Fitch Affirms Smartfren at 'CCC(idn)'
The rating affirmation reflects Smartfren's weak cash flow generation, with EBITDA likely to continue to fall short of its interest expense. The rating also reflects the company's continued reliance on the issuance of mandatory convertible bonds (MCB) to cover its cash shortfall.
'CCC' National Ratings denote that default is a real possibility. Capacity for meeting financial commitments is solely reliant upon sustained, favourable business or economic conditions.
KEY RATING DRIVERS
Increasing Costs Pressure EBITDA: Fitch forecasts Smartfren to generate lower EBITDA of less than IDR150bn (USD11.5m) in 2016 and 2017 (2015: IDR210bn). Smartfren's continued investment in long-term evolution (LTE) networks will translate into higher operational costs (such as sales and marketing costs to attract customers) and increased tower rentals from additional base transceiver stations (BTS), but Fitch expects subscribers to remain relatively flat. The company's strategy has been to enter the LTE segment early by investing significantly. The number of BTS has more than doubled to 15,140 in 2015 (2014: 6,115).
Subscriber Growth Tough: Smartfren's successful return on its LTE investment will depend on its ability to significantly increase subscribers above its current level of 10.5 million. We think this will be a challenge given the dominance of GSM operators. Smartfren's subscriber base has been stagnant at around 10-11 million since 2011, although a larger proportion of LTE subscribers has helped average revenue per user to grow. In comparison, we estimate its closest competitor PT Hutchison 3 Indonesia has a subscriber base of more than 40 million.
The challenge will be exacerbated by the price competitive nature of the Indonesian telecommunication industry, where telcos compete for subscribers by offering cheap data packages. The three largest GSM operators have greater financial flexibility in the event of another tariff war - with solid EBITDA margins of above 35%, funds flow from operations (FFO) adjusted net leverage below 3.5x and solid funding access.
Available Facilities for Capex: Smartfren's strategy to significantly expand its LTE network will require new capital to fund the capex. Fitch forecasts Smartfren to continue to spend more than IDR2.5trn per annum in 2016 and 2017 on its LTE network. The company still has not utilised USD170.6m from Chinese Development Bank (CDB) loan phase III, USD131.9m from CDB handset loan phase II and USD147.9m from a facility from Nokia Solutions and Networks, which total about IDR5.9trn.
Reliance on MCB: EBITDA of less than IDR150bn will not be sufficient to cover annual interest expense of more than IDR450bn in 2016 and 2017. The company will have to issue additional MCB in the next 18-24 months to cover its interest burden and debt principal repayment - including the maturity of IDR675bn of Indonesian rupiah bonds in June 2017. The company still has IDR2.4trn remaining of IDR9trn MCB series II and has not utilised a USD39m (IDR514bn) working capital facility from Cascade Gold Limited.
Fitch does not give credit for future MCB injections despite its successful issuances in the past. This is due to the uncertainty that stems from Smartfren's low equity value and the inability to assess the willingness and ability of the MCB investors to continue funding the company. So far the company has managed to issue IDR4.7trn of MCB I and IDR6.6trn of MCB II.
Fitch's key assumptions within the rating case for Smartfren include:
- Stagnant subscriber base of around 10-11 million in 2016 and 2017
- Blended average revenue per user of IDR25,000 - 35,000 in 2016 and 2017
- Annual capex above IDR2.5trn in 2016 and 2017
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-The company's ability to fund its operations without any reliance on further MCB issuance
Negative: Future developments that may, individually or collectively, lead to negative rating include:
-Weakening liquidity or operating performance such that the company's ability to meet obligations appears unlikely