Fitch Assigns First-Time 'BB-' Rating to Reliance Communications
KEY RATING DRIVERS
Higher Leverage than Peers: Rcom's 'BB-' IDR is constrained due to its higher leverage and weaker market position than average for Fitch's-rated Asian telcos. Fitch's forecast for Rcom's funds flow from operations (FFO)-adjusted net leverage of 5.0x for the financial year ending 31 March 2015 (FY15) is much higher than for its Indian peers. Market leader Bharti Airtel Limited's (Bharti; BBB-/Stable) leverage is below 2.5x and third-largest operator Idea Cellular Ltd's is below 3.5x. The forecast leverage assumes payments in FY15 for licences in the March 2015 spectrum auction.
Commitment to Deleverage: The ratings incorporate management's commitment to deleverage and Fitch's expectation that Rcom will manage its leverage below 4.5x during 2015-16. We believe that deleveraging will be mainly driven by an EBITDA expansion and a planned sale of non-core assets. Fitch acknowledges management's commitment to repay part of its USD6bn in net debt through sale of assets including its sub-sea cable subsidiary Global Cloud Xchange (GCX; B+/Stable), real estate and its pay-TV business. Management intends to achieve a target debt/EBITDA of below 3.0x by end-March 2017.
Weaker Market Position: Rcom's IDR is currently capped at 'BB-' given its market position as the fourth-largest telco in India, with a revenue market share of only 8% in the USD30bn Indian telecom services industry. The top three operators - Bharti, Vodafone India and Idea - collectively have about 70% revenue market share. However, Rcom's integrated approach and high cash generation visibility with large proportion of recurring and contractual revenue contribution from its wireless post-paid, enterprise, tower and sub-sea cable businesses mitigates its weaker market position.
Positive FCF on Low Capex: We believe that Rcom will generate at least USD200m in annual free cash during FY16-18 as capex and interest costs decline following its debt reduction. We forecast that Rcom's FY15 cash flow from operations of USD700m-750m will be sufficient to fund its capex of around USD500m-550m and dividends. We expect Rcom to pay about USD400m-450m in interest and taxes. A lower capex/revenue of 15%-16% than peers (top three telcos: 20%) is driven by infrastructure sharing with Reliance Jio, part of Reliance Industries Ltd (RIL; BBB-/Stable), an under-utilised asset base and a smaller expected spectrum investment in March 2015 than peers.
During 2014, Rcom agreed to share around 43,000 towers and 120,000km of inter- and intra-city fibre network with Reliance Jio for 17-20 years. Rcom's FY15 cash generation and leverage will benefit as it will receive an up-front cash benefit and recurring revenue each year from Reliance Jio. Under the agreement, Rcom has reciprocal access to existing and future tower and fibre assets of Reliance Jio, on similar terms.
Lower Spectrum Payments: We believe that Rcom is likely to commit around INR40bn (USD667m) to renew its spectrum licences that are expiring in seven circles in the March 2015 spectrum auction. That is mainly because there is likely to be limited competition for spectrum in these circles. Management expects this cost to be lower. The top three telcos' are likely to commit about USD2bn-4bn each to renew expiring spectrum licences. Also, we expect Rcom's future spectrum outlays to be minimal given the majority of its spectrum assets expire only in 2021.
Improving Competition: Rcom's ratings factor in a gradual increase in average revenue per user (ARPU) as we expect industry overcapacity to reduce and major telcos to increase tariffs during 2015 in response to high spectrum prices, inelastic demand and lower competition from smaller telcos. However, we believe that the benefits of improving voice tariff realisations will be diluted by a decline in data tariffs caused by the increase in competition in the data segment as Reliance Jio enters the market in 2015.
Price competition in the Indian telco industry has declined significantly since 2012, when three-four smaller operators exited or scaled-back operations after the Indian Supreme Court cancelled 122 licences. Further, during 2013-14, some pricing power returned to the top companies as high costs prevented the financially weaker bottom-six operators from acquiring spectrum in auctions.
Fitch's key assumptions within our rating case for the issuer include:
- Revenue to grow by mid-single-digit percentage in FY16 driven by improvement in ARPUs, increase in data services and income from assets leased to Reliance Jio.
- Operating EBITDAR margin to improve by 150-200bp (FY14:31.3%) driven by improving voice tariff realisation and growing economies of scale in data segment. (Please refer to "2015 Outlook: Indian Telecommunications Services", dated 10 November 2014 for details on Fitch's view on the industry.)
- Rcom to generate at least USD200m in annual FCF. Capex/revenue will be around 17%-18% in FY15 before trending down to 15%-16% during FY16-18. FY15 capex will be higher due to additional spectrum payments of INR10bn, which will account for 25% of total spectrum commitment of INR40bn. Management assumes a lower amount.
- Effective interest rate of about 6.5%-7% over the Fitch base case.
Positive: Although unlikely in the short term, future developments that may, individually or collectively, lead to a positive rating action include:
- Improvement in competitive environment leading to higher cash generation, resulting in Rcom's funds from operations (FFO)-adjusted net leverage improving to below 3.5x on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Higher-than-expected competition and/or an indication of that management is less committed to deleverage, resulting in funds from operations (FFO)-adjusted net leverage remaining above 4.5x on a sustained basis.