TEXT-S&P cuts Magyar Telecom B.V. to 'CCC'; outlook negative

Thu Dec 20, 2012 7:47am EST

(The following statement was released by the rating agency)

Dec 20 -

Overview

-- In the nine months of 2012, the liquidity profile of Netherlands-based holding company Magyar Telecom B.V. continued to weaken.

-- We anticipate that Magyar Telecom's liquidity sources will decline substantially during 2013 and believe that the group's capital structure could become unsustainable in the near term, heightening the risk of a distressed exchange offer.

-- We are lowering our long-term corporate credit rating on Magyar Telecom to 'CCC' from 'CCC+', and revising our assessment of the group's liquidity to "weak" from "less than adequate."

-- The outlook on Magyar Telecom is negative, reflecting our view that the group's capital structure will likely become unsustainable in the next 12 months.

Rating Action

On Dec. 20, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit rating on Netherlands-based holding company Magyar Telecom B.V. to 'CCC' from 'CCC+'. The outlook is negative.

At the same time, we lowered our issue rating on Magyar Telecom's EUR350 million senior secured notes due 2016 to 'CCC' from 'CCC+'.

Rationale

The rating action primarily reflects our decision to revise our assessment of Magyar Telecom's liquidity profile to "weak" from "less than adequate" as defined by our criteria. In our view, the group's liquidity is likely to weaken further in 2013 primarily because we expect meaningful negative free operating cash flow generation due to continued pressure on revenues and margins in a challenging macroeconomic, competitive, and regulatory environment. As a result, we believe that the group's capital structure could become unsustainable in the near term, heightening the risk of a distressed exchange offer, which we would view as a default under our criteria.

Magyar Telecom is the holding company of Invitel Tavkozlesi ZRt (Invitel), which is the second-largest fixed-line telecommunications, cable-TV, and broadband Internet services provider in Hungary.

In our base-case scenario, we expect group revenues in euros to decline by about 13% in 2012 and by about 10% in 2013. In our view, Magyar Telecom's revenues denominated in Hungarian forint (HUF) will remain constrained by strong macroeconomic and competitive pressures. In addition, we assume that the foreign exchange rate will deteriorate to HUF300 to the euro on average in 2013, compared with an average of about HUF290 in 2012 year to date. At the same time, we expect the group's reported EBITDA to decline by about 23% to EUR57 million in 2012 and to about EUR45 million in 2013, primarily due to lower gross profits and the introduction of new taxes.

Due to the anticipated weaker EBITDA generation and continued meaningful capital spending (capex), we forecast negative free operating cash flow (FOCF) of between EUR20 million and EUR25 million in 2012, down from negative EUR14 million in 2011. As a result, we expect Magyar Telecom's cash balances at year-end 2012 to decline to about EUR10 million to EUR15 million, which we believe will offer the group limited ability to meet anticipated cash outflows in 2013, in the absence of additional funding or sizable reductions in discretionary capital expenditures.

The rating on Magyar Telecom B.V. reflects our assessment of the group's financial risk profile as "highly leveraged" and business risk profile as "weak." Our assessment of the group's management and governance is "fair."

The financial risk profile is constrained by the group's high leverage, expectations of continued negative FOCF generation, our assessment of the group's "weak" liquidity profile, and what we regard as a very aggressive financial policy. Furthermore, the group is significantly exposed to foreign exchange volatility in relation to the Hungarian forint. In our view, this is only partly offset by the group's long-term capital structure, with no debt maturities before 2016.

Magyar Telecom's business risk profile primarily reflects the fierce competitive environment, the group's exposure to macroeconomic and regulatory pressures in its domestic market, and continuing revenue declines at the group's very profitable core voice business. These factors are partly offset, in our opinion, by Magyar Telecom's solid market position and extensive network as the former incumbent telecom operator in 14 concession areas in the Republic of Hungary (BB/Stable/B).

Liquidity

We consider Magyar Telecom's liquidity to be "weak," as defined by our criteria. We expect the ratio of the group's sources of liquidity to uses to decline well below 1x in 2013.

We estimate Magyar Telecom's liquidity sources over the next 12 months from Sept. 30, 2012, at about EUR40 million. These include:

-- About EUR29 million in available cash balances, as reported by the group, and

-- Funds from operations of about EUR10 million.

We estimate Magyar Telecom's liquidity needs over the next 12 months to amount to about EUR35 million-EUR40 million, primarily comprising capital spending and modest cash needed to run the group's operations.

We currently don't factor in liquidity support from Magyar Telecom's owner, private equity company Mid Europa Partners (not rated).

We see the group as significantly exposed to exchange rate volatility over the long term, given the currency mismatch between its EBITDA and debt. We understand from Magyar Telecom's management that the group has hedged the foreign exchange risk on the coupon of its senior secured notes with standard forward contracts until June 30, 2013.

The group faces no significant debt maturities until 2016 and does not have to comply with maintenance covenants. However, the documentation of its senior secured notes contains an incurrence covenant that limits the issuance of new debt by Magyar Telecom to 3.5x total debt to EBITDA.

Recovery analysis

Magyar Telecom's EUR350 million (EUR326 million outstanding on Sept. 30, 2012) 9.5% senior secured notes due 2016 are rated 'CCC', the same as the corporate credit rating.

At present, we consider the senior secured notes well secured because they benefit from first-priority liens over bank accounts, receivables, and intercompany loans, floating charges over the assets of the group's domestic operations, as well as pledges over the entire share capital of the group's domestic operations. In addition, we estimate that prior ranking liabilities would not represent more than 15% of total adjusted assets.

Under our hypothetical default scenario, the group's capacity to meet debt-service repayments could come under pressure from continued strong erosion of its core voice fixed-line revenues, owing to increasing competition from cable and fixed-line telecom operators, strong competitive pressure on revenues from wholesale and business customers, the effects of a significant economic downturn, and material weakening of the Hungarian forint against the euro.

In the fast-moving technological environment, a fixed-line network might not retain as much value as a mobile network. Nevertheless, the group has a solid market share in its concession areas and extensive network coverage in Hungary. We therefore assume that the network and subscriber base could still be attractive for an alternative fixed-line, mobile, or wholesale operator. In the event of default, lenders under the senior facilities should therefore benefit from their secured position.

Outlook

The negative outlook reflects our view that Magyar Telecom's liquidity will likely further weaken over the next 12 months, given our forecast of meaningful negative FOCF generation. As a result, we forecast that the current capital structure could become unsustainable in the near term. We also see a potential risk for a payment default on the interest coupon due in December 2013, absent additional funding from its shareholders or significant cuts in capital expenditures.

We will likely consider a downgrade in the next six months if the group's available cash balances continue to decline as a result of negative FOCF generation.

The rating could stabilize if the group manages to curb the expected decline in revenues and EBITDA and at the same time is able to generate at least break-even FOCF. Although not anticipated at this stage, liquidity support from Mid Europa Partners could also be positive for the rating.

Related Criteria And Research

-- Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012

-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012

-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011

-- Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009

-- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012

-- Use Of CreditWatch And Outlooks, Sept. 14, 2009

Ratings List

Downgraded

To From

Magyar Telecom B.V.

Corporate Credit Rating CCC/Negative/-- CCC+/Negative/--

Senior Secured CCC CCC+

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