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Fitch Affirms Digicel at 'B'; Outlook Stable
May 24, 2017 / 9:12 PM / 7 months ago

Fitch Affirms Digicel at 'B'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, May 24 (Fitch) Fitch Ratings has affirmed at 'B' the Long-term Foreign-currency Issuer Default Ratings (IDR) of Digicel Group Limited (DGL) and its subsidiaries, Digicel Limited (DL) and Digicel International Finance Limited (DIFL), collectively referred to as Digicel. The Rating Outlook is Stable. Fitch has also affirmed all existing issue ratings of Digicel's debt instruments. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS Digicel is a diversified telecom operator, with its operational footprints across the Caribbean and South Pacific regions. DGL is the ultimate holding company within Digicel group's organization structure, which owns an intermediate holding company, DL. DIFL is an indirect 100% owned subsidiary of DL, and it owns operating assets in 25 markets in the Caribbean region. The group's Pacific operations are owned by DGL. Under Fitch's approach to rating entities within a corporate group structure, DGL's IDR and those of its subsidiaries, DL and DIFL, are equal at 'B', based on a consolidated group credit profile, given the strong strategic and financial linkages. Different rating levels for each entity's debt instruments reflect varying recovery prospects in case of default according to seniority of the claims. Digicel's ratings reflect the company's well-diversified geographical operations with leading market positions, strong network quality, and brand recognition, which support relatively stable performance on a local-currency basis. This is tempered by the company's high leverage, adverse FX volatility in the absence of effective hedging, and its recent negative FCF generation and low cash balance. Digicel's medium-term refinancing risk for its senior notes from FY21 remains a key credit concern. Continuing increases to the U.S. Federal Reserve's benchmark rate will likely lead to higher interest rates for the company's refinancing activities, and it also could result in continued depreciation of local currencies of Digicel's operational markets. The company needs to materially improve EBITDA generation to be able to cope with these risks in the short to medium term. Meaningful free cash flow generation due to the investments made in cable and cost cutting initiatives under its transformation projects will be key to rating stability in the next two years. Improved Financial Flexibility: Digicel's financial flexibility was improved during May 2017, following DIFL's refinancing of its existing credit facilities. The company issued USD1.26 billion term loans through a five-year USD300 million term loan A and a USD955 million seven-year term loan B, to fully pay off its USD856 million credit facility loans, which were originally scheduled to be amortized from March 2018 on a semi-annual basis until March 2019. Digicel will also redeem DL's USD250 million notes due in 2020 and the USD80 million debt maturity from its Digicel Pacific Limited (DPL) facility loan with the loan proceeds. Digicel will not face any sizable bond maturities until FY21, which will end on March 31, 2021, when its USD2 billion notes become due. The company will also have additional USD100 million revolver, which will be undrawn at the closing of the transaction. High Leverage: Digicel's leverage is high. The company's leverage has been gradually trending up due to uncurbed negative FCF generation since the FY12, caused by high capex, amid ongoing EBITDA contraction. Digicel's adjusted net leverage was 6.4x including off-balance sheet adjustment, with its gross debt amounted to USD6.5 billion at Q3FY17, relatively unchanged from the end-FY16 level, while its EBITDA during the first nine month of FY17 has fallen by 12% compared to the same period a year ago. Material improvement in leverage ratios and FCF generation in the short to medium term is critical for the company to mitigate a refinancing risk ahead of its bond maturities of USD5.2 billion during FY21 - FY23. Negative FCF to Reverse: Fitch forecasts Digicel's FCF generation will turn positive in FY18 driven by gradual EBITDA improvement amid a lower capex requirement. Digicel's FCF has remained in negative territory in recent years mainly due to high capex for fiber network investments. The company's capex soared to USD649 million and USD607 million in FY15 and FY16, respectively, from just USD361 million in FY13, with the capital intensity ratio, measured by capex-to-sales, rising to an average 23%, compared to just 13% in FY13. FY17 Capex is forecast to close at about USD450 million, resulting in continued negative FCF margin of around 3%, based on Fitch's projections. Negative FCF generation is likely to reverse from FY18 as major investments for fiber are mostly completed. EBITDA is expected to improve, mainly supported by first-time positive EBITDA contribution from the cable segment and cost savings from the transformation project, through which the company plans to enhance its EBITDA margins by 2% to 4% by the end of FY18. Fitch estimates that Digicel requires at least about USD1.1 billion of EBITDA to achieve break-even FCF in FY18 and FY19, with about 10% reduction in capex from the FY2017 level of USD450 million. Fitch forecasts the company's EBITDA generation will gradually improve to above USD1.2 billion by FY19, barring worse than expected local currency depreciation against the U.S. dollar, which should support positive FCF generation of close to USD100 million and gradual deleveraging to below 5.5x by end-FY19. This compares to Digicel's publicly announced target of positive FCF generation of at least USD100 million in FY18 and reducing its gross leverage to below 5.25x by the end of FY18 and to 4.5x by the end of FY19. Despite positive FCF generation, Fitch believes that the actual net debt reduction would be slow due to cash outflows related to Digicel Holdings Central America Ltd (DHCAL) investments, license fees, and one-off cash outflows related with its transformation project. FX Threatens Stable Performance: Digicel's relatively stable performance based on constant currency terms have been beset by negative impact from the local currency depreciation against the U.S. dollar. Digicel is subject to FX mismatch as its debt is mostly denominated in U.S. dollar, compared to 50% to 55% of EBITDA generation in U.S. dollars or euros, or currencies pegged to the U.S. dollar. This could continue to weigh on the company's cash flow generation and its ability to service debt obligation, while the company's recent tariff increases in its key markets should help mitigate the risk to an extent. Digicel has generated relatively stable operating results on a local-currency basis in the first nine months of fiscal 2017 (9MFY17). During the period, the company's constant-currency-based service revenue grew by about 1%, underpinned by increasing revenue contributions from mobile data, cable and broadband, and business solutions operations, which helped offset continued voice revenue erosion. Negatively, this growth has been largely diluted by ongoing FX volatility, which led to a 6% revenue contraction in the reported U.S. dollar. Reported EBITDA has also deteriorated by 12% during 9MFY17, although it remained relatively unchanged under the constant currency terms. Positive Revenue Diversification: Ongoing revenue diversification away from traditional mobile voice is positive as the revenue proportion of mobile voice fell to 50% during 9MFY17 from 56% a year ago. The contribution from mobile data should continue to steadily increase over the medium term, mitigating negative pressures on the voice ARPU, which has suffered from competitive pressures and reduced mobile termination rates in some markets. During 3QFY17, mobile data revenues grew by 7% from a year ago on a constant currency basis, accounting for 33% of total service revenues, driven by a steady increase in smartphone penetration to 49% from 41% a year ago. In addition, Digicel's recent strategic focus on cable/broadband, along with business solutions, should enable further revenue diversification as it continues to connect more homes on its established networks. The company's total cable RGUs have increased by 3.6 times in Q3FY17 compared to a year ago to 546,000 from 152,000 with the segmental revenues increasing by 106% to USD43 million from USD21 million. Digicel's cable and business solutions segments represented 7% and 8% of total service revenues, respectively, during 3Q17. The cable segment reached profitable EBITDA for the first time during 3QFY17, and Fitch expects the segment to contribute to about USD40 million EBITDA improvement in FY18. DERIVATION SUMMARY Digicel's solid business profile, with leading mobile market shares in its well-diversified operational geographies supported by network competitiveness, is considered strong for a 'B' rating. Digicel's financial profile, mainly leverage, is materially weaker than its regional diversified telecom peers in the sub-investment grade rating categories, including Millicom International Celular S.A., rated 'BB+', and Cable & Wireless, rated 'BB-'. Digicel's financial leverage is one of the highest among the regional telecom peers, reflected in its 'B' rating level. Strong parent-subsidiary linkage exists among Digicel group companies based on intra-group cash flow movement to service debt at its holding company level, resulting in a same IDR level for DGL, DL, and DIFL. No country ceiling or operating environment influence was in effect for the ratings. KEY ASSUMPTIONS --Low single-digit annual revenue growth in FY18 and FY19; --Gradual EBITDA margin improvement from FY18 backed by profitable cable operations and transformation projects; --Positive FCF generation in FY18 and FY19 with an average annual capex of USD420 million; --No dividend payments over the medium term; --Adjusted net leverage to fall to below 5.5x by FY19. RATING SENSITIVITIES A negative rating action could be considered if consolidated leverage at DGL remains above 6.0x on a sustained basis, due to a combination of competitive pressures, negative FX movement, high capex, sizable acquisitions, and aggressive shareholder distributions. FCF generation of less than USD200 million by end-FY19 and its inability to proactively manage debt maturities would be negative for the ratings. A positive rating action would be limited in the short to medium term, given the company's high leverage and low cash balance compared to the historical levels. LIQUIDITY Digicel's liquidity profile is adequate as the company will not face any sizable bond maturity until FY21, when its USD2 billion notes become due, following the recent DIFL loans refinancing. The company held USD201 million cash balance at Dec. 31, 2016, and Fitch expects USD80 million of DPL loan, originally due in August 2017, to be paid off with the refinancing proceeds. Digicel also has access to its USD100 million revolving credit facility. FULL LIST OF RATING ACTIONS Fitch has affirmed Digicel's ratings as follows: Digicel Group Limited --Long-Term Issuer Default Rating (IDR) at 'B'; Outlook Stable; --USD 2 billion 8.25% senior subordinated notes due 2020 at 'B-/RR5'; --USD 1 billion 7.125% senior unsecured notes due 2022 at 'B-/RR5'. Digicel Limited --Long-Term IDR at 'B'; Outlook Stable; --USD 250 million 7% senior notes due 2020 at 'B/RR4'; --USD 1.3 billion 6% senior notes due 2021 at 'B/RR4'; --USD 925 million 6.75% senior notes due 2023 at 'B/RR4'. Digicel International Finance Limited --Long-Term IDR at 'B'; Outlook Stable; --Senior secured term loans and USD100 million revolving credit facility at 'B+/RR3'. Contact: Alvin Lim, CFA Director +1-312-368-3114 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Diana Barriga Associate Director +1-312-606-2319 Committee Chairperson Daniel R. Kastholm, CFA Regional Group Head - Latin America +1-312-368-2070 Summary of Financial Statement Adjustments EBITDA adjustment was made to exclude non-recurring items such as FX gain/loss, restructuring charges, profit/loss on disposal. During 9MFY17, USD18 million on profit from disposal, FX loss of USD5.9 million, exceptional item of USD5.3 million were excluded from the EBITDA calculation. 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