OREANDA-NEWS. Fitch Rating has affirmed Global Cloud Xchange Limited's (GCX) Long-Term Foreign - and Local-Currency Issuer Default Ratings (IDRs) at 'B+'. The Outlook is Stable.

The agency has also affirmed GCX Limited's USD350m 7% senior secured guaranteed notes at 'BB+' and Recovery Rating of 'RR1'. GCX Limited is a wholly owned subsidiary of GCX. The notes are secured by the assets and equity interests of GCX and its key subsidiaries and are guaranteed by GCX and its key operating subsidiaries.

KEY RATING DRIVERS

Low Ratings Headroom: Fitch believes GCX's FFO-adjusted net leverage for the year ending 31 March 2017 (FY17) could deteriorate to around 4.0x (FY16: 3.7x) due to lower cash generation amid industry overcapacity and price erosion - the level at which Fitch could consider negative rating action if breached on a sustained basis.

Our forecast factors in the sale of the company's US Ethernet business, Yipes, in 2HFY17, which would improve GCX's leverage if divested on a timely basis. Yipes made an EBITDA loss of USD14m and had USD17m of finance lease debt in FY16. We estimate FY17-FY18 leverage would be 0.3x-0.4x higher if GCX fails to sell the Yipes business.

Lower Recurring Revenue: We forecast FY17 FFO will decline to around USD50m (FY16: USD52m) due to lower recurring revenue and predominately fixed cost-base. We also forecast flat indefeasible right of usage sales at around USD65m (FY16: USD64m), of which USD25m was contracted in the first half; typically the second half is seasonally better.

Recurring revenue could decline due to price erosion and customer churn in all business segments, but especially in managed services and internet protocol leased circuit, due to the commoditised nature of these segments. GCX's FY16 recurring revenue fell to USD362m (FY15: USD391m) after losing some customers to intense competition.

Chronic Industry Oversupply: The under-sea cable industry remains oversupplied, as bandwidth increases from commissioning of submarine cables by "over-the-top" operators and telecommunication companies continue to outpace demand growth. Furthermore, technological advancements continue to improve capacity of existing cables. Hence, bandwidth tariffs will continue declining over the medium-term despite increased demand.

Minimal FCF: Fitch forecasts GCX's FY17 FCF deficit of around USD30m-35m, as cash flow from operations will fall short of our assumed capex of USD30m-35m and dividend payments of USD15m. GCX has already paid out its dividend in April 2016. Capex includes maintenance expenditure of USD25m and USD5m-10m to expand landing stations and points of presences. Capex could rise if management decides to expand its under-sea cable network or invest in Indian fibre assets.

Indian Fibre Expansion: GCX plans to acquire Indian fibre assets of USD90m in FY17 in part-payment for providing access to its sea-cable network to its parent, Reliance Communications Limited (Rcom, BB-/Stable). The remaining amount owing from the USD134m agreement will be paid in cash. GCX is currently waiting for licence approval from Indian telecom authorities to start offering fibre services in India. We have not factored in additional EBITDA from such expansion in our forecasts. Rcom owes GCX around USD71m as at March 2016, which will increase to approximately USD110m by FY17. Rcom will pay for the access in cash from FY18 onwards.

Weak Linkages with Parent: We rate GCX's IDR based on its standalone profile under our Parent and Subsidiary Linkage methodology, due to weak legal, operational and strategic linkages with its parent. GCX's cash flows are largely ringfenced within the GCX group by restrictive dividend and asset-sale covenants in USD350m secured note documents. However, bond documents allow GCX to pay dividend as long as debt/EBITDA is below 3.75x (FY17 forecast: 3.2x) and cash/interest is at least 2.25x (FY17 forecast: 2.5x).

Adequate Liquidity: GCX's cash balance of USD83m at end-March 2016, before paying a USD15m dividend in April 2016, and annual cash EBITDA of about USD78m are sufficient to fund an annual interest expense of USD25m and capital leases of USD15m. The secured note of USD350m is due in 2019.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- indefeasible right of usage sales of about USD65m in FY17 and USD60m in FY18

- revenue to decline by 6% in FY17 and 3% in FY18

- sale of the Yipes business in 2HFY17, which will provide savings of about USD14m at the EBITDA level for a full year

- negative working capital movement of USD32m-34m due to non-payment of receivable by Rcom waiting for Indian fibre asset transfer

- annual capex of about USD30m-35m, compared with management's estimate of maintenance capex of USD25m.

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- sustained negative FCF generation

- a deterioration in the operating environment or evidence of the parent accessing cash from GCX and negatively affecting its credit profile, with FFO-adjusted net leverage rising above 4.0x (FY17 forecast: 4.1x) on a sustained basis

- FFO interest-charge coverage falling below 3.0x on a sustained basis (FY17 forecast: 2.9x).

Positive: Although an upgrade is not probable in the next 12-18 months, future developments that may, individually or collectively, lead to positive rating action include:

- consistent generation of positive FCF

- a substantial increase in scale and absolute EBITDA generation

- FFO-adjusted net leverage falling below 2.5x on a sustained basis.

In accordance with Fitch's policies, the issuer appealed and provided additional information to Fitch that resulted in a rating action different than the original rating committee outcome.