November 2, 2017 / 4:08 PM / a year ago

Fitch Rates Axtel's Proposed USD500 Million Notes 'BB- (EXP)'

(The following statement was released by the rating agency) CHICAGO, November 02 (Fitch) Fitch Ratings has assigned a 'BB-(EXP)' rating to Axtel S.A.B. de C.V.'s (Axtel) proposed issuance of up to USD500 million of senior unsecured notes due 2024. The proceeds from the issuance are expected to be used to refinance the company's existing bank loans and related issuance expenses. KEY RATING DRIVERS Axtel's ratings reflect the company's solid market position in the enterprise telecom business segment, achieved by the merger with Alestra in 2016, and limited exposure to retail segments where competitive intensity is high. As a subsidiary of Alfa S.A.B. de C.V. (Alfa, 'BBB-'/Stable), one of the largest business groups in Mexico, the company has good access to financing, which bolsters its financial flexibility. The ratings are tempered by Axtel's weak financial profile for the rating category, small market positions in Mexico and volatile demand outlook from its government clients Enterprise-driven Growth: Fitch forecasts Axtel to undergo stable low single-digits revenue growth in 2017 and 2018, driven mainly by continued solid growth in the enterprise segment, which represented about 65% of its total sales during the first nine months of 2017 (9M17). Fitch believes that the demand outlook for network connectivity and IT solutions for enterprise clients should remain relatively stable in Mexico, in line with the regional trend. Also, the recurring revenue proportion based on multi-year contracts represents about 95% of the company's total enterprise revenues, which should remain relatively stable given the switching cost of service providers. Negatively, Fitch expects revenue contraction in the residential segment to continue until 2018, while demand from government clients could remain volatile. For the residential services, Fitch expects continued subscriber loss for the wireless service until the service discontinuation in 2018, which will dilute the steady growth in its fiber-to-the-home (FTTH) subscribers. The mass market segment revenue is forecast to resume growth from 2019, as FTTH revenues continue solid double-digit growth annually backed by steady expansion in the subscriber base. Any material improvement in contract volumes from the public sector would be challenging in the short to medium term, as the discretionary budgets for IT and telecom investments will likely remain constrained. Contribution from Red Compartida Project: Axtel's participation in Red Compartida project will enable additional revenue growth headroom and a wider breadth of service offerings from 2018. In November 2016, Ministry of Communications and Transport of Mexico granted to ALTAN Redes, a multinational consortium in which Axtel has about 2% stake in non-voting shares, the exclusive right to use the 90 MHz spectrum in the 700 MHz band and develop a national 4G wholesale network in Mexico. Based on the vendor agreement for this project, Red Compartida, Axtel will provide its assets, such as fiber capacity and data centers among others, to support the project's coverage obligation. The company expects to generate over MXN250 million revenues in 2018, with a potential to scale up the business as the project progresses with increased network coverage. In addition, Axtel plans to set up a Mobile Virtual Network Operator/Enabler (MVNx) platform in 2018 by utilizing Red Compartida networks. Fitch does not expect material cash flow generation from the MVNx business at least for the short to medium term given low operating margins for the service. Positive Merger Impact: The impact of Axtel's merger with Alestra has been positive in terms of a strategic fit of Alestra's operations, increased market presence, as well as opex and capex savings. Axtel disclosed that the merger synergy during 2016 was about MXN500 million, with additional MXN500 million headroom to be achieved in 2017 for a total run-rate of MXN1 billion. Synergy benefits have and will continue to come from network-related opex efficiencies and lower corporate expenses, following the integration of operations. In addition, Fitch believes that being a part of a reputable group in Alfa helps Axtel gain better access to banks/capital markets, leading to stronger financial flexibility. Negative FCF to Continue: Fitch forecasts that Axtel's negative FCF generation will remain uncurbed at least for the short term. Fitch projects the company's capital intensity, measured by capex/sales, to remain consistently above 20% in 2017 and 2018 at around MXN3.3-MXN3.4 billion, which will largely consume the projected CFFO during the period. Annual cash interest payments in 2017 and 2018 should fall by about 50% from the 2016 level of MXN2.4 billion, which was high due to expenses related to the prepayment of Axtel's previous bonds. Fitch does not expect any dividend payments in the short- to medium-term. High Leverage: Axtel's current leverage is weak for the rating level, despite an ongoing deleveraging trend, and its failure to continue to lower leverage over the medium term would be negative for the ratings. The company's adjusted net leverage was 4.2x as of Sept. 30, 2017, which was modest improvement from 4.4x at end-2016. This is an elevated level from Axtel's pre-merger leverage of 3.8x at end-2015, due mainly to MXN depreciation against the USD, integration costs, as well as continued revenue contraction in its government business in 2016. Axtel is negatively exposed to MXN depreciation as about 65% of its total debt is denominated in USD against its approximately 90% of EBITDA generation in MXN. Fitch forecasts the company's net leverage to remain stable at around 4.0x over the medium term as steady increase in EBITDA offsets then impact of modest negative FCF generation. DERIVATION SUMMARY Axtel's 'BB-' ratings reflect the company's relatively weak financial profile, mainly its high leverage compared to mid-to-high 'BB' category telecom operators in the region. The company's weak market position and small scale of operations are also negative considerations versus its peers in the rating category; this is somewhat offset by its business concentration in the enterprise segment which faces less competition than the residential segment. Axtel's financial profile is weaker than Columbian fixed-line operator Empresa de Telecomunicaciones de Bogota, S.A., E.S.P, rated 'BB+'/Negative, and Colombia Telecomunicaciones S.A., E.S.P., rated 'BB'/Stable. Axtel's financial profile is deemed broadly in line with VTR Finance B.V., rated 'BB-'/Stable, which is a leading Chilean cable operator. Parent/subsidiary linkage exists between Axtel and Alfa, given the latter's 52.8% ownership in the company. However, the ratings are based on Axtel's stand-alone credit profile given weak legal and strategic linkages. No country ceiling constraint and operating environment influence were in effect for the ratings. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Low-single-digit revenue growth on a pro forma basis in the short- to medium-term, mainly led by enterprise segment; --WiMax service to be discontinued from mid-2018; --Stable EBITDA margin of 32%-33% in 2017-2018; --Capex to represent 22% of sales over the medium term; --Adjusted net leverage to gradually fall toward 4.0x over the medium term. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Strong revenue growth backed by continued solid growth in the enterprise and the FTTH business, with stable demand from the government segment; --Positive FCF generation to strengthen its cash position; --Improved adjusted net leverage to comfortably below 3.5x on a sustained basis. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Unfavorable economic conditions negatively affecting IT/telecom budgets of the corporate and public segments; --Uncurbed negative FCF generation; --Dpreciation of MXN against the USD in the absence of meaningful hedge measures; --Failure to improve adjusted net leverage toward 4.0x on a sustained basis (end-2016: 4.4x). LIQUIDITY Adequate Liquidity: Axtel's liquidity profile is adequate. The company's cash balance was MXN722 million as of Sept. 30, 2017 against its short-term debt obligation of MXN734 million. Following the proposed notes issuance, the company will not face sizable bullet maturities until 2020, when MXN4.7 billion of bank loans become due. While the company does not have any committed credit facilities, Fitch believes that Axtel can retain solid financial flexibility in terms of access to domestic financial institutions in Mexico, as a part of Alfa group. FULL LIST OF RATING ACTIONS Fitch currently rates following ratings: Axtel S.A.B. de C.V. --Foreign-currency Long-term Issuer Default Rating (IDR) at 'BB-'; Outlook Stable; --Local-currency Long-term IDR at 'BB-'; Outlook Stable; --National Long-term Rating at 'A-(mex)'; Outlook Stable. Fitch has assigned the following rating: Axtel S.A.B. de C.V. --'BB-(EXP)' for proposed USD500 million senior unsecured notes due 2024 . Contact: Primary Analyst Alvin Lim, CFA Director +1-312-368-3114 70 W Madison St. Chicago, IL 60602 Secondary Analyst Velia Valdes Associate Director +52 81 8399 9100 Committee Chairperson Daniel R. Kastholm, CFA Regional Group Head - Latin America Corporates +1-312-368-2070 Summary of Financial Statement Adjustments Fitch excluded the following items in its recurring EBITDA calculation for 9M17: --Merger-related expenses: MXN193 million; --Asset impairment charges: MXN10 million; --Gains from tower sales: MXN475 million. 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