November 24, 2017 / 1:55 AM / a year ago

Fitch Affirms Global Cloud Xchange at 'B-'; Outlook Negative

(The following statement was released by the rating agency) SINGAPORE/HONG KONG, November 23 (Fitch) Fitch Ratings has affirmed Global Cloud Xchange Limited's (GCX) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B-'. The Outlook is Negative. Simultaneously, Fitch has affirmed the rating on GCX Limited's USD350 million 7% senior secured notes due 2019 at 'B+' with a Recovery Rating of 'RR2'. GCX Limited is a wholly owned subsidiary of GCX. The notes are secured by the assets and equity interests of GCX and its key subsidiaries and are guaranteed by GCX and its key operating subsidiaries, which generate most of the group's revenue and EBITDA. The notes are rated two notches higher than GCX's IDR due to superior recoveries of between 71%-90% on senior secured notes in a default scenario, based on our estimated value that would be available to creditors. The affirmations reflect better prospects for higher cash generation in the second half of the financial year ending March 2018 (FY18) and FY19, supported by increased indefeasible right of usage (IRU) sales. GCX's free cash flow (FCF) could also improve if it successfully completes its plan to replace receivables of USD120 million due from its parent, Reliance Communications Limited (Rcom, Restricted Default), with data centre assets. This would significantly lower the increasing receivables associated with Rcom. The Negative Outlook reflects the uncertainty and execution risks surrounding GCX's IRU sales and its plan to acquire Rcom's assets. The asset acquisition would require GCX and Rcom board approval and, more importantly, agreement from Rcom's joint lenders. We could take negative rating action if there is a deterioration in financial performance, such that cash remains below USD40 million (end-September 2017: USD37 million), or a lack of resolution of Rcom's receivables impairing GCX's refinancing prospects. A revision of the Outlook to Stable would be contingent upon an improvement in GCX's cash generation along with minimal working capital outflows, such that FCF breaks even. If GCX's IDR is downgraded to 'CCC', the bond rating will be downgraded by two notches to 'B-'. In such a situation, the bond would still be two notches higher than the IDR, as instruments can be rated 'CCC+' under Fitch's criteria. KEY RATING DRIVERS Deteriorating Liquidity: Cash has fallen to USD37 million (FY17: USD62 million, 1QFY18: USD53 million) - below Fitch's negative guidance of USD40 million - due to IRU sales of only USD21 million in 1HFY18. We forecast FY18 IRU sales of around USD50 million-55 million (FY17: USD51 million). However, management has disclosed that it could sign a large IRU deal in 2HFY18, leading to overall FY18 cash sales of around USD64 million. Persistent Negative FCF: We forecast a FCF deficit of around USD30 million for FY18, with cash flow from operations falling short of our capex estimate of around USD30 million (1HFY18: USD13 million) and dividends of at least USD13 million. GCX may pay USD13 million of loans due at its immediate parent, Reliance Global BV (RGBV), whose stake in GCX is pledged for the loan. GCX paid USD15 million in dividends in FY17. However, management does not intend to make any dividend payment unless IRU sales are exceptionally high at around USD80 million. We believe FY18 cash EBITDA could decline to around USD65 million-70 million (FY17: USD78 million) due to flat IRU sales and weakness at its managed service segment. Cash flow will remain exposed to industry oversupply and frequent price erosion. Furthermore, technological advancements continue to improve the capacity of existing cables. Hence, bandwidth tariffs are likely to continue declining over the medium-term, despite increased demand. Refinancing Risk: Refinancing risk exists around the USD350 million secured notes due August 2019. The company's financial performance has weakened since the notes were issued in 2014 and lenders are likely to require a higher interest rate than the current 7%, even if replacement credit is available, putting pressure on GCX's cash generation. Higher Counterparty Risk: GCX's net receivables from Rcom steadily increased to USD120 million at end-September 2017 (FYE17: USD94 million). GCX continues to face high counterparty risk due to the uncertainty over the collection of the receivables from Rcom, with which it has an annual trading relationship worth about USD30 million-35 million. However, GCX hopes to replace Rcom's receivables by acquiring its data centres. This could replace a large part of the lost revenue and EBITDA from Rcom after the company shut down its wireless business. We rate GCX's IDR based on its standalone profile under our Parent and Subsidiary Rating Linkage methodology due to weak legal, operational and strategic linkages with its parent. Rcom defaulted on the coupon payment on its USD300 million bond on 6 November 2017. We understand Rcom may be looking to sell all or part of its stake in GCX. GCX's cash flow is ringfenced and dividends to Rcom are subject to an incurrence test of debt/EBITDA of below 3.75x (FY17: 3.00x) and restricted payment covenants. However, GCX is able to pay about USD10million-15 million in annual dividends under the ringfencing conditions. Recovery Rating of 'RR2': We have affirmed GCX Limited's USD350 million bond at 'B+'/'RR2'. We use the going-concern value approach to calculate the post-restructuring enterprise value, as the liquidation approach is not appropriate since GCX's assets are of little use if dismantled and liquidated. We estimate post-restructuring cash flow of around USD74 million, the same as last year. This assumes the depletion of the current position to reflect the distress that provoked a default and a level of corrective action that Fitch assumes would have occurred during restructuring. We assume a cash flow multiple of 4.5x, as we believe Rcom may settle for a lower value for GCX, given its weak liquidity and cash requirements. The adjusted going concern enterprise value after administrative claims of USD300 million is then applied to the USD350 million secured notes, giving an estimated 86% recovery. DERIVATION SUMMARY The affirmation reflects the uncertainty around GCX's ability to refinance its USD350 million secured notes due August 2019. Its cash balance is depleting on persistently negative FCF due to lower cash generation and lack of collection of Rcom's receivables. GCX's business profile is exposed to high execution risk on the successful completion of lumpy IRU sales in FY18-FY19 amid an oversupplied industry that is characterised by frequent price erosion. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue to decline by a low-single digit percentage in FY18 - Cash EBITDA of around USD65 million-70 million, with IRU sales of USD50 million-55 million - Rcom will not pay for net sales of around USD30 million-35 million during FY18. Minimal working capital outflow starting FY19 - Dividend of USD13 million to GCX's immediate parent, RGBV, during FY18 - Annual capex of around USD30 million RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to the Outlook reverting to Stable - An improvement in GCX's cash generation and minimal negative working capital outflow, such that FCF breaks even Developments that May, Individually or Collectively, Lead to Negative Rating Action - Deterioration of liquidity, as evidenced by GCX's cash balance remaining below USD40 million (end-September 2017: USD37 million) - FFO adjusted net leverage deteriorating to above 6.0x (FY18f: 4.0x-4.5x) - Deterioration in trading performance or cash receipts that negatively affect refinancing prospects LIQUIDITY Cash-Driven by IRU Sales: GCX had an unrestricted cash balance of USD37 million at end-September 2017, (1QFY18: USD53 million, FY17: USD62 million). Cash balance is driven by IRU sales and the resolution of Rcom receivables. Its only debt is the secured notes of USD350 million due in August 2019. The finance lease of USD13.5 million was extinguished in 1HFY18 after the completion of its Yipes Inc. sale. GCX's committed undrawn facilities of USD30 million expired in September 2017. It needs a minimum cash balance of USD40 million-50 million to pay its annual interest cost of USD25 million, maintenance capex of USD22 million and taxes of USD3 million. In accordance with Fitch's policies, GCX appealed and provided additional information to Fitch that resulted in a rating action different than the original rating committee outcome. Contact: Primary Analyst Nitin Soni Director +65 6796 7235 Fitch Ratings Singapore Pte Ltd. 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