Fitch Revises P4 Sp zoo's Outlook to Stable on Subordinated PIK Plan

Wed Jul 30, 2014 10:58am EDT

(The following statement was released by the rating agency) LONDON, July 30 (Fitch) Fitch Ratings has revised the Outlook on Poland-based P4 Sp z.o.o's (P4) to Stable from Positive. Its Long term Issuer Default Rating (IDR) and National Long term Rating have been affirmed at 'B+' and 'BBB-(pol)' respectively, A full list of rating actions is available at the end of this commentary. The change in the Outlook reflects increased financial risk associated with P4's capital structure following the company's announced plan to issue a subordinated PIK note at the Play Topco level, the proceeds of which will be used to pay shareholder dividends. The PIK issue for the purpose of a shareholder dividend, so soon after the inaugural senior debt issue and associated dividend recap, confirms that management are likely to manage the group's capital structure and financial policies in a shareholder-friendly manner, which is less likely to lead to the deleveraging previously envisaged by Fitch. KEY RATING DRIVERS Pay- if-You-Can PIK The PIK notes are not rated by Fitch - its terms have, however, been reviewed by Fitch and we will not include its issue as part of the consolidated debt of the senior secured/senior notes' (senior debt) restricted group. The existence of the PIK notes will, however, create cash flow pressures at the senior debt restricted level, as interest is structured as a "pay-if-you-can" payment rather than a fully discretionary PIK payment. This will, in Fitch's view, drive dividend payments at the restricted level, subject to the 3.75x net debt/ EBITDA restricted payment test in the senior debt documentation. Given the sound underlying operational performance of the business, Fitch expects the PIK to be serviced on a cash-pay basis and will therefore include cash payments on the PIK when assessing the company's interest and fixed charge cover ratios. Rational Market, Low Convergence Risk Fitch views competition in the Polish mobile market as developed and diversified with no single operator owning a disproportionate share of the market, while as the market challenger, Play has taken a measured approach to gaining market share, product position and pricing. We consider that a population of 38 million people in a reasonably advanced economy can support a four-player market and that the market structure is less likely to experience the kind of value-destructive price wars seen in other markets. The somewhat underdeveloped fixed telephony infrastructure and limited pervasion of traditional triple-play services suggest an aggressive move to convergent fixed-mobile bundles is currently a limited risk over the medium term. Efficient Infrastructure Strategy Play has developed an efficient approach to network coverage, concentrating its own network infrastructure in more populous and urban areas, relying to a limited extent on roaming agreements with each of the other three main network operators. Data traffic is almost entirely carried on the company's own network, while spectrum and planned LTE (next generation data technology) investment are adequately provisioned relative to competition. This hybrid asset-light approach allows for a lower level of capital intensity, in turn supporting improving cash flow. While roaming agreements are entirely commercially negotiated, Fitch does not see high renegotiation risk given the current existence of multiple agreements, and the recently signed seven-year agreement with T-Mobile. Mature Competitive Market As the smallest in a four-player market in an emerging economy, Play has proven a nimble competitor and has grown rapidly and consistently. Careful management of the pace of growth is key given that the two large incumbent-owned multinational competitors - Orange (BBB+/Negative) and T-Mobile (Deutsche Telecom; BBB+/Stable) - are financially strong and experienced enough to intensify competition if they so choose. Financial Policy The ratings are constrained by financial policies that allow leverage to remain somewhat high (incurrence tests of 4.25x net leverage; 3.0x net secured leverage and a restricted payment test limited at 3.75x net debt to EBITDA). Currency mismatch between a predominantly euro-denominated debt structure and 100% domestic revenue base is a further constraint. The introduction of the PIK notes - treated by Fitch outside the senior debt restricted group - suggests that financial policies will be managed with a shareholder friendly bias and that the flexibility to pay dividend cash out of the restricted group will be utilised. RATING SENSITIVITIES POSITIVE: Any positive action would be subject to the continued rational behaviour of the market and that market share gains and other performance indicators are in line with Fitch's rating case. The shareholders' approach to financial policy will also be important. With a potential IPO deemed a number of years away and the bonds incorporating a restricted payment test (set at 3.75x) Fitch expects recurring dividends to consistently re-leverage the balance sheet. The level at which the shareholders choose to re-leverage using dividends combined with continued sound operational performance, will determine whether the financial profile supports a higher 'BB-' rating. Future developments that could lead to a positive rating action are: - Continued strong subscriber growth and an ongoing shift in the subscriber mix to post-paid customers, with subscriber acquisition cost and post-paid churn close to management's expectations - EBITDA margin in the high 20s and EBITDA less capex margin in the high teens. - A financial policy that is likely to see FFO net adjusted leverage managed at or below 4.0x, a level consistent with net debt/EBITDA of around 3.3x-3.4x - fixed charge cover (including the cash-pay element of interest on the PIK) consistently at or above 3.0x NEGATIVE: Future developments that could lead to a negative rating action are: -Intensification of the competitive (pricing) environment, making revenue growth and margin expansion targets more challenging. An expectation that convergent services were deemed by the market to be a more important offering could also create negative rating pressure -A financial policy or weakened financial performance leading to FFO net adjusted leverage consistently above 5.0x, which would be expected to result in a downgrade to 'B' -Fixed charge cover consistently below 2.5x FULL LIST OF RATING ACTIONS P4 Sp. Z.o.o. Long-Term IDR: affirmed at 'B+'; Outlook Stable Play Finance 2 S.A. senior secured notes: affirmed at 'BB-'/'RR3'/'BBB (pol)' Play Finance 1 S.A. senior notes: affirmed at 'B-'/'RR6' P4 Sp. Z.o.o. National Long-Term rating: affirmed at 'BBB-(pol)'; Outlook Stable Contact: Principal Analyst Slava Bunkov Associate Director +7 495 956 9931 Supervisory Analyst Stuart Reid Senior Director +44 20 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chair Damien Chew Managing Director +44 20 3530 1424 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com; Malgorzata Socharska, Warsaw, Tel: +48 22 338 62 81, Email: Malgorzata.Socharska@Fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable criteria, 'Corporate Rating Methodology', dated May 2014, are available at www.fitchratings.com. 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