August 10, 2017 / 8:40 PM / a year ago

Fitch Places Coltel's Ratings on Rating Watch Negative

(The following statement was released by the rating agency) CHICAGO, August 10 (Fitch) Fitch Ratings has placed the following ratings of Colombia Telecomunicaciones S.A. ESP (ColTel) on Rating Watch Negative: Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR), its senior unsecured notes, rated 'BB-', and its subordinated perpetual notes, rated 'B'. The Negative Watch reflects increased pressure on ColTel's already weak liquidity position due to the negative arbitration ruling in force since Aug. 8, 2017, related to the concession assets from 1994, which requires the company to pay a COP1.6 trillion arbitration verdict (equivalent to 160% of the capex projected by the company in 2017). The company is negotiating payment terms with the Ministry of Telecommunications (MinTic) to minimize the negative cash flow impact. A short deferral period without any material payment-in-kind arrangements will be negative for the ratings. Also, any material delay in the recapitalization plan due to the arbitration ruling will be critically negative for the ratings. The Rating Watch will be resolved based on the final terms of the arbitration payment agreement and the progress on recapitalization. ColTel's tight liquidity condition and constrained financial flexibility, due to piercing of an incurrence covenant, remain unresolved. Its weak cash flow generation forced it to postpone COP170 billion in PARAPAT payments during March through June 2017. An additional waiver was approved for COP170 billion for the July through October 2017 time period. These PARAPAT arrears must be paid with interest by no later than Oct. 31, 2017. The company has additional permitted debt of only USD92 million as of June 30, 2017. Future ratings actions will depend on the payment terms for the arbitration verdict and the timeliness of the capitalization. Fitch believes ColTel cannot afford further delays in the implementation of its planned capital injection, which is necessary to turn around its weak cash flow generation. ColTel's ratings will be downgraded should the company fail to show meaningful measures to improve its weak financial position in the short term. KEY RATING DRIVERS EBITDA Performance Improvement: ColTel's EBITDA increased by 7.1% during the six-months as of June 2017, compared to the same period in 2016 and its EBITDA margin expanded to 32% from 30%. The margin expansion is a result of the company's efforts to increase prices for some of its services during the fourth quarter of 2016 and first half of 2017 which helped achieve a 2.6% revenue increase as of June 2017, year over year, just over the increase in costs and expenses of 0.1% during the same period. Fitch expects the company's ability to adjust prices going forward to be more limited given the fierce competitive landscape and relatively weaker GDP growth expected in the near term. Fitch also expects ARPU pressure to continue in its mobile operation. Fitch expects EBITDA growth to be modest given the expectation of a slow diversification from voice revenues to non-traditional services, keeping ColTel's margins close to 31% in 2017-2019. Future cash outflow for the payment of the arbitration verdict, whether it is in cash or as payment-in-kind (capex), will be negative to ColTel's competitiveness given that it will likely lead to a reduction in core capex, which is focused on strengthening and expanding network quality. Fitch estimates that, regardless of the payment arrangement, the company will have to allocate a part of its investment funding to pay for the arbitration consideration, which in Fitch's view can negatively impact its competitive position. Cash Flow Performance Hinges on Capitalization: ColTel's negative FCF generation will not turn around in the short- to medium-term unless the company is recapitalized. Under the current capital structure, the cash outflow burden related to its PARAPAT payments remains high. ColTel's CFFO stood at COP875 billion as of LTM June 2017 because the company received a waiver on its PARAPAT payments in 2017. With these payments, adjusted CFFO would have been COP700 billion during this period. With the recapitalization, FCF is expected to be positive and average close to COP130 billion in 2017-2019. High Leverage due to PARAPAT: ColTel's leverage is high for the rating category. Fitch's calculation of net debt-to-EBITDA (including PARAPAT debt, 50% of the perpetual bond and the hedging of FX risk) remained above 5x as of June 2017, while the leverage ratio calculated under the 2022 USD750 million senior bond covenant (which includes 100% of the perpetual bond, excludes the PARAPAT debt but adjusts EBITDA by subtracting LTM PARAPAT payments), stood at 4.3x during the same period. Fitch expects ColTel's leverage to fall close to 3x if the capitalization takes place. Weakening Competitive Position: ColTel had yet to show meaningful growth in its high-ARPU products, such as broadband (UBB) and HD-TV, which would improve its EBITDA and achieve higher revenue diversification. The contribution from its pay-TV service remained at just 6% of total sales as of June 2017, significantly lower than its 10% target. On UBB the company lost market share due to limited ability to bundle services and lower speeds than what the competition can offer. Fitch expects ColTel's capex intensity to fall from an average of 23.8% in 2012-2016 to approximately 18% in 2017-2019 if the recapitalization is successful. The company plans to optimize its capex primarily focusing on deploying its fiber-to-the-home (FTTH) network and plans to increase home passes (HPs) to 203,000 by FY2018 while HP are expected to reach 109,000 as of FY 2017. It may prove difficult for ColTel to double HPs in the short term - a situation that would continue to negatively impact its fixed operation and, as a result, its competitive position. Equity Remains Negative: ColTel's equity has remained in negative territory as of June 2017 (-COP 1.4 trillion once the perpetual bond is adjusted for 50% equity credit), pointing to the need to find a structural and permanent solution to the capital structure of the company. ColTel was already forced to implement a major restructuring of the PARAPAT obligation in 2012, when it became evident that EBITDA performance was not sufficient to absorb PARAPAT payments agreed to in the Investment agreement signed between Telefonica and ColTel in 2006. The EBITDA underperformance during 2006 - 2011 led the government to assume 48% of the total PARAPAT consideration (estimated then at USD3 billion) and leaving ColTel to assume the remaining 52%. However; the remaining PARAPAT obligation following the restructuring has proven to be too large an obligation for ColTel's cash generation capacity. In 2015 ColTel adopted the IFRS accounting standard which required registering the PARAPAT obligation on its balance sheet. This drove the company's equity position into negative territory, requiring the issuance of a deeply subordinated bond to bring the equity position back to positive numbers. However: the continuing deteriorating financial results have again created a negative equity position as of June 2016, begging the need for a structural solution that ensures a sustainable capital structure. DERIVATION SUMMARY Coltel's financial profile is weak compared to other 'BB' category telecom operators in the region. Empresa de Telecomunicaciones de Bogota, S.A., E.S.P. (ETB), which is rated 'BB+'/Negative and is a direct competitor to ColTel in Colombia, boasts significantly lower leverage than Coltel, although its narrow breadth of service offerings offsets the strength to an extent. Also, the company financial profile is materially weaker than Millicom's operating subsidiaries in Guatemala and Paraguay, which are both rated 'BB+'/Stable. While Coltel's current liquidity profile, leverage, and cash flow generation are deemed weaker than Cable & Wireless Communications Limited, VTR Finance, and Axtel S.A.B. de C.V., which are all rated 'BB-', its pro forma financial profile as far as capitalization will place the company's financial profile more in line with a 'BB' category. No parent-subsidiary, and operating environment factors were considered in the rating. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Coltel include: -The capitalization is expected to take place in September 2017; -Waved PARAPAT payments are paid with the capitalization; -Leverage after capitalization remains approximately 3x in 2017-2019. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -A positive rating action is unlikely absent the perfection of the capital structure in the short term. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Failure to improve its current precarious capital structure and liquidity profile. -Continued profitability deterioration due to competitive pressures and slow growth in its non-traditional business segments. -Negative FCF generation amid persistently high PARAPAT payments -Adjusted net leverage, excluding the PARAPAT liability to remain above 3x on a sustained basis. -Adjusted net leverage, including the PARAPAT liability to remain above 5x on a sustained basis. -An unfavorable (i.e. below management expectations) payment agreement with MinTic to honor the recently awarded arbitration verdict. LIQUIDITY ColTel's liquidity remained weak as of June 2017 when cash balances, including short-term investments, fell to COP87 billion from COP215 billion in 2016, representing just 8% of short-term debt obligations of COP1,157 billion, an amount that includes COP692 billion associated with the PARAPAT consideration. If the mark to market asset derivative position that could be unwound during the second half of 2017 is considered, then the company could obtain additional cash resources of approximately COP500 billion. Although ColTel reported COP309 billion in available lines of credit as of March 2017, the company cannot draw a significant amount from this liquidity backup as the piercing of its 2002 bond leverage covenant threshold (3.75x) continues. The company's financial flexibility has diminished following its crossing of the 3.75x leverage incurrence covenant under the 2022 bond indenture as of March 2016 and as a result can only take additional debt to a maximum of USD300 million. As of June 30, 2017, USD207.6 million out of the permitted USD300 million additional debt was drawn from its credit facilities. The limited headroom for additional debt imposes a material financial constraint to meet financial obligations and simultaneously fund its capex strategy. Further delays in the capitalization of the company to pay down its PARAPAT liability could lead to an important reduction in capex execution in the short term, postponing the deployment of its FTTH investment strategy further weakening its competitive position. FULL LIST OF RATING ACTIONS Fitch has placed the following ratings on Rating Watch Negative: Colombia Telecomunicaciones S.A. ESP --FC IDR at 'BB-' --LC IDR at 'BB-'; --2022 notes at 'BB-'; --Subordinated bond at 'B'. Contact: Primary Analyst Alvin Lim, CFA Director +1-312-368-3114 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Julio Ugueto Associate Director +571-484-6770 Ext. 1038 Committee Chairperson Joseph Bormann, CFA Managing Director +1-312-368-3349 Date of Relevant Rating Committee: Aug. 9, 2017. Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are as follows:. --Subordinated perpetual bond is adjusted for 50% equity credit. --Financial Debt is adjusted for derivative position. 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