Fitch Affirms Sri Lanka Telecom Debt Ratings; Outlook Stable

Fitch Ratings has today affirmed Sri Lanka Telecom's (SLT) Long-term foreign currency (LTFC) Issuer Default Rating (IDR) at 'B+', which is constrained by the debt ratings of the Sri Lankan government.

SLT's ratings reflect its entrenched position in the country's telecommunications market, its robust ability to generate cash flow from operations and its strong financial profile. SLT is a fully integrated operator with a monopoly in wire-line services. The company has defended its market share in the fixed-wireless space (June 2008: 30%) and has improved its market share in the mobile segment (June 2008: 20%; FY06: 16%). The latter is expected to account for a significant share of SLT's revenue growth over the short- to medium-term and is now positively contributing to SLT's operating cash generation. The company also enjoys a dominant share of the international long-distance and IP and data-related services. In the nine moths to September 2008, SLT reported revenues of LKR35bn (+9.8% over the FY07 corresponding period).

The changes to SLT's ownership with the exit of Japan's NTT Corporation do not appear to have resulted in any notable changes to its business or financial strategy. Fitch says that it understands that the Government of Sri Lanka is in negotiation with Usaha Tegas (UT, a major shareholder of Malaysia's Maxis Communications) which acquired NTT's stake, with regards to various administrative arrangements.

Fitch expects competition to increase, particularly in the mobile segment, following the launch of services by India's Bharti Airtel as the fifth mobile operator later this year. The weak macroeconomic environment in Sri Lanka with sustained high inflation has set a more challenging stage for the telecom operators - operating costs are increasing, and the operators are witnessing lower usage levels and experiencing more difficulties penetrating in to the lower income segments. This is evident in SLT's margins - its EBITDA margins have deteriorated in the nine months to September 2008 to 43% from 46% a year ago.

SLT's capex is expected to increase through FY10 in order to expand coverage and capacity, as well as to make the transition to an IP-based Next Generation Network (NGN). This could result in SLT generating negative free cash flow (FCF) over the next two years. However, barring any substantial increase in cash returns to shareholders, SLT should be able to revert quickly back to positive FCF generation once its capex moderates. Notwithstanding this, SLT is expected to maintain a strong financial profile and credit metrics appropriate for its current ratings. SLT's debt maturities will increase in FY09 with the USD100m notes falling due. The company has built-up cash reserves (US$155m) at September 2008) to repay this liability. Its medium-term liquidity is supported by strong cash generation, low debt maturities and good access to bank funding.

SLT had total debt of LKR19.1bn at September 2008 and very low net debt with strong cash balances. Leverage measured by adjusted debt net of cash to EBITDA was 0.1x for 9M08. Fitch expects SLT to maintain its net leverage below 1.0x over the short- to medium-term. However, a negative rating action could be taken if net leverage increases to over 1.5x on a sustained basis and/or any action by shareholders which might be detrimental to its financial profile.

At the same time, the agency has affirmed SLT's Long-term local currency IDR at 'BB-' (BB minus), as well as its National Long-term rating at 'AAA(lka)'. The Outlook is Stable. The rating on SLT's USD100m senior-unsecured notes due in 2009 has been affirmed at 'B+' with a recovery rating of 'RR4'.

Posted to the site on 1st December 2008