December 7, 2016 / 10:52 PM / 10 months ago

Fitch Assigns Unitymedia 'B+' Rating; Outlook Stable

(The following statement was released by the rating agency) LONDON, December 07 (Fitch) Fitch Ratings has assigned Germany-based Unitymedia GmbH (UM) a Long-Term Issuer Default Rating (IDR) of 'B+'. The Outlook is Stable. We have also assigned instrument ratings of 'BB+'/''RR1' to the group's secured debt and 'B'/'RR5' to the group's unsecured notes. A full list of rating actions is at the end of this commentary. UM's ratings are supported by the company's strong operating profile including its strong challenger position in consumer and small business broadband markets, solid growth, high earnings and cash flow margins. These factors are offset by an industry structure that remains fragmented with UM covering around a third of the country and limited prospects of further consolidation, along with financial leverage which is relatively high. Fitch's rating case envisages Fitch-defined net-debt-to-EBITDA remaining stable at around 5.5x, a level that is consistent with the rating given the strength of the underlying cash flow and operating profile. KEY RATING DRIVERS Solid Operating Profile UM exhibits strong and improving operating metrics with key measures such as ARPU, broadband additions and market share consistently solid. Revenue generating unit (RGU) per customer trends continue to increase but a metric of 1.78x at September 2016 offers scope for further growth. At the end of September 2016, the company reported 55% of its subscriber base still on a single-play bundle. This metric along with targeted new build and in-building upgrade capex should support growth broadband penetration and ARPUs. LG's experience and expertise in product development - examples including the group-wide roll-out of its Connect WiFi router, Horizon video platform - and experience in content aggregation support service quality. Limited opportunity exists for cost synergies given the already high EBITDA margin reported, although scale economies and the limited marginal cost of up-selling services, could support some margin expansion. Strong Financial Trends, High Leverage UM consistent revenue, EBITDA growth and solid underlying cash flow, are strong for the sector and the rating. Our forecasts envisage sustained results albeit with some FCF dilution given our assumptions on cash taxes and capex. A net-debt-to-EBITDA covenant of 5.5x along with documented carve-outs of certain debt allow for higher leverage than some of LG's other subsidiary credit pools. This drives our assumption that leverage is likely remain at historic levels. Fitch recognises UM's capacity for organic deleveraging, while the cash flows generated across LG's credit pools suggest LG's targeted share buybacks should not impose undue pressure on leverage. Cable Market Not Fully Consolidated Germany's so-called legacy Level 3 / 4 cable structure has in Fitch's view led to a degree of fragmentation and less developed approach to network upgrades and key performance metrics. Nonetheless, UM's footprint covers about 32% of the country's households and therefore has considerable scale. Scale economies are evident in financial performance, while network investment including the upgrade of in-building networks is addressing some of the industry's former structural complexity. UM's nascent mobile base is important in terms of churn management, albeit we consider the German mobile market remains competitive despite market consolidation. Competitive but Rational Market Cable is expected to maintain its broadband speed advantage given Deutsche Telekom's VDSL-focused fibre strategy and the evolving capabilities of DOCSIS technology. The German cable industry is growing faster than the market average as it is taking market share in telephony and broadband with scope to upsell bundled services. This is likely to support continued growth in UM's broadband subscribers given trends in bandwidth demand. Fixed-line revenues in Germany are growing in low single digits. Vodafone's presence in German fixed line, alongside Deutsche Telekom, and the relatively unconsolidated nature of the cable industry, in Fitch's view support a competitive but rational market structure. Instrument Ratings and Recoveries Fitch applies a bespoke and going concern approach to recoveries in the case of UM - refer to our criteria 'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers', dated 7 April 2016. The capital structure is similar to those across the Liberty Global group portfolio with the business financed largely by senior secured debt and a smaller layer of unsecured debt. The weighting of secured debt in the structure leads to an RR1 recovery for the super senior revolving credit facility, as well as the senior secured instruments, both categories of which are rated three notches above the IDR at 'BB+'. The recovery rating on the unsecured debt is 'RR5' and the instrument rating at 'B' is one notch lower than UM's IDR. DERIVATION SUMMARY UM's operating and market position compare well relative to similarly leveraged European telecoms peers. The company has stronger revenue growth and cash flow generation than many of its peers, and has a good organic deleveraging capacity. Its relatively low funding costs and continued growth expectations, in Fitch view, are likely to ensure that parent company, Liberty Global, maintains slightly higher leverage at UM than at Telenet or Virgin Media - both rated 'BB-/Stable'. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Unitymedia include: - Mid single-digit revenue growth in 2016 - 2017; slowing thereafter as the market matures. - Adjusted EBITDA margin in 2016-2018 of around 62% - Cash taxes, rising from around EUR15m in 2016 to above EUR40m by 2019. - EUR600m-EUR650m of accrual capex per year as network and customer premises infrastructure is upgraded. - Cash distributions in the form of shareholder loan payments in line with available free cash flow and a bank covenant of up to 5.5x total net debt to annualised EBITDA. RATING SENSITIVITIES Future developments that may, individually or collectively, lead to positive rating action include: - FFO-adjusted net leverage lower than 5.0x (5.7x at end 2015) on a sustainable basis, with strong and stable FCF generation, reflecting a stable competitive and regulatory environment. Future developments that may, individually or collectively, lead to negative rating action include: - FFO-adjusted net leverage above 5.5x (5.7x at end 2015) on a sustainable basis. - FCF margin consistently below 10% (22% at end 2015). LIQUIDITY Sound Liquidity Liquidity is provided by undrawn bank lines - the group has an EUR80m super senior RCF due 2020 and EUR420m senior secured RCF due 2020 both fully available based on September 2016 compliance reporting. Underlying cash flow generation is strong although Fitch expects available cash to be upstreamed to parent company, LG subject to group leverage. FULL LIST OF RATING ACTIONS Unitymedia GmbH Long-Term Issuer Default Rating: assigned 'B+', Outlook Stable Senior notes: assigned 'B; recovery rating 'RR5' Unitymedia Hessen GmbH & Co KG Super senior revolving credit facility: assigned 'BB+'; recovery rating 'RR1' Senior secured revolving credit facility: assigned 'BB+'; recovery rating 'RR1' Unitymedia Hessen GmbH & Co. KG and Unitymedia NRW GmbH as co-issuers Senior secured notes: assigned 'BB+'; recovery rating 'RR1' Contact: Principal Analysts Slava Bunkov Director +7 495 956 9931 Brendan Condon Director + 44 203 530 1599 Supervisory Analyst Stuart Reid Senior Director +44 20 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN] Committee Chairperson Damien Chew, CFA Senior Director +44 20 3530 1424 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Summary of Financial Statement Adjustments - Fitch applies a weighted multiple of 6.5x for operating lease capitalisation purposes instead of the standard 8x for Germany. The multiple reflects company guidance with respect to the proportion of leases related to assets with a short term economic life and leases relating to energy and telecoms capacity; the latter considered to have a shorter economic life than more typical long term assets. 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