S&P: Spanish Fiber Infrastructure Provider Ufinet Affirmed At 'B'; Outlook Stable; Recovery Now '4' On Recapitalization Plans
At the same time, we affirmed our 'B' issue ratings on the company's term loan, which we expect will be increased by €124 million, and revolving credit facility (RCF).
However, we have revised down our recovery rating on the term loan and RCF to '4' from '3', because the proposed dividend recapitalization will dilute recovery prospects for secured lenders. We now expect recovery in the higher half of the 30%-50% range, down from the lower half of the 50%-70% range we expected previously.
The affirmation reflects our belief that the recapitalization will not materially affect our leverage metrics, as we had already included the preferred shares to be partly repaid with the proposed additional €124 million term loan B in our calculations of Ufinet's debt. In addition, we have reviewed Ufinet's recent performance and business prospects, both organic and inorganic, which has led us to update our base-case forecasts.
The group continues to expand its operations in Spain, where volumes have offset price declines, and in Latin America, where demand for infrastructure is high. Consequently, the company's backlog and margins remain healthy. However, we expect the group will modify its investment model this year, resulting in lower coverage of capital expenditure (capex) by indefeasible right-of-use contracts (IRUs) and reduced free operating cash flow (FOCF). Also, Ufinet's highly leveraged capital structure, financial sponsor ownership, and proposed dividend recapitalization continue to constrain the rating.
On the positive side, we consider Ufinet's business risk profile to be fair. We base our assessment on the company's extensive fiber optic network of about 50,000 kilometers in Spain and Latin America. We also factor in the industry's high barriers to entry, owing to the cost of expanding a fiber network and high switching costs for customers. Furthermore, Ufinet's business model provides recurring revenues and a sizable contractual cash revenue backlog, thanks to multiple-year contracts on capacity leasing (so-called "dark fiber"; Ufinet provides fiber rental services on its own deployed optical fiber cables; clients lease Ufinet's cable and put their own infrastructure at each end), which translate into healthy profit margins. Finally, the company does not engage in speculative network developments. Rather, it focuses on growth from new customer contracts, and capex continues to be partly self-funded through IRUs.
However, we expect that capex, spurred by investments in fiber to the home (FTTH) and new market entrance (Peru, Chile, Paraguay, and Ecuador), will outpace IRU funding, resulting in only slightly positive FOCF and a potentially riskier investment model. Moreover, Ufinet's strengths are tempered by its limited size and high customer concentration, especially in dark-fiber activities. In addition, Spain's fairly mature telecom market has been consolidating, and competition from better-capitalized fiber-based telecom providers is rising. These factors would likely sustain price pressure, which we expect will continue to be mitigated by increasing volumes and additional services provided by Ufinet.
The rating remains constrained by our assessment of Ufinet's highly leveraged capital structure and, its ultimate ownership by private-equity firm Cinven, which we consider a financial sponsor. This, in turn, affects our assessment of Ufinet's financial policy, including our belief in potential future debt-funded mergers and acquisitions or further dividend recapitalization.
We understand that proceeds from the addition of €124 million to term loan B will be used to pay an exceptional dividend of €131 million, which will be allocated to the repayment of part of the preferred shares. As a consequence, the transaction is neutral in terms of adjusted leverage-–which we expect at between 6.5x and 7.0x in 2016--as our adjusted debt figure includes the preferred shares and their accrued dividend.
Under our base case, we assume IRUs will cover a declining portion of Ufinet's rising capex. In 2016, the group also heavily invested in FTTH projects, which resulted in lower, but slightly positive, FOCF, as well as an estimated ratio of FOCF to debt of about 0.3% in 2016 and about 3.5% in 2017 (about 0.5% and 4.7%, respectively, excluding the preferred shares).
The stable outlook on Ufinet reflects our expectation that increasing demand for bandwidth from companies and telecom carriers, as well as for dark fiber in Latin America, will support solid revenue growth and a sound EBITDA margin of 50%-51%. This should translate into slightly positive FOCF, with FOCF to debt between 0% and 5% and adequate liquidity.
We could consider lowering the long-term rating if increased competition resulted in even lower prices for fiber-optic services, leading to a substantial decline in EBITDA margins below 40%. We would also lower our rating if FOCF turned significantly negative, and liquidity came under pressure.
We view an upgrade as unlikely as long as preferred shares are treated as debt under our criteria. However, a positive rating action could occur if we continue to see positive revenue and EBITDA growth and improving credit metrics, with the S&P Global Ratings' adjusted debt-to-EBITDA ratio sustained at around 5.0x-5.5x, combined with a cash interest cover ratio remaining at more than 3.0x and solid cash flow generation, with FOCF to debt sustainably above 5%.