September 27, 2017 / 5:37 AM / 2 years ago

Fitch Affirms Smartfren at 'CCC(idn)'

(The following statement was released by the rating agency) JAKARTA, September 27 (Fitch) Fitch Ratings Indonesia has affirmed Indonesia-based PT Smartfren Telecom Tbk's (Smartfren) National Long-Term Rating at 'CCC(idn)'. 'CCC' National Ratings denote very high default risk relative to other issuers or obligations in the same country. KEY RATING DRIVERS Weak Cash Flow Generation: Fitch expects Smartfren's EBITDA to remain weak in the next 18-24 months. EBITDA will be below IDR350 billion in 2017 and 2018, which will be insufficient to cover annual interest expense of more than IDR600 billion. The company's weak EBITDA forces Smartfren to continuously rely on external funds to meet working capital, network investment and debt servicing requirements. Its EBITDA margin will decline to around 8% in 2017 after a temporary improvement in 1H17. Smartfren's 1H17 EBITDA margin was 11% due to average revenue per user (ARPU) growth to IDR33,000 (2016: IDR28,000) and lower operational costs from the gradual shutdown of its code division multiple access (CDMA) antenna since 4Q16. We expect further margin pressure starting from 2H17 as Smartfren's significant roll-out of a long-term evolution (LTE) network will increase its operational costs while subscriber numbers will remain relatively stagnant. LTE Investment Adds Liquidity Pressure: Capex requirement for the LTE network expansion will exacerbate Smartfren's cash flow pressure. Fitch believes that extensive network coverage is necessary to attract subscribers. Smartfren will have to invest significantly to remain competitive in the Indonesian telco industry. Smartfren is significantly behind in terms of nationwide network coverage with fewer than 20,000 base transceiver stations (BTS) compared with PT Indosat Tbk's (BBB+/AAA(idn)/Stable) 59,000 - although Smartfren's LTE BTS of more than 13,000 in 1H17 were already ahead of Indosat's 5,533. We estimate the company will spend around IDR2 trillion on capex in 2017 and 2018, which is significantly lower than PT XL Axiata Tbk's (BBB/AAA(idn)/Stable) IDR4.5 trillion per annum since 2015. Stagnant Subscriber Base: Subscriber acquisition will remain challenging for Smartfren in 2017 and 2018 due to competitive pricing in the Indonesian telco industry. The company's subscriber base has remained relatively stagnant since 2015, with 10.7 million in 1H17 (2015-2016: 11 million), despite the company's significant investment in its LTE network; the company's 4G BTS increased to more than 13,000 in 1H17 from around 9,000 in 2015. Smartfren needs a significantly larger subscriber base to generate profits which are commensurate with its network investment. We expect monetisation of current data users to be gradual and slow as the intense competition for subscribers among Indonesian telcos will make it more difficult. Uncertain Funding Source: We estimate that Smartfren's current funding sources will not be adequate to cover its short-term liquidity. At end-June 2017, the company had around USD60 million (IDR792 billion) in undrawn credit facilities and USD130 million (IDR1,716 billion) in available capex facilities. Smartfren has also fully utilised its mandatory convertible bonds (MCB) phase II of IDR9 trillion in 1H17 with a IDR1,400 billion issuance. The company is currently in talks with lenders for additional working capital and capex facilities. In the past, Smartfren's financial flexibility has been limited with liquidity mostly coming from MCB issuance and China Development Bank facilities. DERIVATION SUMMARY The rating at the lower end of the scale is largely driven by Smartfren's liquidity situation rather than peer comparison. Smartfren's rating reflects its weak cash flow generation and liquidity position. We expect the company's EBITDA generation in the next 18-24 months will not be sufficient to cover its interest expense. Smartfren's available borrowing facilities at end-June 2017 are not sufficient to cover its liquidity needs in the next 18-24 months. Poor cash flow generation forces Smartfren to rely on external liquidity sources to cover its cash shortfall for working capital, capex and debt servicing requirements. The rating also reflects the company's limited financial flexibility due to its high credit risk. Funding sources in the past have been limited mostly to the issuance of MCB and loans from China Development Bank. 'CCC' National Ratings denote very high default risk relative to other issuers or obligations in the same country. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Stagnant subscriber base at 11 million in 2017 and 2018 - Blended average revenue per user of IDR30,000 - 33,000 in 2017 and 2018 - EBITDA margin will improve to around 8% in 2017 and decline to around 6% in 2018 - Annual capex of around IDR2.0 trillion in 2017 and 2018 RATING SENSITIVITIES Positive: Future developments that may, individually or collectively, lead to positive rating action include: -The company's ability to fund its operations without any reliance on further MCB issuance Negative: Future developments that may, individually or collectively, lead to negative rating action include: -Weakening liquidity or operating performance such that the company's ability to meet obligations appears unlikely LIQUIDITY Inadequate Short-Term Liquidity: Smartfren repaid its rupiah bonds in June 2017 using the funds from the issuance of MCB. At end-June 2017, Smartfren had around IDR162 billion of cash and cash equivalents and USD60 million (IDR792 billion) in undrawn working capital facilities from Equimark Investment Holding Ltd and Niven Holdings Limited. These facilities will not be sufficient to cover debt maturing within 12 months of IDR1,909 billion. Contact: Primary Analyst Olly Prayudi Director +62 21 2988 6812 Fitch Ratings Indonesia DBS Bank Tower 24th Floor, Suite 2403 Jl. Prof. Dr. Satrio Kav 3-5 Jakarta 12940 Committee Chairperson Steve Durose Managing Director +61 2 8256 0307 Note to editors: Fitch's National ratings provide a relative measure of creditworthiness for rated entities in countries with relatively low international sovereign ratings and where there is demand for such ratings. The best risk within a country is rated 'AAA' and other credits are rated only relative to this risk. 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