August 31, 2017 / 8:28 PM / a year ago

Fitch Upgrades Coltel's Ratings to 'BB'/Stable Outlook; Removes Rating Watch Negative

(The following statement was released by the rating agency) CHICAGO, August 31 (Fitch) Fitch Ratings has upgraded Colombia Telecomunicaciones S.A. ESP's (Coltel) Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) to 'BB' from 'BB-'. Fitch also upgraded its senior unsecured notes to BB from 'BB-', and its subordinated perpetual notes to B+ from 'B'. The Negative Rating Watch has been removed and a Stable Outlook has been assigned. KEY RATING DRIVERS The removal from Rating Watch Negative and the upgrade reflect Coltel shareholders' approval on Aug. 29, 2017 of the recapitalization of the company to fund a full repayment of the company's Parapat liability of COP4.8 trillion and arbitration verdict of COP1.65 trillion. Telefonica SA (Telefonica) will provide in cash COP4.35 trillion, in line with its 67.5% ownership, and the Ministry of Finance of Colombia will assume its pro-rated proportion of Parapat liability without disbursement of funds. The company already paid off its arbitral award on Aug. 29, with 67.5% paid by the cash injection from Telefonica, and the remainder assumed by the Ministry of Finance. The remaining capital injection process to pay for the Parapat liability is expected to be completed, following the final termination of the Parapat operating agreement. This will result in a transfer of Parapat operating assets to Coltel, including fixed-line network operations in Bucaramanga and Barranquilla, which should provide increased scale and operational synergies. Fitch believes that this capitalization will materially improve the company's weak capital structure, with its adjusted net leverage estimated to improve to around 3.0x from 5.5x as of December 2016 with a full prepayment of Parapat debt. It also frees up cash resources equivalent to approximately 30% of the company's projected EBITDA during 2017-2019 to be used for its capex to shore up network competitiveness. Capitalization to Benefit Cash Flow Performance: Coltel's negative FCF generation is expected to turn modestly positive over the medium term once the capitalization is completed and Parapat liability is removed. Under the current capital structure, the cash outflow burden related to its PARAPAT payments pressured its FCF generation into negative territory. Upon consummation of the capitalization, Coltel's FCF is expected to become positive and average about COP45 billion annually assuming the company executes a capex strategy in line with a historical capex-to-sales ratio of 20% of revenues to strengthen its weak fixed-line network business in 2017-2019. Deleveraging Expected: Coltel's leverage has been high for the 'BB' rating category. Fitch's calculation of adjusted net debt-to-EBITDAR (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 adjusted net leverage to fall close to 3.0x post capitalization, a level that is deemed in line with its 'BB' rating level. The capitalization will improve not only the company's leverage metrics, but will also enable compliance with the 2022 notes incurrence leverage covenant (no greater than 3.75x), affording it much needed financial flexibility to issue additional debt if needed to support its investment strategy. EBITDA 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 (4Q16) and 1H17 which helped achieve a 2.6% revenue increase as of June 2017, on a year-over-year basis, 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 pressures to continue in its mobile operation. Fitch expects Coltel's EBITDA growth to be modest given the expectation of a slow diversification from voice revenues to non-traditional services, resulting in EBITDA margin close to 31% in 2017-2019. Competitive Position Remains Weak: Coltel has yet to show meaningful growth in its high-ARPU products, such as broadband (UBB) and HD-TV, which would improve its EBITDA and 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's market share declined due to its re-basing of the subscriber numbers and a high level of competition. Fitch expects Coltel's capex intensity to average 20% in 2017-2019 (23.8% in 2012-2016) as it tries to optimize its capex, focusing primarily on deploying its fiber-to-the-home (FTTH) network and increase home passes (HPs) to 203,000 by FY2018, after reaching 109,000 by end-2017. Should the company fail to increase its number of HPs as planned in the short term, this could continue to negatively impact its market position in the fixed-line operation. Equity Expected to Turn Positive: Coltel's equity remained negative as of June 2017 (negative COP1.4 trillion once the perpetual bond is adjusted for 50% equity credit), which needs a structural and permanent solution to the capital structure of the company. The approved capitalization will cure the negative equity position registered since 2015, as a result of the adoption of the IFRS standard which brought the PARAPAT liability onto the balance sheet and drove the company's equity into negative territory. This situation kept the company susceptible to dissolution under the Colombian Code of Commerce if a permanent solution to the sustainability of its capital structure was not reached before September 2018. 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 lower leverage than Coltel, although its narrow breadth of service offerings offsets the strength to an extent. Also, the company's financial profile is materially weaker than Millicom's operating subsidiaries in Guatemala and Paraguay, which are both rated 'BB+'/Stable. Based on the pro forma capital structure on the completion of the capital injection, Coltel's financial profile will become stronger compared to the 'BB-' rated telecom peers in the region, such as Cable & Wireless Communications Limited, VTR Finance, and Axtel S.A.B. de C.V. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Coltel include: -The capitalization is completed as announced; -Leverage after capitalization remains approximately 3.0x in 2017-2019. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action A positive rating action could follow once the capital structure takes place if: -The eventual realization of synergies derived from the consolidation of Parapat assets leads to a strengthening of Coltel's competitive position; -The strengthening of the fixed operation in support of EBITDA generation leads to a market share improvement in its fixed business; -The company deleverages to below 2.5x on a sustained basis. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Failure to improve its still relatively weak liquidity profile; -Continued profitability deterioration due to competitive pressures and slow growth in its non-traditional business segments; -Negative FCF generation; -Adjusted net leverage above 3.5x on a sustained basis. LIQUIDITY Coltel's liquidity remains weak, but Fitch expects this will improve with the approved capitalization, which will provide enhanced financial flexibility. The company's cash balances as of June 30, 2017, 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 2H17 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 December 2015 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 and further weakening its competitive position. FULL LIST OF RATING ACTIONS Fitch has upgraded the following ratings: Colombia Telecomunicaciones S.A. ESP --FC IDR to 'BB' from 'BB-'; --LC IDR to 'BB' from 'BB-'; --2022 notes to 'BB' from 'BB-'; --Subordinated bond to 'B+' from '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 Alberto Moreno Senior Director Date of Relevant Rating Committee: Aug. 30, 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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