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Fitch Rates Liquid Telecom's Proposed Tap Issue 'B+(EXP)'
November 6, 2017 / 1:42 PM / a month ago

Fitch Rates Liquid Telecom's Proposed Tap Issue 'B+(EXP)'

(The following statement was released by the rating agency) LONDON, November 06 (Fitch) Fitch Ratings has assigned South Africa-based Liquid Telecommunications Holdings Limited's (Liquid Telecom; B+/Stable) proposed tap issue of the company's US dollar 2022 senior secured notes expected ratings of 'B+(EXP)'/'RR4(EXP)'. The tap issue will carry the same terms and conditions as the existing USD550 million senior secured notes due 2022. The notes will be issued by Liquid Telecommunications Financing plc, a wholly owned subsidiary of Liquid Telecom, and will be guaranteed on a senior basis by the latter and its certain subsidiaries. The gross proceeds from the issue are expected at USD180 million. The company intends to use the proceeds to repay outstanding USD146 million rand and dollar loans under a term loan facility and for general corporate purposes. As part of the transaction the company will amend its existing USD55 million revolving credit facility (RCF) to provide for drawings up to 10% of the sum of the principal amount of the notes. The final ratings on the proposed bonds are contingent upon the receipt of final documents conforming to information already received. KEY RATING DRIVERS Robust Performance: Liquid Telecom's 1H18 results were in line with Fitch's expectations. Following the acquisition of Neotel the group reported significant year-on-year growth across all key divisions. On a pro-forma basis, revenue and EBITDA increased 6.7% and 12.5% yoy, respectively. Operational performance was driven by high-margin divisions - enterprise and retail - which offset the low but improving Neotel margins and declining wholesale voice margins. Fitch expects demand for data, storage and bandwidth to continue supporting growth in enterprise and retail, as well as in operational strengths such as Cloud services and content delivery. High Capex Weakens Free Cash Flow: High capex scheduled for FY18 and FY19 (financial year ends in February) is part of Liquid Telecom's plan to turn around Neotel and to expand the company's network to support continued revenue growth. We expect these investments to be funded by upfront payments from anchor customers as well as external financing, with the payback period likely to be over four years, leading to short-term FCF pressures. The potential to increase dividend distributions may also weaken the liquidity profile. In a case of slower top-line growth, we believe the company has the flexibility to hold back expansionary capex to maintain a more neutral FCF profile Emerging-Market Risks: A large portion of the group's revenue (48% in FY17) is generated in South Africa (BB+/Stable), which has been subject to weak GDP growth. The rest of the group's revenue is generated in countries such as Zimbabwe, Kenya (B+/Negative) and Zambia (B/Negative), which have relatively weak operating environments. Regulatory uncertainty in these jurisdictions can have a negative impact on Liquid Telecom's business profile. Our sensitivity guidance for Liquid Telecom has been set tighter than for peers operating in developed markets to reflect these emerging-market risks. A majority of US dollar revenue is collected in the UK and Mauritius, reducing currency transfer and convertibility risks. Strategic Partnerships to Support Growth: Liquid Telecom strengthened their position as a cloud service provider (CSP) through the initiation of their partnership with Microsoft. Additionally, an acquired ownership in Econet Media Ltd (EML) opens full access to the latter's content library, including Netflix and over 100 other channels. The distribution arrangement includes a revenue-sharing agreement, which management expects to contribute an approximate USD25 million in additional EBITDA over five years. Fitch expects such value-adding services to increase growth opportunities within Liquid Telecom's enterprise, retail and wholesale divisions. Solid Business Model: Liquid Telecom's 'B+' rating reflects a robust business model with a unique fibre footprint offering cross-border telecommunication connectivity in southern, eastern and central Africa. Higher demand for data, storage and bandwidth provides future growth opportunities for Liquid Telecom's enterprises and wholesale data divisions. The addition of Neotel's network in South Africa has enhanced Liquid Telecom's competitive position. Limited Substitution Threat: Liquid Telecom's market-leading position is underpinned by a unique cross-border fibre network spanning 13 countries in Africa, with limited substitution threat from alternative network operators. The company is able to add new customers at low marginal costs once network capacity has been put in place. The business model is supported by long-term contracts with global and regional enterprises and telecoms operators where we see a history of low customer churn rates. Favourable Market Trend: The African telecommunications market is growing on the back of an increase in data traffic from an increasing number of connected devices and higher broadband speeds as internet penetration and mobile network coverage improve. Expansion of IT applications in end-markets such as finance, healthcare and media should support this growth. We believe Liquid Telecom is well-placed to benefit from this favourable market trend and we do not foresee any sharp reversal as long as the overall African economic backdrop remains stable. Exposure to FX Volatility: Liquid Telecom's cash-flow profile is subject to some FX volatility, with revenue derived in South Africa denominated in rand and a large proportion of the remaining revenue denominated in US dollars. We estimate that the majority of costs are denominated in local currency, leaving a major part of EBITDA linked to the US dollar. Overall, we estimate that a 25% adverse move in the dollar/rand would only increase our FFO adjusted net leverage metric by 0.1x. DERIVATION SUMMARY Liquid Telecom's business profile compares best with US peers Level 3 Communications, Inc. (BB/Stable) and Zayo Group, LLC. Liquid Telecom benefits from long-term customer relationships, strong network coverage and favourable industry trends. While the growth opportunity is greater in Africa than in developed markets, Liquid Telecom operates in countries in which the economic and regulatory environment can be unstable. Liquid Telecom's FX mismatch between cash flow and debt could lead to some volatility in credit metrics should there be material changes in its key currency pair dollar/rand. The company's FCF profile is constrained by high levels of capex over the next two years. Following the Neotel acquisition and taking into account the proposed refinancing, we expect Liquid Telecom's credit metrics to be weaker than those of Level 3 Communications but stronger than those of Zayo Group. We highlight the company's exposure to emerging markets as the key differentiating factor from its sector peers. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: -Moderate compound annual growth in revenue of over 5% in FY17-FY20 (pro forma for Neotel), supported by growth in enterprises and wholesale data mitigated by wholesale voice, which is subject to pricing as well as volume pressures; -Operating EBITDA (before income from associates) margin of 28% in FY17 (pro forma for Neotel), improving to 32% in FY20; -Capex as a percentage of revenue of 25%-30% in FY18 and FY19, declining to below 20% in FY20; and -Dividends paid of around USD13 million per year in FY18 and beyond. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Successful implementation of the business strategy, including a turnaround of Neotel, with an improvement in operating performance leading to funds from operations (FFO) adjusted net leverage sustainably below 3.0x; and FCF margin of 3%. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action Material deterioration in operating performance leading to FFO adjusted net leverage sustainably above 4.0x; and negative FCF margin leading to liquidity pressure. LIQUIDITY Satisfactory Liquidity: Following the refinancing the company should have an improved debt maturity profile with only a large debt repayment in 2022. Existing cash on the balance sheet (USD77 million at end-1H18) combined with access to a USD55m RCF (to be increased in refinancing deal) should be sufficient to cover negative FCF driven by high expansionary capex. Excess proceeds from the refinancing should also improve the company's cash position. There are operating challenges with the company's subsidiary in Zimbabwe (around 15% of revenue), in which cash is subject to transfer and convertibility risks. We treat Liquid Telecom's cash in Zimbabwe as restricted and exclude it from our net leverage calculations. Contact: Principal Analyst Joe Howes Analyst +44 20 3530 1382 Supervisory Analyst Slava Bunkov Director +7 495 956 9931 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chairperson Damien Chew, CFA Senior Director +44 20 3530 1424 Date of Relevant Rating Committee: 17 July 2017 Summary of Financial Statement Adjustments - Lease-equivalent debt was calculated using an operating lease multiple of 6.0x for property and 4.3x for network equipment. The blended operating lease multiple was 5x. Cash of USD35 million held in Zimbabwe and bank guarantees of USD12 million are treated as restricted. 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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