Sri Lanka's Dialog Telekom Debt Ratings Downgraded - Outlook Negative

Debt ratings agency, Fitch has downgraded Sri Lanka's Dialog Telekom PLC's (Dialog) National Long-term rating to 'AA(lka)' from 'AAA(lka)'. Fitch has also downgraded the National Long-term rating on Dialog's outstanding cumulative redeemable preference shares of LKR4.5bn to 'AA-(lka)' (AA minus(lka)) from 'AA+(lka)'. The Outlook has been revised to Negative from Stable.

These rating actions reflect the recent deterioration in Dialog's credit profile as a result of continuing price competition and inflationary pressures on its expanded cost structure within the group, leading to a sharp 41% yoy decline in its overall EBITDA in 2008, as well as the high level of debt-funded capex investments over 2007 and 2008.

The rating also factors in support from Dialog's key shareholder, TM International (TMI, 83.3% ownership) which is driven by TMI's majority ownership, majority board representation, Dialog's association with TMI's brand, common creditors and the associated reputation risk to TMI. Moreover recent examples of tangible support provided by TMI to Dialog include deferral of FY08 dividends, the provision of soft loans, and an explicit corporate guarantee on debt.

Dialog's rating of its outstanding redeemable preference shares reflects the subordinate nature of the instrument. However the agency notes that in the event of a default the residual recovery for preference shareholders is likely to be negligible considering the company's increased level of debt.

Though Dialog has initiated an aggressive group-wide cost reduction exercise, through which it hopes to achieve some improvement to its EBITDA margin in FY09, the revision of the Outlook to Negative reflects the agency's concern that the company's credit profile could further deteriorate in light of ongoing aggressive price-based competition in the Sri Lankan mobile industry, and uncertainty over the extent to which the company's planned cost rationalising efforts will be successful.

Profitability as measured by EBITDA margin fell to 23% at FYE08 from 43% at FYE07, due to the abovementioned factors. At FYE08 mobile operations broadly accounted for 92% of Dialog's group revenue. The growth of alternative revenue streams (such as fixed wireless, pay TV and broadband) have been stifled by inflationary pressures on disposable income and the resulting impact on market penetration and usage levels, as well as competition.

The group's debt maturities peak in FY09 with LKR18.8bn of debt up for repayment. Such debt includes approximately LKR4.9bn worth of loans from TMI, on which Dialog is likely to benefit from some repayment flexibility, if required. The company has indicated the availability of committed undrawn credit lines which cover its commercial debt maturities in FY09, while external financing is being sought to fund capex which is largely discretionary. Dialog has also rationalised its capex for FY09, proportionately increasing investments with near-term returns such as building mobile network capacity and quality. Nevertheless Fitch expects Dialog to face some refinancing risk over the medium term driven by its continued negative free cash flow generation. However the agency takes comfort from Dialog's access to banks, which is underpinned by TMI's majority shareholding.

Fitch notes that TMI's support will continue to play an integral role in maintaining Dialog's ratings at the present level. The ratings could be downgraded further if there is a negative change to TMI's intention or ability to extend support, or if there is a further material deterioration in Dialog's credit profile.

Posted to the site on 2nd March 2009