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Fitch Affirms Sri Lanka Telecom's debt ratings following tax hike

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Fitch Ratings has affirmed Sri Lanka Telecom's debt ratings, with a stable outlook following changes to the tax regime introduced by the new government.

Fitch said that the Sri Lankan government's interim budget plan to impose significant recurring and one-off taxes will cause a decline in SLT's 2015 operating EBITDAR margin to 26% (2014: 30%) and its funds flow from operation (FFO)-adjusted net leverage to deteriorate to 1.8x (2014: 1.3x). SLT is likely to pay around LKR3.5bn-4bn in additional taxes.

However, SLT's ratings will remain unaffected as headroom is sufficient.

The interim budget introduced a one-off super gains tax of 25% on profits and a one-off tax of LKR250m on each mobile operator. It also shifted the burden of a recurring telecom levy of 25% on prepaid revenue on telcos from consumers; operators can no longer pass these taxes onto consumers given retail pricing changes require approval from the telecom regulator. The budget proposals, once enacted, will be effective from 1 April 2015.

Acquisition Risk

Fitch thinks that SLT's plan to do a debt-funded acquisition of a smaller operator in 2015 has the potential to threaten its National Long-Term Rating, although probably not its IDRs. Any rating action would depend on the acquisition price and forecast financial profile of the combined entity.

The ratings agency also believes that the taxation changes will hasten industry consolidation as the number of telcos may be reduced to three from five. Two smaller loss-making operators including Hutchison Lanka and Bharti Airtel's Sri Lanka subsidiary, Airtel Lanka, may exit the industry.

Reduced Ratings Headroom

SLT's 'BB-' debt rating has sufficient ratings headroom to accommodate a debt-funded acquisition of a smaller operator as long as FFO-adjusted net leverage remains below 2.5x. The ratings are underpinned by its market leading position in fixed-line and second-largest position in the mobile market, along with its ownership of a country-wide optical fibre network.

Negative FCF to Continue

They also forecast that SLT will have negative free cash flows (FCF) in 2015-18 given lower EBITDA due to new recurring taxes and a large capex plan. SLT will continue to invest about 25%-28% of revenue in capex each year to expand its optical fibre infrastructure and 3G/4G mobile networks. Dividends would likely remain similar to the historical levels at LKR1.5bn.

Profitability to Decline

Fitch expects SLT's 2015 revenue to rise by high single-digits driven by mobile data and fixed-broadband services, which will more than offset declines in fixed-voice and international revenue. Voice usage is likely to grow as subscribers save 25% of their telecom spend as a result of the shift of the telecom levy to telcos. Fitch forecasts that operating EBITDAR margin will also fall, apart from tax changes, due to a change in the revenue mix as low-margin data services replace relatively higher-margin voice and text revenue.

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