(The following statement was released by the rating agency)
Dec 07 -
Summary analysis -- Hong Kong Telecommunications (HKT) Ltd. ------- 07-Dec-2012
CREDIT RATING: BBB/Stable/-- Country: Hong Kong
Primary SIC: Communications
Credit Rating History:
Local currency Foreign currency
28-Nov-2008 BBB/-- BBB/--
The rating on Hong Kong Telecommunications (HKT) Ltd. (HKT) reflects the company’s leading position in Hong Kong’s fixed-line telecommunications and broadband markets and its well established network infrastructure. It also reflects HKT’s stable and recurring operating cash flows. These strengths are offset by the highly competitive nature of Hong Kong’s matured telecommunications industry and risks associated with the moderately aggressive financial policies and growth strategies of HKT’s parent, PCCW group. In addition, the group’s “significant” financial risk profile constrains the rating.
We take a consolidated view of PCCW group when analyzing HKT’s credit profile. That is because PCCW Ltd. (not rated) remains the major shareholder of HKT Trust and HKT Ltd. (HKT Trust; not rated), with a stake of about 63%, and, in our view, relies on cash flows from HKT Trust for its dividend payout and investments. The trust represents the vast majority of the group’s earnings and assets. HKT Trust owns 100% of HKT Group Holdings Ltd. (not rated), which in turn fully owns HKT.
HKT’s strong market position and solid subscriber base in Hong Kong and PCCW group’s unique quadruple-play service underpin the company’s “strong” business risk profile. The service offers fixed-line, broadband Internet access, mobile, and pay-TV. As of June 30, 2012, HKT has a share of about 68.1% of Hong Kong’s broadband market (1.54 million subscribers) and a 62.1% share of the fixed-line market (2.64 million subscribers). Price competition in the domestic broadband market has softened since City Telecom (H.K.) Ltd. (not rated) sold its telecom assets to CVC Asia Pacific Ltd. (not rated) in May 2012. We expect that market participants will focus increasingly on protecting margins than expanding market share, and that HKT could improve its broadband average revenue per user (ARPU) when more of its subscribers renew their contracts or migrate to fiber broadband.
We expect HKT to continue to generate stable and solid operating cash flow. However, we do not expect the company’s financial performance to significantly improve because HKT Trust will distribute almost all its adjusted fund flow (AFF; defined as EBITDA minus capital expenditures, customer acquisition costs, license fees paid, taxes paid, net finance costs paid, and adjusted for changes in working capital). In the first half of 2012, AFF was Hong Kong dollar (HK$) 1.43 billion. We expect PCCW group’s profitability to remain flat given that telecom growth opportunities in Hong Kong are limited by the relatively small market and high penetration rate. In our view, any growth will come largely from the group’s mobile operations. Demand for mobile data services is increasing rapidly due to the growing popularity of smart phones and other wireless devices. We expect such demand to support an increase in mobile penetration and ARPU. Mobile penetration in Hong Kong stood at 222.6% in August 2012, the highest in Asia. Hong Kong also has a high smartphone penetration rate (about 60% in August 2012).
In our view, PCCW’s media business carries higher business risk than its telecom operations even though its pay-TV subscriber base continues to increase steadily. Subscriber numbers stood at about 1.17 million in June 2012, compared with 1.09 million a year earlier. In November 2012, PCCW announced that it had won exclusive rights to broadcast Barclays Premier League soccer in Hong Kong for three seasons starting 2013. We do not expect a significant increase in subscriber numbers but ARPU appears likely to improve. In our opinion, PCCW’s plans to enter the highly competitive free-to-air television business could increase business risk even though the timing is uncertain and the company’s investment plan is at a preliminary stage. The main source of income in this business is advertising, which is closely tied to economic cycles and consumer spending. Currently, two licenses cover over 2.2 million households in Hong Kong. Television Broadcasts Ltd. (not rated) dominates the market with a viewership share of more than 90%. PCCW and two other companies could enter the market in 2013.
We expect PCCW group’s financial risk profile to remain “significant” even though the group had substantially deleveraged at the end of 2011 using the net proceeds from the listing of HKT Trust and from internal cash resources. In our base-case projection, we estimate HKT Trust’s debt-to-EBITDA ratio will remain at or below 3.5x for the next few years at least. However, we expect PCCW’s debt-to-EBITDA ratio after netting off surplus cash to stay at about 3.5x. Our expectation assumes no material acquisition or change in PCCW’s business risk profile, which could arise from significant investments in new, higher-risk businesses. PCCW’s high dividend payout ratio and growth strategy could constrain further improvement in its financial risk profile, in our view.
HKT’s liquidity is “adequate,” as our criteria define the term. We expect the company’s sources of liquidity to exceed its uses by 1.2x or more over the next 12 months. Our liquidity assessment incorporates the following expectations and assumptions:
-- The company’s sources of liquidity include unrestricted cash balances of about HK$1.37 billion as of June 30, 2012, FFO of about HK$5.6 billion, and undrawn committed banking facilities.
-- Its uses of liquidity include capital expenditure (about 10% of total revenue), working capital requirements, debt repayments, and dividend payouts. HKT has no short-term borrowings as of June 30, 2012, but it has to refinance US$500 million in bonds and US$546 million in bank loans in the second half of 2013.
-- Net sources will remain positive and the company has significant headroom within its financial covenants even if EBITDA declines by more than 15%.
-- The group has established and supportive banking relationships. Refinancing risk is manageable, because debt maturities are fairly well spread. HKT Trust has undrawn committed banking facilities of about US$1.1 billion as of June 30, 2012.
In April 2012, PCCW issued US$300 million in guaranteed notes. In our view, the fund-raising has not affected the group’s financial risk profile because PCCW has no imminent plan to use the proceeds for material investments. As of June 30, 2012, PCCW has unrestricted cash balance of about HK$4.94 billion and short-term debt of about HK$3.0 million.
The stable outlook reflects our view that HKT will maintain its stable and solid operating cash flows because of its strong market position. We believe PCCW group’s financial risk profile will remain consistent with the rating, with the ratio of total debt to EBITDA at or below 3.5x, after considering surplus cash. We do not expect either PCCW’s or HKT’s business risk profile to change significantly.
We could lower the rating if either PCCW’s or HKT Trust’s debt-to-EBITDA ratio stays above 3.5x as a result of weaker-than-expected operating performance or debt-funded growth. The rating could also come under pressure if the group’s growth strategy and financial policies become more aggressive, causing its business or financial risk profile to deteriorate.
Although less likely, we could raise the rating if HKT were to show strong revenue growth and its profitability and financial performances were to improve, such that PCCW’s ratio of debt to EBITDA remains well below 3.0x.