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Fitch Downgrades Global Cloud Xchange to 'B-'; Outlook Negative; Bond to 'B+'
July 13, 2017 / 6:02 AM / 5 months ago

Fitch Downgrades Global Cloud Xchange to 'B-'; Outlook Negative; Bond to 'B+'

(The following statement was released by the rating agency) SINGAPORE/HONG KONG, July 13 (Fitch) Fitch Ratings has downgraded Global Cloud Xchange Limited's (GCX) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to 'B-' from 'B+'. The Outlook is Negative. Fitch has also downgraded the rating on GCX Limited's USD350 million 7% senior secured notes due 2019 to 'B+' with a Recovery Rating of 'RR2' from 'BB+/RR1'. GCX Limited is a wholly owned subsidiary of GCX. The notes are secured by the assets and equity interests of GCX and its key subsidiaries and are guaranteed by GCX and its key operating subsidiaries, which generate most of group's revenue and EBITDA. The downgrades reflect our expectations that GCX's liquidity could weaken significantly in the financial year ending March 2018 (FY18). GCX's cash balance could deplete to below USD40 million in FY18 (FY17: USD62 million) due to lower indefeasible right of usage (IRU) sales, weakness at its managed service segment and working capital outflows. We forecast FFO-adjusted net leverage to deteriorate to over 5.0x in FY18 (FY17: 4.2x). The 'RR2' Recovery Rating indicates superior recoveries on the senior secured notes in a default scenario - between 71%-90% - based on our prudent estimate of value that would be available to creditors. The Negative Outlook reflects near-term risks to the credit profile, in particular the risk of persistently negative FCF, deteriorating liquidity, and therefore higher refinancing risk of the bond due in August 2019. A revision of the Outlook to Stable would be contingent upon an improvement in GCX's cash generation due to high IRU sales or improvement in receivable collections such that FCF breaks even. In case GCX's IDR is downgraded to 'CCC', the bond rating will be downgraded by two notches to 'B-' as instruments cannot be rated 'CCC+' under Fitch's criteria. KEY RATING DRIVERS Depleting Cash Balance: We expect GCX's cash balance in FY18 to drop below USD40 million, the minimum it needs to meet financial and operational commitments. It needs a minimum cash balance of USD40 million-50 million to meet its interest expense of USD25 million, maintenance capex of USD22 million and taxes of USD3 million. Cash EBITDA could decline to around USD70 million (FY17: USD78 million) due to lower IRU sales of around USD50 million (FY17: USD51 million) and weakness at its managed service segment. FCF Deficit: Fitch forecasts GCX to have negative FCF of USD30 million-35 million in FY18, as cash flow from operations may fall short of our capex estimate of around USD30 million and dividend payments of USD15 million. GCX paid USD15 million in dividends in FY17. Capex includes maintenance expenditure of USD22 million and USD6 million-8 million to invest in its Indian enterprise business and expand landing stations. Management does not intend to pay any dividends and make any capex for the Indian enterprise business in FY18. Higher Counterparty Risk: GCX's faces higher counterparty risk due to uncertainty over collection of receivables, mainly from its parent Reliance Communications Limited (Rcom; RD), with which it has about USD30million-35 million worth of trading relationship in FY18-19. We assess GCX's IDR based on its standalone profile under our Parent and Subsidiary Rating Linkage criteria, due to weak legal, operational and strategic linkages with its parent. We understand that Rcom may be looking to sell all or part of its stake in GCX. GCX's cash flows are ring-fenced and dividends to Rcom are subject to an incurrence test of debt/EBITDA of below 3.75x (FY17: 3.0x) and restricted payment covenants. However, GCX is allowed to pay about USD10million-15 million in dividends annually under the ring-fencing conditions. Enterprise Venture is Credit Negative: We believe that GCX's entry into the enterprise telecommunications market in India is negative for its credit profile as we expect minimal additional FCF during FY18-19. Rcom will assign GCX enterprise assets, including an intra-city fibre network, worth USD90 million to partly pay its USD94 million of receivables due to GCX at end-March 2017. GCX is still waiting to obtain unified telecom licence approval from the Indian telecom regulator. Chronic Industry Over-Capacity: EBITDA remain vulnerable to chronic industry over-capacity, which has resulted from bandwidth increases from new submarine cables added by "over-the-top" operators and telecommunication companies. Also, technological advancements continue to improve the capacity of existing cables. Hence, bandwidth tariffs will continue declining over the medium term despite increased demand. Recovery Rating of 'RR2': The rating on GCX Limited's senior secured guaranteed bond is now two notches higher than the IDR. We use the going-concern value approach to calculate the post-restructuring enterprise value as the liquidation approach is not appropriate given GCX's under-sea cable assets are of little use if liquidated. We estimate post-restructuring cash flow to be around USD74 million - the same as at our last review - which assumes depletion of the current business position to reflects the distress that provoked a default, and a level of corrective action that would have occurred during restructuring. We have assumed a lower cash flow multiple of 4.5x instead of earlier 5.0x as we believe that Rcom may settle for lower value for GCX given the parent's weak liquidity and cash requirements. The adjusted going-concern enterprise value after administrative claims of USD300 million is then applied to USD380 million owed to creditors, comprising an undrawn revolving credit facility of USD30 million and USD350 million of secured notes. DERIVATION SUMMARY GCX is smaller and has a weaker market position than US-based Level 3 Communications, Inc. (LVLT, BB/Stable). LVLT, with its strong position in the US enterprise market and solid network capabilities, generates FCF of over USD1 billion compared with the consistently negative FCF for GCX. LVLT is committed to deleverage to the low end of its net leverage target of between 3.0x and 4.0x, while we expect GCX's leverage to worsen to over 5.0x in FY18. GCX's ratings reflect its worsening liquidity profile due to weaker cash generation. GCX also has a weaker business risk profile because its cash generation is exposed to lumpy IRU sales. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue to remain flat in FY18 - Fitch's calculated cash EBITDA of around USD70 million-75 million with IRU sales of USD50 million - Working capital outflow of USD30 million-35 million during FY18 - Dividends of USD15 million to Rcom in FY18 - Annual capex of around USD30 million - Recovery analysis used a going-concern value approach with post-restructuring EBITDA of USD74 million and cash flow multiple of 4.5x. - 10% administrative claims are applied on the going-concern value. RATING SENSITIVITIES Developments That May, Individually or collectively, lead to the Outlook reverting to Stable - An improvement in GCX's cash generation and receivable collection such that FCF breaks even. Developments That May, Individually or Collectively, Lead to Negative Rating Action - Deterioration of liquidity evidenced by cash balance falling below USD40 million. - FFO-adjusted net leverage deteriorates to above 6.0x (FY18 forecast: above 5.0x) LIQUIDITY Deteriorating Liquidity: We expect GCX's unrestricted cash balance to deplete to below the minimum critical level of USD40 million (FY17: USD62 million) in FY18. Its only debt is the USD350 million secured note due in 2019. GCX has committed undrawn facilities of USD30 million, of which USD10 million was drawn in March 2017 but was paid back in May 2017. Its ability to access additional debt is limited due to an incurrence covenant in its bond indenture that limits debt/EBITDA to 3.75x. Contact: Primary Analyst Nitin Soni Director +65 6796 7235 Fitch Ratings Singapore Pte Ltd. One Raffles Quay, South Tower #22-11 Singapore 048583 Secondary Analyst Kelvin Ho Director +85 2 2263 9940 Committee Chairperson Steve Durose Managing Director +61 2 8256 0307 Media Relations: Bindu Menon, Mumbai, Tel: +91 22 4000 1727, Email:; Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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