Fitch Affirms Sri Lanka Telecom's Debt Ratings

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Fitch Ratings has affirmed Sri Lanka Telecom's long term debt ratings and confirmed the stable outlook.

­The ratings agency however warned that Sri Lanka Telecom's (SLT) rumoured debt-funded acquisition of Hutchison Lanka could increase its leverage and would lead to a downgrade of its National Long-Term Rating to 'AA+(lka)'. The acquisition would be negative for SLT's credit profile as it would double its net debt and dilute operating EBITDAR margin because Hutchison Lanka has EBITDA losses. However, SLT will gain 800,000 subscribers and key spectrum assets in 900MHz/1800MHz, and will save on capex in 2014/15 following the acquisition.

SLT's debt ratings have relatively high rating headroom given its 2013 funds flow from operations (FFO)-adjusted net leverage of just 1.0x, its market-leading position in fixed-line and position as the second-largest mobile service provider. SLT's IDRs are unlikely to be downgraded in the medium term despite Fitch's expectations of negative free cash flow (FCF) of LKR2bn-LKR3bn for the next three years and the potential Hutchison Lanka acquisition.

Fitch expects SLT's 2014 revenue to rise by 5%, driven by mobile data and fixed-broadband services, which will more than offset declines in fixed-voice and international revenue.

Fitch forecasts operating EBITDAR margin to fall by 50bps-100bps each year during 2014-17 (2013: 31.5%) due to changes in the revenue mix as low-margin data services replace relatively higher-margin voice and text revenue. However, profitability will be supported by an imminent industry consolidation and a regulatory tariff floor on voice services.

Free cash flow will be negative during 2014-17 as SLT's ratio of capex to revenue will remain high at around 28%-30% as it will invest LKR18bn-LKR20bn each year to expand its fibre broadband and 3G/4G mobile infrastructure. Dividends would likely remain similar to the 2012 level at LKR1.5bn.

Industry to Consolidate

The number of industry participants will likely reduce to three from five as it is likely that SLT will acquire Hutchison Lanka and third-largest operator Etisalat could acquire Bharti Airtel's unprofitable Sri Lanka subsidiary, Airtel Lanka, which is the fourth-largest operator. The regulatory tariff floor on voice services has prevented smaller operators from competing on price and has left them unviable in the medium term.

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