UPDATE 2-China's reforms not enough to arrest mounting debt - Moody's
* China facing dilemma of deleveraging without hurting growth
Overview -- Mexico-based telecommunications company Axtel's financial performance continued to weaken during second-quarter 2012 and we believe profitability will remain under pressure. -- We are lowering our ratings on Axtel to 'CCC+' from 'B-', and the recovery rating of '3' on the notes remains unchanged. -- The negative outlook reflects the pressures on the company's liquidity as a result of the weakening EBITDA generation due to strong competition. Rating Action On Aug. 10, 2012, Standard & Poor's Ratings Services lowered its long-term issuer credit and senior unsecured ratings on Axtel S.A.B de C.V. to 'CCC+' from 'B-'. The recovery rating of '3' on the notes, indicating the expectation of meaningful 50%-70% recovery in the event of payment default, remains unchanged. The outlook is negative. Rationale The downgrade reflects our concerns regarding Axtel's liquidity, which we now assess as weak, especially its ability to meet its 2013 coupon payments and higher-than-expected working capital needs from payments due from government and its still high, though decreasing, capital expenditures. The company has narrow covenant headroom, which it has already amended. We believe Axtel could need another amendment to its revolving credit facility in the near term, if EBITDA further deteriorates or if the Mexican peso continues to depreciate. The downgrade also reflects Axtel's weak financial performance during the second quarter of 2012. Top line continues to suffer from lower international traffic segment revenues due to pricing pressures from tough competition. The outlook on prices and volume for this segment is uncertain and could further erode the company's EBITDA. The ratings on Axtel reflect its currently highly leveraged financial risk profile and vulnerable business risk profile amid very competitive operating conditions and dependence on interconnection through Telefonos de Mexico S.A.B. de C.V. The ratings also incorporate the company's marginal revenue growth and weak liquidity. Axtel's wide reach within Mexico and its flexible, advanced network featuring several access technologies are positive factors. Under our base-case scenario, we expect a mid-single-digit percentage decrease in revenues, a 23% drop in EBITDA for 2012, which would cause EBITDA margin to fall to 28% at the end of 2012 from 34.1% during first-quarter 2012. For the 12 months ended June 30, 2012, Axtel posted total debt to EBITDA of 4.1x and funds from operations (FFO) to total debt of 24.8%, adjusted for operating leases and pensions. We expect these ratios to deteriorate to 4.4x and 15.2% by the end of 2012, due to the international traffic segment's woes, the devaluation of the Mexican peso, some delays in certain projects, and the ongoing phasing out of the Nextel agreement. Although these ratios could qualify for an aggressive financial risk profile, the company's weak liquidity constrains it. Axtel is currently working on several recapitalization alternatives in order to have a healthier capital structure and a sustainable growth trend. This might include the sale of nonstrategic assets, infusion of fresh capital, or joint ventures in the IT business. Liquidity Axtel's liquidity is weak under our criteria, which means sources of liquidity over uses could result in a significant deficit in the next tree quarters. Sources of liquidity consist of about MXN664 million in cash, about MXN260 million in available revolving credit line--although access to it will be limited due to its financial covenants which we believe could be breached in the near term--and FFO of more than MXN2 billion in the next 12 months. Cash uses are likely to include capital expenditures of about MXN2.1 billion, working capital outflows of MXN400 million - MXN450 million, and principal payments of about MXN$355 million for 2012. The company has expressed its intentions to scale back capital expenditures to $150 million for 2012 to preserve cash; however, we believe that this will limit its growth and its ability to compete with larger and better capitalized peers in the future, pressuring its competitive position. During the second quarter, the company amended its leverage and interest coverage ratios under the syndicated loan facility, giving it additional, but narrow, headroom for 2012. For 2013, if the company's EBITDA falls more than 4% and debt remains at the same levels due to high peso-dollar exchange rate volatility, covenant headroom will tighten further, requiring the company another amendment to its credit facility. Outlook The negative outlook reflects the pressures on the company's liquidity as a result of weaker EBITDA generation, eroded cash flow due to continuing capital expenditure requirements and working capital needs, and our concerns that the company's EBITDA generation could result in another covenant amendment. We could lower the ratings further if the company incurs higher-than-expected capital expenditures and working capital requirements that further weaken the company's liquidity and/or if industry conditions and increased competition result in higher churn and greater pricing pressures that further erode the company's EBITDA generation. An upgrade is possible if the company successfully implements its recapitalization projects, improving its capital structure, liquidity, and its ability to continue investing. Related Criteria And Research -- Key Credit Factors: Business And Financial Risks In The Global Telecommunication, Cable, And Satellite Broadcast Industry, Jan. 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded To From Axtel S.A.B. de C.V. Corporate Credit Rating CCC+/Negative/-- B-/Negative/-- Senior Unsecured CCC+ B- Recovery Rating 3 3 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
* China facing dilemma of deleveraging without hurting growth
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