Fitch Assigns Play Finance 2's Tap Issue 'BB-(EXP)'
The final rating is contingent upon the receipt of final documents conforming to information already received.
The rating action reflects Fitch's expectation that the proposed issuance will be used to help fund upcoming spectrum acquisition. Fitch views Play as encompassing a strong operating profile, measured approach to incremental market share gains, strong margin and cash flow expansion combined with a relatively high degree of financial leverage. Play closed 2014 with funds from operations (FFO) net leverage of 4.1x. The current spectrum auctions are likely to interrupt a trend of the company continuing to deleverage in 2015, although Fitch expects deleveraging to resume from 2016. In addition, the company has headroom versus the downgrade guideline of 5.0x.
KEY RATING DRIVERS
2014 Performance
Play increased revenues by 21% and EBITDA by 52% improving the EBITDA margin by 5.4 percentage points to 24.4% in 2014. The company added 1.5 million net customer additions, of which 1.04 million were contract subscribers, taking 51% of mobile number ports in the year. Margin expansion was slightly lower than expected by Fitch, due to management's decision to reinvest cash flow beyond a given target into market growth. FFO net leverage of 4.1x was marginally outside the agency's base case forecast of 4.0x but comfortably within the 5.0x downgrade guideline. Fitch considers performance solid, with management delivering strong operational performance without compromising the market by provoking price war or providing an unduly disruptive influence.
Top-line Growth, Margin Expansion
Fitch continues to expect solid, albeit slower top-line growth with our base case assuming revenue growth in mid-to-high single digits and an EBITDA margin which is likely to expand by a further 1.5 to 2.0 percentage points in 2015. The company's consistent leadership in the share of contract mobile ports acquired has been key to its success. Play, followed by Orange, has shown consistent leadership in this regard, mostly at the expense of T-Mobile. Risks remain that T-Mobile or the market generally responds more aggressively to Play's progress or that fixed-mobile bundles become more important to the Polish consumer. Fitch does not view the latter risk as high at present.
Cash Flow Performance Verses Leverage
Play exhibits strong free flow performance for its rating, with its capital structure ultimately determining its ratings. Its free cash flow margin (pre-dividend free cash flow to sales) was 7.6% in 2014, and is expected by Fitch to remain at a similar level in 2015, which is consistent with higher ratings. An FFO margin in the mid-high teens is consistent with a 'BB' rating. FFO net leverage is expected to remain at around 4.1x or to rise moderately in 2015 depending on the outcome and absolute cash costs of the spectrum auctions. This metric, along with relatively weak fixed charge coverage - forecast at 2.6x in 2015 - anchor the rating at 'B+' at present. Fitch would expect the latter metric to be closer to 3.0x to be viewed in line with a higher rating.
Infrastructure Strategy
Play employs a hybrid-infrastructure / national roaming approach to its network. The company carries almost all data traffic over its own network and with LTE (fourth-generation data technology) built out to 73% of the population and with limited plans to increase this depth of coverage. For voice and data traffic outside its own coverage area, it relies on national roaming agreements. Its main agreement is with T-Mobile and is in place to 2020 and includes national roaming on LTE technology. This strategy allows the company to invest significantly less on capex than its competitors, although it leaves it exposed to the risk of needing to invest more heavily in the future should the availability of roaming capacity become constrained (with roaming contracts being agreed on purely commercial terms). However, Fitch does not view this risk as high at present.
Spectrum Importance
In Fitch's view, the company's hybrid approach to infrastructure partly underlines a need to maintain spectrum parity with its larger MNO competitors. While the company is believed to have plenty of capacity for its current needs, Fitch believes its roaming partners could seek to exploit a situation where Play was considered to have spectrum limitations in future contract negotiations. Spectrum auctions have shown in a number of markets to exert unexpectedly high one-off investment needs on operators. Fitch's scenario analysis suggests a reasonable amount of rating headroom if the auctions prove expensive while cash flow generation is likely to lead to deleveraging in the event of a spectrum-induced leverage spike.
KEY ASSUMPTIONS
- Revenues grow in 2015 at mid-to-high single digits driven by continued leading share of mobile number ports and shift in the post-pay mix; growth to remain strong in 2016 but to slow thereafter.
- EBITDA margin to expand by 1.5 to 2.0 percentage points in 2015 and to reach high 20s by 2018.
- Management to achieve public EBITDA target of EUR300m to EUR325m in 2015 and capex excluding spectrum to remain flat to 2014.
- 800MHz and/or 2.6GHz spectrum to be treated as exceptional capex in 2015, although to be included in leverage metrics.
- Cash interest to be paid on Play Topco PIK. Although outside the restricted borrower group for the purposes of rating the senior secured and senior notes cash interest on the PIK notes to be included in coverage calculations. FFO fixed charge cover falls to 2.6x in 2015.
- FFO net leverage to remain flat at 4.1x in 2015; deleveraging to resume thereafter.
RATING SENSITIVITIES
Positive: Any positive rating action would be subject to the continued rational behaviour of the market and market share gains and other performance indicators being in line with Fitch's rating case. The shareholders' approach to financial policy will also be important. With a potential IPO deemed a number of years away and the bonds incorporating a restricted payment test (set at 3.75x net debt/EBITDA) Fitch accepts the potential for dividends to re-leverage the balance sheet. The level at which the shareholders choose to manage leverage combined with continued sound operational performance, will determine whether the financial profile supports a higher 'BB-' rating.
The following metrics would be important for an upgrade to be considered:
- Continued strong subscriber growth and an ongoing shift in the subscriber mix to postpaid customers, with subscriber acquisition cost and postpaid churn close to management's expectations.
- EBITDA margin in the high 20s and EBITDA less capex margin in the high teens.
- A financial policy that is likely to see FFO net adjusted leverage managed at or below 4.0x, a level consistent with net debt/EBITDA of around 3.3x-3.4x.
-FFO fixed charge coverage (including cash interest on the Play Topco PIK) consistently around 3.0x or better.
Negative:
-Intensification of the competitive (pricing) environment, making revenue growth and margin expansion targets more challenging. An expectation that convergent services were deemed by the market to be a more important offering could also create negative rating pressure.
-A financial policy or weakened financial performance leading to FFO net adjusted leverage consistently above 5.0x, which would be expected to result in a downgrade to 'B'. Fixed charge cover including cash pay interest on the Play Topco PIK note consistently below 2.5x would result in a downgrade.
FULL LIST OF RATING ACTIONS
P4 Sp. z.o.o. Long-Term IDR: affirmed at 'B+'; Outlook Stable
P4 Sp. z.o.o. National Long-Term Rating: affirmed at 'BBB-(pol)'; Outlook Stable
Play Finance 2 S.A. Senior Secured Notes: affirmed at 'BB-'/'RR3'; 'BB-(EXP)'/'RR3(EXP' assigned to proposed tap issue
Play Finance 2 S.A. Senior Secured Notes National Long-Term Rating: affirmed at 'BBB(pol)'
Play Finance 1 S.A. Senior Notes: affirmed at 'B-'/'RR6'
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