OREANDA-NEWS. S&P Global Ratings today revised its outlook on the 'BB-' long-term corporate credit rating on Israeli-based telecommunications investment holding company B Communications Ltd. (Bcom) to positive from stable.

At the same time, we affirmed our 'BB-' issue rating on the company's senior secured notes.

The positive outlook reflects our assessment that the company's credit ratios, notably its interest coverage, will likely meaningfully improve in 2017 given the high cash balances in a "lock-box" mechanism--most of which we forecast will be used to pay down debt after the senior secured notes become callable in February 2017. We think that the expected debt reduction, as well as a potential reduction in the coupon on the company's notes, will likely improve Bcom's S&P Global Ratings-adjusted EBITDA interest coverage to more than 3x, compared with less than 2x in our base case for 2016. This is supported by the current yield on the company's notes of less than 5% compared with a nearly 8% coupon payable.

During the first quarter of 2016, Bcom sold 4.18% of its stake in Bezeq for NIS982 million. As a result, its stake in Bezeq declined to about 26%, but it remains the controlling shareholder with no other shareholder permitted to own a stake larger than 5%. We assume that Bcom will use the proceeds from this sale to partly repay its senior secured notes. Bcom's attempt to buy back bonds with the proceeds in April, through a tender offer, supports our assumption. The tender offer resulted in a marginal reduction in debt due to lack of investor demand to sell back these notes.

Our assessment of Bcom's business risk profile reflects our view of Bezeq's position as the No. 1 telecommunication company in Israel, with a leading brand name and market position in most segments, high-quality network-based services across all telecommunications segments, and higher-than-average profitability, with EBITDA margins of more than 40%. This is mainly constrained by the highly competitive Israeli telecommunications market, notably in the wireless market, and lack of geographic diversification.

We analyse Bcom, including its business risk profile, using our standard corporate rating methodology because its only holding is a controlling stake in Bezeq (which gives it control of the board of directors), and because it has very limited flexibility to sell shares due to regulatory restrictions.

Bezeq has a stated dividend policy of distributing 100% of its net income to shareholders as ordinary dividends. This policy has been upheld in recent years despite fierce competition in the wireless market, which resulted in some decline in its EBITDA. In terms of its financial risk profile, Bcom's only access to Bezeq's cash flows is through dividends, which are based on Bezeq's net income after it has serviced its debt. These dividends are also restricted, by law, up to Bezeq's net income, while a higher dividend requires a court approval. We therefore calculate Bcom's credit measures by treating it as an equity affiliate as we believe this provides a better picture of its EBITDA and cash flows. We therefore deconsolidate Bezeq's financial results and only add dividends received from Bezeq to Bcom's stand-alone figures, including EBITDA and cash flows. This is in contrast to Bcom's accounts, which fully consolidate Bezeq. Additionally, we net Bcom's debt with cash of NIS1.2 billion, which we consider to be surplus cash available for debt repayment.

According to our base-case scenario, we forecast a reduction in Bcom's reported debt to about NIS2.6 billion in 2017 from NIS3.5 billion in 2015. We also forecast that its adjusted debt to EBITDA will decline to about 4.9x in 2016 and remain at a similar level in 2017. However, we expect adjusted EBITDA interest coverage to potentially improve to more than 3x in 2017 from 1.4x-1.7x in 2016. This is mainly as a result in reduction in its cost of debt following refinancing and our assumption of dividends received from Bezeq of NIS360 million–NIS370 million.

We assess Bcom's liquidity position as adequate. This view is primarily supported by our forecast of ongoing dividend payments from Bezeq, maintenance of substantial cash balances, and limited debt maturities.

The positive outlook reflects the potential for a one-notch upgrade over the next 12 months if refinancing results improve, with adjusted EBITDA interest coverage of about 3x, and if Bcom maintains meaningful liquidity reserves.

We could raise the rating to 'BB' if Bcom successfully refinanced its senior secured notes in early 2017 with new notes reflecting lower cost of funding, and uses the majority of the cash in the lock-box mechanism to pay down debt. An upgrade would be subject to a sustainable improvement in adjusted EBITDA interest coverage to about 3x or more, while maintaining both adjusted debt to EBITDA at less than 5x and meaningful liquidity buffers, including liquidity sources (including expected dividends from Bezeq) sufficient to cover the next 12 months expected uses by more than 150%. An upgrade would also need us to maintain our assessment that dividends from Bezeq would remain stable compared with 2016.

We could revise the outlook to stable if the refinancing is unsuccessful, or results in no meaningful debt and interest expense reduction. We may also revise the outlook if we see Bezeq's competitive position weakening; for example, if we witness a meaningful decline in its fixed-line market share and profitability. We could also consider a negative rating action if the company's liquidity position deteriorates because of a substantial decrease in dividends from Bezeq.