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March 7 (The following statement was released by the rating agency)
Fitch Ratings says that although Pacnet Limited's (Pacnet, B/Stable) EBITDA has improved in the past four quarters, its ratings remain constrained by low profitability, a weak balance sheet and strong competition from better-capitalised market participants. The successful rollout and rapid take-up of its new data centre capacity are important to Pacnet's long-term strategy and could drive improvement in credit metrics, which would lead to a positive rating action.
Fitch expects that further improvement in EBITDA in the next few quarters will be slow, compared with 2013, as competition in the international connectivity business remains intense and it takes time to build up the contributions from the data centres. Improved profitability in 2013 was due to cost streamlining and elimination of low-margin businesses. However this low-hanging fruit has now been picked. Reported EBITDA rose 32.3% yoy to USD115m in 2013 with an EBITDA margin of 24.4% (2012: 16.8%) - a level comparable with global independent submarine cable operators.
New carrier- and consortium-led cables may result in a realignment of the Asia-Pacific region's submarine bandwidth markets. The majority of the region's largest telecom operators have stakes in their own next-generation, pan-regional submarine infrastructure, thus challenging Pacnet's wholesale bandwidth model.
In Pacnet's key markets, two new submarine cable systems - Asia Submarine-Cable Express and Southeast Asia-Japan Cable - started operation in 2013. Another major system, Asia-Pacific Gateway, is expected to be launched before the end of 2014.
Nevertheless, Fitch believes that Pacnet's indefeasible right of use (IRU) business will remain stable in 2014, but expects that the average size of new contracts, from both enterprises and telecom operators, to be smaller. Cash receipts from new IRU business in 2013 rebounded to USD57m from USD28m in 2012. However, a significant portion of the cash receipts was from a single contract, which may not recur in 2014.
We think that a more meaningful contribution from core data centres - those that are built, owned and operated by Pacnet rather than reselling of facilities - is likely to come in 2015. To date, contribution from Pacnet's core data centres has been limited. Both the Singapore and Hong Kong facilities look to be on track to achieve target take-up rates. Pacnet has already pre-sold about 100 racks (about 17% of racks available) of its newly completed Singapore data centres. However, the progress was slower at Pacnet's core data centres in Sydney and Chongqing.
Fitch expects capex will continue to exceed Pacnet's cash flow from operations (CFO) in the next one to two years, hence the free cash flow (FCF) deficit is likely to continue though it would diminish. CFO was USD42m but capex reached USD81m in 2013. We expect capex to ease to around USD60m in 2014. Pacnet has some flexibility to manage its cash requirements should internal funds need to be retained, as maintenance capex and committed capex are low.
Fitch expects FFO-adjusted net leverage to remain at over 4x for the next 18 months (2012: 4.5x), due to weak FCF generation. However, liquidity should remain satisfactory following the refinancing last year. Unrestricted cash totalled USD54m at end-2013, but there is no debt maturing in 2014. The average debt maturity has been extended to 4.9 years, from 2.0 years before the issue of USD350m senior secured notes in late 2013.
Fitch may consider positive rating action if FFO-adjusted net leverage falls below 4x and FFO fixed-charge coverage rises above 2.5x (2012: 2.0x), both on a sustained basis. However, Fitch may downgrade the rating if Pacnet's FFO-adjusted net leverage rises over 5x and FFO fixed charge coverage falls below 2x, both on a sustained basis.