OREANDA-NEWS. Fitch Ratings has affirmed the whole business securitisation (WBS) bonds issued by both Arqiva Financing plc and Arqiva PP Financing at 'BBB', and the high-yield (HY) bonds issued by Arqiva Broadcast Finance plc at 'B-'. The Outlook is Negative on the WBS bonds and Stable on the HY bonds.

The affirmation of the WBS bonds reflects mainly the appropriate (despite a downward revision of Fitch's base case) Fitch base case free cash flow synthetic debt service coverage ratios (FCF DSCRs), notably on a 20-year basis, of 1.57x, fairly rapid deleveraging and continued resilience to RPI and Libor sensitivities. We expect net senior debt-to-EBITDA under Fitch's base case to fall to around 3.0x by FY25 (financial year ending June) (from 5.8x in FY15) and close to 0x by FY30 (which is broadly in line with our previous review). The HY bonds deleveraging profile is also similar to our previous review, falling to 6.8x in FY20 at maturity from 7.1x in FY15.

Arqiva has performed broadly in line with Fitch's base case with FY15 EBITDA expected to reach around GBP418.1m and growing year-on-year by 2.5%. Since Fitch's last review, Arqiva has secured some new long-term contracts (notably in radio broadcasting and smart water metering) and its order book is maintained at a similar level to last year at GBP6.1bn. Fitch's revised base case EBITDA is, however, over 2% lower in cumulative between FY15 and FY33. This results mainly from assumed lower revenues, notably in digital platforms (DP, with lower pricing) and satellite and media divisions, and harsher stresses at the renewal of key contracts of the telecoms' division.

The Negative Outlook reflects the lack of visibility resulting from Arqiva's strategic overhaul, together with the recent departures of key personnel such as the CEO, CTO and MD of DP. Fitch, however, understands from Arqiva that its aim is to increase focus in more core infrastructure assets, which could be a credit positive. To drive this reorientation (which includes some cost savings initiatives), Arqiva has hired a Chief Transformation Officer from a specialised advisory firm in turnaround management. The recently announced mergers of some mobile network operators (MNOs) with BT acquiring EE and H3G acquiring O2 (subject to regulatory approvals) also add some uncertainties as these may impact the telecoms' business, most notably at renewals of the key contracts (with a potential consolidation risk of the wireless towers).

KEY RATING DRIVERS

Fitch has assigned the following attributes to the three key rating drivers (and relevant sub-KRDs) as per Fitch's UK WBS criteria.

INDUSTRY PROFILE: 'STRONGER'
(Operating Environment: 'Stronger')
Arqiva is the sole UK national provider of network access and managed transmission services (regulated by Ofcom) for terrestrial television and radio broadcasting. The company owns and operates all television and 90% of the radio transmission towers used for digital terrestrial television (DTT) and terrestrial radio broadcasting in the UK. Arqiva has long-term contracts with public service broadcaster customers (who depend on Arqiva to meet the obligations under their licences to provide coverage to 98.5% of the UK population) as well as with commercial broadcasters. Arqiva also owns two of the three main national DTT commercial multiplexes (out of a total of six) plus two new (HD-compatible) DTT multiplexes. Similarly, Arqiva owns one national commercial digital radio multiplex and, since March 2015, 40% of the second.

Arqiva is also the largest independent provider of wireless tower sites in the UK, which are licensed to the MNOs and other wireless network operators, with approximately 25% of the total active licensed macrocell site market (as of end-March 2015).

Embedded in its industry nature, Arqiva is not exposed to discretionary spending and its sector is not viewed as cyclical.

(Barriers to Entry: 'Stronger')
The industry's barriers to entry are viewed as high, notably due to the stringent regulatory framework and the industry's capital-intensive nature.

(Sustainability: 'Midrange')
Arqiva is exposed to potential changes in technology in the medium- to long-term with, for instance, the emergence of new means for content delivery (e.g. IPTV), which may affect pricing, in particular in the DP and satellite and media divisions (representing over 15% of Arqiva's revenues each).

COMPANY PROFILE: 'MIDRANGE'
(Financial Performance: 'Midrange')
Overall Arqiva's trading history has been strong with past reductions in revenues having been typically compensated by gains in margins. Since FY08, EBITDA, in particular, had grown strongly at a CAGR of 7.7% until FY13, when performance turned subdued. This was followed by a decline of 2% in FY14 and an expected increase of 2.5% in FY15. EBITDA margin is also expected to decline to 49% in FY15 from a peak of 50.8% in FY13.

(Company Operations: 'Midrange')
Fitch views the company's operations positively, as Arqiva has constantly met its various key contract operating obligations. Over half of Arqiva's revenues are generated from long-term contracts (typically RPI-linked with no or little volume risk) with counterparties with strong credit ratings (such as the BBC, large MNOs and utilities companies).

Arqiva's sponsors are large and experienced infrastructure funds with a long-term view. However, the company has seen some recent significant changes in management with the departures of the CEO, CTO and the MD of DP. The board has recently added a new management board position of Chief Transformation Officer (until December 2015) to drive the business transformation programme. These departures and expected corporate restructuring add some short-term uncertainty. Fitch will therefore closely monitor corporate changes.

(Transparency: 'Midrange')
Good insight into the financials and operations of Arqiva is balanced by the inherent complexity of the operations, which hampers its transparency.

(Dependence on Operator: 'Weaker')
Given the specialised and complex nature of Arqiva's operations, there are only a few alternative operators capable of running their secured assets, which diminishes the value of administrative receivership.

(Asset Quality: 'Midrange')
Assets of this nature are very infrequently traded and there are no alternative values, but assets can be disposed of on an individual basis or on a going-concern basis. Maintenance capex is generally well defined but timing and exact funding amount could be uncertain.

WBS bonds - DEBT STRUCTURE: 'MIDRANGE'
(Debt Profile: 'Midrange', Security Package: 'Stronger', Structural Features: 'Midrange')
The senior debt is fully amortising either by way of cash sweep or following a fixed schedule. There are many large swaps present (due to legacy positions), notably super senior index-linked (IL) swaps and index-linked swaps overlays (and other interest rate (IR) and FX swaps), which adds to the complexity of the debt structure. These IR and IL swaps essentially slow down any deleveraging due to either potentially incurred IR swap breakage cost (following cash sweeps) or IL RPI accretion paydowns (which occurs every three years until 2027).

Some senior loans are also exposed to some interest rate risk past their expected maturities. The senior debt also contains many prolonged interest-only periods, which is a credit negative.

The senior debt benefits from a typical WBS security package, namely, first ranking security over freehold / long leasehold sites with the possibility to appoint an administrative receiver. The senior debt benefits also from a comprehensive set of covenants and cash lockup triggers set at moderate levels. The issuer liquidity facility covers only 12 months of debt service. The issuer is not an orphan SPV; however, given the structural protections in the transaction's legal documentation, the potential conflicts of interest (due to the non-orphan status of the SPVs and their directors also being directors of other group companies) are deemed remote and consistent with the notes' ratings.

HY bonds - DEBT STRUCTURE: 'WEAKER'
(Debt Profile: 'Weaker', Security Package: 'Weaker', Structural Features: 'Weaker')
The HY bonds are bullet. They are deeply structurally subordinated and would default if dividends pay-out from the WBS group is disrupted for more than six months. Their security package is viewed as weak as it consists of share pledges over holding companies with no second lien security over the WBS security package. The covenants and lockup triggers are comprehensive but are set at low levels. The issuer's liquidity cash reserve account covers only six months of interest payments.

RATING SENSITIVITIES
An unforeseen significant change in regulation (by Ofcom) with regard to any changes in its pricing formulas (notably for future DTT or radio broadcasting contracts), licensing costs (e.g. administrative incentive pricing) or even spectrum allocations could hit Arqiva's future cash flow and impact the ratings.

The risk of alternative and emerging technologies (such as IPTV) could also threaten Arqiva's revenues either through technology obsolescence risk and/or lower ad-pool available to linear TV content providers. This risk is currently mitigated by the potentially rapid deleveraging of the transaction (assuming cash sweep amortisation) and the long-term contracts securing significant revenues.

As suggested by the Negative Outlook, clearer visibility with regard to the outcomes of the corporate restructuring and the mergers of the telecom network operators may impact the ratings. Additionally, any signs of deterioration in performance against Fitch's base case impacting, notably the deleveraging profile, may lead to a downgrade.

SUMMARY OF CREDIT
The transactions are the refinancing of senior and junior bank debt of Arqiva Financing No.1 and No. 2 Limited through the issuance of around GBP1,612.5m of WBS notes, GBP180m of ITL and GBP190m of EIB loan, plus around GBP353.5m of Finco term loans (the underlying WBS issuer/senior borrower loans ranking pari-passu with the underlying secured Finco/senior borrower loans, the ITL and EIB loan), and GBP600m of structurally subordinated HY notes. The remaining Finco term loans are expected to be refinanced under the WBS programme.

The rating actions are as follows:

Arqiva Financing plc (WBS issuer):
GBP164m 5.34% Series 2014-1 notes due 2037: affirmed at 'BBB'; Negative Outlook
GBP350m 4.04% Series 2013-1a notes due 2035: affirmed at 'BBB'; Negative Outlook
GBP400m 4.882% Series 2013-1b notes due 2032: affirmed at 'BBB'; Negative Outlook

Arqiva PP Financing plc (WBS issuer - US Private Placement (USPP)):
USD358m (GBP235.5m equivalent) Series 1 guaranteed secured senior notes (WBS) due 2025: affirmed at 'BBB'; Negative Outlook
GBP163m Series 2 guaranteed secured senior notes (WBS) due 2025: affirmed at 'BBB'; Negative Outlook
GBP300m Series 3 guaranteed secured senior notes (WBS) bonds due 2029: assigned 'BBB', Negative Outlook

Arqiva Broadcast Finance plc (HY issuer):
GBP600m 9.5% senior notes due 2020: affirmed at 'B-'; Stable Outlook