Overview -- Our assessment of Hungary-based fixed-line telecommunications operator Magyar Telecom B.V.'s liquidity has notably weakened over the past six months, and we see an increasing risk that the group will continue to burn cash beyond 2012 or conduct transactions dilutive of its creditworthiness. -- We are lowering our long-term corporate credit rating on Magyar Telecom to 'CCC+' from 'B' and revising our assessment of the group's liquidity to "less than adequate" from "adequate". -- We are also lowering our long-term corporate credit ratings on related entities Invitel Holdings A/S and HTCC Holdco I B.V. to 'CCC+' from 'B' and then withdrawing them. Invitel Holdings was liquidated in the first quarter of 2012, and we expect HTCC Holdco I to be liquidated by the end of 2012. -- The outlook on Magyar Telecom is negative, reflecting our view that the group's liquidity could continue to weaken over the next few quarters. Rating Action On July 6, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit ratings on Hungary-based fixed-line telecommunications operator Invitel Holdings A/S and related entities Magyar Telecom B.V. and HTCC Holdco I B.V. to 'CCC+' from 'B'. We then withdrew the ratings on Invitel Holdings and HTCC Holdco I. Invitel Holdings was liquidated in the first quarter of 2012, and we understand that HTCC Holdco I will be liquidated by the end of 2012. The outlook on Magyar Telecom is negative. At the same time, we lowered our issue rating on Magyar Telecom's EUR350 million senior secured notes due 2016 to 'CCC+' from 'B'. Rationale The rating action primarily reflects our decision to revise Magyar Telecom's liquidity profile to "less than adequate" from "adequate" as defined by our criteria. In our view, the group's liquidity could weaken further in the next six months primarily because we expect meaningful negative free operating cash flow generation due to continued pressure on revenues and margins in a challenging macroeconomic, competitive, and regulatory environment. As a result, we believe that the group's capital structure could become unsustainable in the near to medium term, heightening the risk of a distressed exchange offer. In our base-case assessment, we expect group revenues in euro terms to decline by about 14% in 2012 and 6% in 2013, driven by continued fierce pressure on revenues denominated in Hungarian forint, particularly residential voice revenues and, to a lesser extent, wholesale and business revenues. In our base-case forecast, we assume a deterioration of the foreign exchange rate to Hungarian forint (HUF) 300 to the euro in 2012 and 2013, compared with about HUF279 for full-year 2011. In addition, we anticipate reported EBITDA will decline by about 19% to EUR59 million in 2012 primarily due to lower gross profits and the introduction of a new telecom tax in July 2012. As result, we forecast negative free operating cash flow of about EUR25 million in 2012, down from negative EUR14 million in 2011, because we expect continued meaningful capital spending (EUR45 million in 2011) by the group to sustain its competitive position. Nevertheless, we acknowledge that the group has some flexibility to reduce its capital spending in the short term to support its liquidity, if needed. The rating on Magyar Telecom reflects our assessment of the group's financial risk profile as "highly leveraged" and business risk profile as "weak". The financial risk profile is constrained by the group's high leverage and what we regard as a very aggressive financial policy. Furthermore, the group is significantly exposed to foreign exchange volatility in relation to the Hungarian forint and, we believe, negative free cash flow generation. In our view, this is only partly offset by the group's long-term capital structure, with no debt maturities before 2016. Magyar Telecom's gross leverage on March 31, 2012, as adjusted by Standard & Poor's, stood at 5.0x. The business risk profile primarily reflects the fierce competitive environment, the group's exposure to macroeconomic and regulatory pressures in its domestic market, as well as the continuing revenue decline at the group's very profitable core voice business. This is partly offset, in our opinion, by Magyar Telecom's solid market position and extensive network as the former incumbent operator in 14 concession areas in the Republic of Hungary (BB+/Negative/B). Liquidity We consider Magyar Telecom's liquidity to be "less than adequate", as defined by our criteria. We expect the group's sources of liquidity, including surplus cash, to uses to remain at less than 1.2x over the next 12 months. As of March 31, 2012, we estimate liquidity sources over the next 12 months of about EUR55 million. These include: -- About EUR29 million in excess cash. As of March 31, 2012, Magyar Telecom reported cash balances of about EUR39 million. We estimate that the group needs about EUR10 million to run its operations. -- Funds from operations of about EUR26 million. We estimate Magyar Telecom's liquidity needs over the next 12 months to comprise about EUR45 million-EUR50 million in capital spending. We currently factor in no liquidity support from Magyar Telecom's owner, private equity company Mid Europa Partners. We see the group as significantly exposed to exchange rate volatility over the long term, given the currency mismatch between its EBITDA and debt. We understand from Magyar Telecom's management that the group has hedged the foreign exchange risk on the coupon of its senior secured notes with standard forward contracts until Dec. 31, 2012. The group faces no significant debt maturities until 2016 and does not have to comply with maintenance covenants. However, the documentation of its senior secured notes contains an incurrence covenant that limits the issuance of new debt by Magyar Telecom to 3.5x total debt to EBITDA. Recovery analysis Magyar Telecom's EUR350 million (EUR326 million outstanding as of March 31, 2012) 9.5% senior secured notes due 2016 are rated 'CCC+', the same as the corporate credit rating. At present, we consider the senior secured notes well secured because they benefit from first-priority liens over bank accounts, receivables, and intercompany loans, floating charges over the assets of the group's domestic operations, as well as pledges over the entire share capital of the group's domestic operations. Under our hypothetical default scenario, the group's capacity to meet debt-service repayments could come under pressure from sharper-than-envisaged erosion of its core voice fixed-line revenues, owing to increasing competition from cable and fixed-line telecom operators, strong competitive pressure on revenues from wholesale and business customers, the effects of a significant economic downturn, and material weakening of the Hungarian forint against the euro. In the fast-moving technological environment, a fixed-line network might not retain as much value as a mobile network. Nevertheless, the group has a solid market share in its concession areas and extensive network coverage in Hungary. We therefore assume that the network and subscriber base could still be attractive for an alternative fixed-line, mobile, or wholesale operator. In the event of default, lenders under the senior facilities should therefore benefit from their secured position. Outlook The negative outlook reflects our view that Magyar Telecom's liquidity will continue to weaken over the next six months due to further pressure on revenues and margins. We might consider a downgrade if the group's available cash balance declines towards EUR10 million or if we perceive that there is an increased likelihood that Magyar Telecom might consider a distressed debt exchange offer. The rating could stabilize if the group can stop the expected deterioration of its liquidity profile by significantly containing its currently negative free cash flow generation. Although not expected at this stage, we would also view liquidity support from Mid Europa Partners as positive for the rating. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Principles Of Credit Ratings, Feb. 16, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009 -- Key Credit Factors: Business And Financial Risks In The Global Telecommunication, Cable, And Satellite Broadcast Industry, Jan. 27, 2009 -- How Standard & Poor's Uses Its 'CCC' Rating, Dec. 12, 2008 -- Credit FAQ: Knowing The Investors In A Company's Debt And Equity, April 4, 2006 Ratings List Downgraded; Outlook Action To From Magyar Telecom B.V. Corporate Credit Rating CCC+/Negative/-- B/Stable/-- Senior Secured CCC+ B Downgraded; Outlook Action; Withdrawn To To From Invitel Holdings A/S HTCC Holdco I B.V. Corporate Credit Rating NR CCC+/Negative/-- B/Stable/-- 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.