre S.p.A (B+/Stable) have relatively stronger domestic positions but manage leverage at higher levels. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Low single digit revenue decline in 2017 with 0% to 1% growth thereafter. - Broadly stable EBITDA margin around 32%. - Capex (excluding spectrum)-to-revenue of 17% in 2017 declining to around 14% thereafter. - Dividend payments of CHF150 million in 2017 and 85% of pre-dividend FCF from 2019. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - FFO-adjusted net leverage below 3.0x (2016: 3.8x) - FFO fixed charge cover above 3.7x on a sustained basis (2016: 4.4x) Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Failure to reduce FFO-adjusted net leverage to 3.5x on a sustained basis - FFO fixed charge cover below 3.2x on a sustained basis - Loss of service revenue market share or expectations of negative free cash flow, excluding spectrum payments, in the next two years LIQUIDITY Comfortable Liquidity: We expect Sunrise to generate between CHF30 million to CHF40 million of FCF per annum and has an undrawn revolving credit facility of CHF200 million that matures in 2020. Cash and equivalents amounted to CHF159 million (1H17). The combination of internal cash generation and available revolving credit facilities comfortably cover short-term debt liabilities of CHF7.3 million. FULL LIST OF RATING ACTIONS Sunrise Communications Holdings SA --Long-Term IDR: affirmed at 'BB+' ; Outlook Stable --Senior secured notes due 2022: affirmed at 'BBB-' Sunrise Communications AG --Term loan B facility due 2022: affirmed at 'BBB-' Contact: Principal Analyst Irina Andrievskaia Associate Director +44 20 3530 1715 Supervisory Analyst Tajesh Tailor Senior Director +44 20 3530 1726 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Nikolai Lukashevich, CFA Senior Director +47 495 956 9931 Summary of Financial Statement Adjustments - Fitch has increased Sunrise's lease rental expense by CHF 18 million as of 2018 from CHF 99 million in 2016. The adjustment effects Sunrise's estimated off-balance debt, leading to a pro-forma increase of CHF 167 million compared to 2016 and is in line with Fitch's criteria for capitalising operating lease expense. Due to limited information disclosure for IFRS requirements, the adjustment represents an estimate by Fitch of the incremental cost of replicating the non-service elements of the sold tower infrastructure. Fitch has made the adjustment to maintain the comparability of Sunrise's rating with its sector peers. The treatment under IFRS is different. Under IFRS, all of Sunrise's sold infrastructure can be classified for use by Sunrise as a service and not an operating lease. This is due to the nature of the legal contract between Sunrise and the acquiring party, Cellnex Telecom. As result of the IFRS classification, Sunrise's reported operating lease expense will be lower than Fitch's estimated adjustment. - Fitch has included Indefeasible Right of Use costs within its capital expenditure costs. These are otherwise reported as part of cashflow from financing activities by Sunrise. Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@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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