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Consolidation to Slow Margin Decline for Sri Lankan Telcos

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Over capacity in Sri Lanka's telecommunications industry could shrink as two weaker operators may exit the sector, which would benefit the remaining players, Fitch Ratings says in a special report.

Data tariffs could rise following consolidation, and this would slow the decline in profitability and prevent duplication of capex. The number of industry participants could fall to three from five. Sri Lanka Telecom, the largest integrated operator, plans to acquire Hutchison Lanka; while the third-largest operator, Etisalat Lanka, could merge with the fourth-largest, Airtel Lanka.

The credit profiles for SLT and Dialog Axiata ­will remain stable; ratings headroom will remain moderate despite a decline in profitability and continued large capex requirements.

SLT's and Dialog's average operating EBITDAR margins might decline to 30%-31% in 2015 (2014: average of 32%), excluding any benefits of consolidation, due to price-based competition and the substitution of low-margin data services for traditional voice/text services.

Free cash flow (FCF) for both SLT and Dialog is likely to be negative in 2015 as average capex/revenue for the two telcos will remain high, at around 28% (2014: 30%), to expand 3G/4G network coverage and fibre connectivity. We expect SLT's and Dialog's fund flow from operations (FFO)-adjusted net leverage to deteriorate in 2015 to 1.3x and 2.0x, respectively (2014: 1.1x and 1.9x), as cash generated from operations will fall short of capex requirements, and they would require debt funding. However, leverage will remain at levels appropriate for their current ratings.

Fitch may revise the outlook for Sri Lanka's telecommunications sector to positive if industry consolidation results in improvement in profitability. The regulator's introduction of a data tariff floor could also ease pressure on profitability.

Significant debt-funded acquisitions leading to weaker balance sheets could significantly reduce ratings headroom for both SLT and Dialog. SLT's National Long-Term rating would be downgraded to 'AA+(lka)' if it executes a debt-funded acquisition of Hutchison Lanka that raises its FFO-adjusted net leverage to over 1.5x.

Also, a major dilution in ownership or board control by Dialog's parent, Axiata Berhad, removal of the common brand name, or a weakening of the current strategic and operational ties between the companies, could lead to negative rating action on Dialog's National Long-Term Rating. Fitch assesses Dialog's standalone profile at 'AA+(lka)'.

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Tags: Sri Lanka