OREANDA-NEWS. Fitch Ratings has affirmed Israel-based B Communications Ltd.'s (B-Com) Long-term Issuer Default Rating (IDR) at 'B+' with a Stable Outlook. The instrument rating on the company's 2021 USD 800m bonds has also been affirmed at 'BB-'/'RR3'.

B-Com is a holding company and the ultimate owner of an approximately 31% stake in Bezeq, an incumbent telecoms operator in Israel. B-Com depends on dividends from Bezeq as a core income stream for servicing its debt obligations. B-Com holds a significant cash cushion that mitigates the negative impact of likely contracting dividends from Bezeq, which is being challenged by the introduction of wholesale regulation in early 2015.

KEY RATING DRIVERS
Control of Bezeq
Fitch views B-Com's 31% stake in Bezeq as sufficient for full operational and management control over the telecoms operator. Under Israeli law, a controlling shareholder in Bezeq must be pre-approved by the government. A 30% stake is defined as sufficient to apply for controlling shareholder status. It is against the law for a single shareholder to accumulate more than 4.99% without prior approval by the government. This law provision effectively rules out the emergence of a large minority shareholder.

As Bezeq's debt carries no financial covenants, the telecoms operator can theoretically increase debt without restrictions and upstream any amount of dividends to B-Com. In practice, distributions above 100% net profit would require court approval, which may not be easily procured. Accounting asset write-downs could also impede the normal flow of dividends from Bezeq, but Fitch views the likelihood of this as low.

Limited Flexibility to Sell Shares in Bezeq
Given the legal requirements over controlling stakes, B-Com has limited flexibility to dispose of its stake in the market beyond 1%. However, any proceeds from a 1% stake sale are likely to be significantly below expected annual interest payments and negligible relative to the total size of B-Com's debt obligations.

Bezeq's Strong Credit Profile
Bezeq's credit profile is consistent with the mid 'BBB' range, reflecting the company's strong position as a telecoms incumbent in Israel. The company has been able to withstand facilities-based competition with the country's only cable operator, despite Bezeq's premium pricing. The prospect of further facilities-based competitive threats is remote.

Challenges Ahead
We expect Bezeq's revenue and EBITDA generation to remain under moderate pressure, driven by continuing severe mobile competition and tough regulation. The introduction of fixed-line wholesale in February 2015 will likely increase broadband competition and may dampen Bezeq's ARPUs and revenues from this segment. The fixed-line segment has been resilient so far, with next generation network efficiencies contributing to strong EBITDA margins. Any negative impact from the wholesale introduction may be mitigated by the expected removal of structural separation, which would entitle Bezeq to substantial operating synergies.

The Israeli mobile market is over-competitive with five facilities-based operators. Although some operators are joining together for a joint development of LTE infrastructure, suggesting a stronger emphasis on quality, pricing and ARPU pressures remain unabated. Bezeq's mobile ARPU shed 3.8% qoq and 12.8% yoy in 4Q14.

Yes Acquisition Credit Neutral
Bezeq's proposed acquisition of a 50.2% stake in the already 49.8%-owned pay-TV operator, Yes, has strong strategic appeal. The consolidation of Yes would allow the company to start offering bundled packages and realise substantial synergies in the medium to long term assuming the regulatory approval for operational integration.

However, Bezeq had to make significant regulatory concessions including giving up content exclusivity and agreeing to wholesale its TV packages, which dilute the immediate operating benefits. An expected 0.3x increase in leverage from the deal (both in terms of net debt/EBITDA and FFO adjusted leverage) is neutral for Bezeq's credit profile. The company expects to realise an up to NIS1bn value of tax loss carry forwards acquired with Yes, but over seven to 11 years, starting from 2016-2017.

Improved Proportional Leverage, Low Interest Cover
B-Com's leverage and coverage levels continue to be consistent with a 'B+' credit profile. B-Com's pass-through proportional leverage (defined as B-Com's net debt and 31% of Bezeq's net debt/31% of Bezeq's EBITDA) improved in 2014. However, dividend coverage will become tighter driven by declining EBITDA and net profit at Bezeq. Fitch notes there is limited rating headroom for further coverage pressures.

B-Com's pass-through proportional leverage reduced as a result of lower net debt at Bezeq, driven by Coral Tel divestment and stronger cash flow from real estate sales and changes in working capital in 2013-2014. We expect that pass-through proportional leverage would likely remain at 4.2x-4.3x in the medium term versus the 4.4x-4.5x previously expected. However, Bezeq's shrinking net income will lead to lower regular dividends pushing dividend/interest ratio to below 2x. We believe the stabilisation of dividend coverage is achievable if synergies from the Yes acquisition are fully realised at Bezeq.

Both B-Com and its immediate parent Internet Gold (IG) have substantial debt with no recourse to Bezeq. Both entities ultimately depend on dividends from Bezeq as a core source of cash for servicing their debt obligations.

No Ring-fence Around B-Com
B-Com's public bonds do not have any covenants that would effectively limit the leverage or payments from the company.

No Parent-Subsidiary Linkage
Fitch views the parent-subsidiary linkage between B-Com and its ultimate shareholder, Eurocom Group, as weak due to the presence of an intermediary holding company IG between B-Com and Eurocom and the fact that IG has its own debt. B-Com's ratings do not reflect any potential support from the parent. IG reduced its interest in B-Com to 67% from 80% in 2013 and used the proceeds towards debt reduction.

Instrument Rating
The 2021 USD800m senior secured notes are secured by a 30% interest that B-Com owns in Bezeq and benefit from a lock-box mechanism mitigating temporary disruptions in dividend flows from Bezeq and conserving some cash for debt repayment. In view of these features, the bond is rated one notch above the IDR.

RATING SENSITIVITIES
A sustained deterioration in normalised dividend interest coverage to below 1.75x would be rating negative.

Operating pressures and financial underperformance coupled with higher leverage at Bezeq may also be negative.

A reduction in leverage to below 4.3x standalone net debt/dividends and pass-through proportional net leverage (including B-Com debt) to below 4x while improving normalised dividend interest coverage to above 2x may be rating positive.