November 20, 2017 / 8:39 AM / a year ago

Fitch Rates WTT Investment USD670m Notes Final 'BB-'

(The following statement was released by the rating agency) SINGAPORE/HONG KONG, November 20 (Fitch) Fitch Ratings has assigned WTT Investment Limited's (WTT) USD670 million 5.5% senior unsecured notes due 2022 a final rating of 'BB-'. The Recovery Rating on the notes is 'RR3'. The final rating follows the receipt of documents conforming to information already received and is in line with the expected rating assigned on 7 November 2017. The notes are rated one notch higher than WTT's Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'B+', reflecting above-average recovery prospects in the event of a default as indicated by the 'RR3' Recovery Rating. The Outlook is Positive on WTT's IDR. WTT is an investment holding company which holds a 100% stake in Hong Kong-based WTT HK Ltd. The notes are guaranteed by most of the key operating subsidiaries, and are subordinated to any future secured debt of the issuer or its subsidiaries including the proposed USD50 million (HKD390 million) senior secured revolving credit facility. The notes are structurally subordinated to any future debt at some non-guarantor subsidiaries which represent approximately 3% and 6% of consolidated revenue and assets, respectively. WTT will use the bond proceeds to refinance existing debt of HKD5 billion, and to cover transaction fees and other expenses incurred in the note issuance. The Positive Outlook on IDR reflects our expectation that WTT's FFO adjusted net leverage can come down to below 4.8x by 2020, driven by its ability to generate a pre-dividend free cash flow (FCF) margin of around 10% (or HKD200 million-250 million) - supported by its position in Hong Kong's business-to-business telecoms market. Furthermore, WTT's sponsors - MBK Partners and TPG Capital - have stated their commitment to achieve net debt/EBITDA of 4.0x (or 4.5x on a FFO adjusted net leverage basis) over the medium term. The covenants attached to the notes also impose certain restrictions on the additional debt that WTT can assume, based on a net debt to EBITDA threshold of 4.0x. KEY RATING DRIVERS High Leverage; Challenger Status: WTT's ratings are constrained by its Fitch-estimated 2017 FFO adjusted net leverage of 6.0x, and a "market challenger" position with about a 16% market share in the Hong Kong enterprise market. The enterprise market consists of business voice, broadband and IT services among other related offerings. The industry is dominated by incumbent Hong Kong Trust (HKT), part of PCCW group, which has around a 60% market share. However, WTT's ratings benefit from its second-largest market position, benign competitive dynamics in Hong Kong's enterprise market, a strong network position, and a loyal and diversified customer base of 55,000 business clients with only a limited churn rate. About 60% of customers have relationships of over five years with WTT. The average length of a customer's contract is around two to three years. Strong Network Position: WTT's business risk profile is reasonably strong, with extensive fibre coverage which connects 5,300 commercial buildings - estimated to cover 90% of business customer demand in Hong Kong. Hutchison Global (HGC) and HK Broadband (HKBN), the other two industry participants, have a weaker network reach and could struggle to achieve similar network strength as WTT, given capital requirements and space constraint in existing buildings to inject new sets of fibre cables and to house equipment. WTT, with its better execution and sole focus on the enterprise market, has steadily improved its market share in the Hong Kong sector over the last five years. WTT differentiates itself by offering customised packaged solutions including connectivity, fixed-voice and IT services to its customers, and thereby enhancing customer loyalty. WTT's in-house ICT capabilities give it a competitive edge over some of the smaller rivals that lack such capabilities. WTT's network position is further enhanced by ownership of submarine cables connecting Hong Kong islands and Kowloon via Lantau, which HGC and HKBN lack. We expect higher competition in the small- and medium-scale customer segments, which is not a key focus of WTT. However, rising competition from HKBN and HKT could mean that WTT is not completely immune from pricing pressures, notwithstanding the low churn rate of its core clientele. High FCF Margin Visibility: We believe that the visibility of WTT's pre-dividend FCF margin of 10% (HKD HKD200-250 million) is high, as it invests only about 15% of its revenue on maintenance and growth capex, and is likely to spend another 15% on interest expense with limited cash taxes and working-capital movements. We expect WTT's post-dividend FCF margins to reach a comparable level to that of its peers in the 'B+' and 'BB-' rating levels when WTT starts dividend payments. Low but Stable Revenue Growth: We expect WTT's revenue and EBITDA to grow by 3%-4% over the rating horizon as it adds new customers, secures larger orders from existing customers, and gradually wins market share from HKT. We expect its operating EBITDAR margin to improve to around 44%-46% (2016: 44%), benefitting from inherent operating leverage due to low marginal costs of adding new customers. Furthermore, the declining trends in the revenue of the low-margin international voice segment will help to boost its operating EBITDA margin. Recovery Rating of 'RR3': We have rated WTT's USD670 million senior unsecured bond at 'BB-' with a Recovery Rating of 'RR3, one notch higher than its IDR of 'B+'. The company derives most of its economic value from Hong Kong; under our criteria, Country-Specific Treatment of Recovery Ratings, Hong Kong falls into Group B, which allows up to two notches of uplift for securities above the issuer's IDR based on above-average recovery prospects. We use the going-concern value approach to calculate the post-restructuring enterprise value. We estimate post-restructuring cash flow to be around HKD633 million - a discount of 25% from Fitch-forecast EBITDA of HKD844 million in 2017 - which assumes a depletion of the current business position leading to any financial distress, and a level of corrective action that would have occurred during restructuring. We have assumed a cash flow multiple of 6.0x, given the cash-generative characteristics of the business, and is in line with 'BB-' rated peers in similar businesses. The adjusted going-concern enterprise value after administrative claims of HKD3.4 billion is then applied to the potential HKD390 million senior revolving credit facility, and the balance to the senior unsecured notes, which results in a recovery in line with 'RR3' for the notes. DERIVATION SUMMARY WTT's ratings reflects its high 2017 Fitch-estimated FFO adjusted net leverage of 6.0x, but with potential to improve over the medium term; small scale; and "market challenger" market position in the Hong Kong enterprise market, despite a relatively better business risk profile than some peers. WTT's leverage is higher than most 'BB-' peers - including the UK's Virgin Media Inc. (BB-/Stable) at 5.0x and TalkTalk Telecom Group PLC (BB-/Stable) at 3.3x; Belgium's Telenet Group Holding N.V. (BB-/Stable) at 5.0x; and Axtel, S.A.B. de C.V. (BB-/Stable) of Mexico, at 4.2x. WTT's strong business profile benefits from its extensive fibre coverage, high competition barriers and recurring revenue derived from an established customer base, despite its relatively small scale and a "market challenger" position. European fixed broadband network providers such as Virgin Media Inc., TalkTalk and Telenet operate in markets that are more competitive and have lower competition barriers than WTT, although many of these peers have a significantly higher scale. MBK Partners and TPG Capital, owners of WTT having 50% stake each, acquired WTT in November 2016 from Wharf Holdings for HKD9.5 billion. The Positive Outlook reflects our expectation that WTT's FFO adjusted net leverage can improve to below 4.8x by 2020, provided its ability to generate strong pre-dividend FCF remains largely unimpaired notwithstanding some increase in competition, and supported by the sponsors' commitment to achieve net debt/EBITDA of 4.0x over the medium term. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue to grow by around 3%-4% during 2017-2019, driven by new customer additions and broadband and IT demand from existing customers. - Operating EBITDAR margin to improve to around 44%-45% during 2017-2018, reflecting benign competition in the enterprise market. - Capex/revenue ratio of around 15%. - No dividend payment during 2017-2020 until it achieves net debt/EBITDA of 4.0x or FFO adjusted net leverage of 4.5x. - Effective tax rate of 16.5%. - No M&A activity. RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to an Upgrade of the IDR to 'BB-' - Greater clarity on WTT's ability to improve its FFO adjusted net leverage to or below 4.8x by 2020, and - Ability to maintain FFO fixed-charge coverage of at least 2.5x, and - WTT retaining its market position with no significant adverse changes to its pricing power and operating EBITDA margin. Developments That May, Individually or Collectively, Lead to Outlook being Revised to Stable - Failure to achieve FFO adjusted net leverage of below 4.8x by 2020 on a forecast basis, and/or - Failure to maintain FFO fixed-charge cover at or above 2.5x by 2020 on a forecast basis. - Deterioration in WTT's market position or its ability to generate positive pre-dividend FCF as currently expected by Fitch. LIQUIDITY Adequate Liquidity: Liquidity was adequate at end-2016, with an unrestricted cash balance of HKD136 million and an undrawn revolving credit facility of HKD405 million which is sufficient to pay short-term debt maturities of HKD134 million due in 2017. WTT has paid HKD270 million up to August 2017, which includes a prepayment of HKD203 million on its senior secured bank facility. The senior secured loan is amortised through 2021 and has an average maturity of 5.5 years. The mezzanine facility of HKD814 million bearing an interest cost of 11% has a bullet maturity in May 2022. The proceeds from the USD670 million notes issue are to be utilised to fully refinance these debt facilities. Contact: Primary Analyst Nitin Soni Director +65 6796 7235 Fitch Ratings Singapore Pte Ltd. 6 Temasek Boulevard #35-05 Suntec City Tower 4 Singapore 038986 Secondary Analyst Kelvin Ho Director +852 2263 9940 Committee Chairperson Buddhika Piyasena Managing Director +65 6796 7223 Date of Relevant Rating Committee: 6 November 2017 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email:; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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