OREANDA-NEWS. S&P Global Ratings today affirmed its 'B' long-term corporate credit rating on Spain-based provider of fiber infrastructure Ufinet Telecom Holding SLU. The outlook remains stable.

At the same time, we affirmed our 'B' issue ratings on the company's term loan and revolving credit facility (RCF). The '3' recovery rating reflects our expectation of recovery in the lower half of the 50%-70% range in the event of a default.

The affirmation follows our review of Ufinet's recent performance and business prospects, which led us to update our base-case forecasts. The group continues to expand its operations in Spain, where volumes have offset price declines, and in Latin America, where demand for infrastructure is high. Consequently, the company's backlog and margins remain healthy. However, starting in 2016, we expect the group will modify its investment model, resulting in lower coverage of capital expenditure (capex) by indefeasible right-of-use contracts (IRUs) and reduced free operating cash flow (FOCF). Also, Ufinet's highly leveraged capital structure and financial sponsor ownership continue to constrain the rating.

On the positive side, we consider Ufinet's business risk profile to be fair. We base our assessment on the company's extensive fiber optic network of about 46,000 kilometers in Spain and Latin America. We also factor in the industry's high barriers to entry, owing to the cost of expanding a fiber network and high switching costs for customers. Furthermore, Ufinet's business model provides recurring revenues and a sizable contractual cash revenue backlog, thanks to multiple-year contracts on capacity leasing (dark-fiber), which translate into healthy profit margins. Finally, the company does not engage in speculative network developments. Rather, it focuses on growth from new customer contracts, and capex continues to be partly self-funded through IRUs.

However, we expect that capex, spurred by investments in fiber to the home (FTTH) and new market entrance (Peru and Chile), will outpace IRU funding, resulting in only slightly positive FOCF and a potentially riskier investment model. Moreover, the above-mentioned strengths are tempered by Ufinet's limited size and high customer concentration, especially in dark-fiber activities. In addition, Spain's fairly mature telecom market has been consolidating, and competition from better-capitalized fiber-based telecom providers is rising. These factors would likely sustain price pressure, which we expect will continue to be mitigated by increasing volumes and additional services provided by Ufinet.

The rating remains constrained by our assessment of Ufinet's highly leveraged capital structure and its ultimate ownership by private-equity firm Cinven, which we consider a financial sponsor. This in turn affects our assessment of Ufinet's financial policy, including our belief of potential future debt-funded mergers and acquisitions or dividend recapitalization.

Under our base case, we assume IRUs will cover a declining portion of Ufinet's rising capex, resulting in lower, but slightly positive FOCF and a ratio of FOCF to debt of about 0.5% in 2016 and almost 1% in 2017 (about 0.9% and 1.5% respectively excluding preferred shares).

As anticipated, Ufinet hedged about one-third of its debt and coupons against fluctuations in the euro to U. S. dollar exchange rate to offset any currency mismatches, given its exposure to Latin America.

The stable outlook on Ufinet reflects our expectation that increasing demand for bandwidth from companies and telecom carriers, as well as for dark fiber in Latin America, will support solid revenue growth and a sound EBITDA margin of 50%-51%. This should translate into slightly positive FOCF, with FOCF to debt between 0% and 5% and adequate liquidity.

We could consider lowering the ratings if increased competition resulted in even lower prices for fiber-optic services, leading to a substantial decline in EBITDA margins below 40%. We would also lower our ratings if FOCF turned significantly negative, and liquidity came under pressure.

We view an upgrade as unlikely as long as preferred shares are treated as debt under our criteria. However, a positive rating action could occur if we continue to see positive revenue and EBITDA growth and improving credit metrics, with the S&P Global Ratings' adjusted debt-to-EBITDA ratio of durably 5.0x-5.5x combined with solid cash flow generation with FOCF to debt sustainably above 5%.