OREANDA-NEWS. Fitch Ratings has assigned India-based telecom service provider Reliance Communications Limited's (Rcom; BB-/Stable) proposed senior secured notes an expected rating of 'BB-(EXP).

The final rating of the proposed notes is contingent upon the receipt of documents conforming to information already received. Rcom will use part of the note proceeds to fund the USD173m up-front payment for spectrum won in the March 2015 auction and the rest for capex.

The notes are rated at the same level as Rcom's Issuer Default Rating (IDR). Although the notes are secured, under our methodology for "Country-Specific Treatment of Recovery Ratings", India is classed as a category D country, and, as such, the ratings of senior obligations in India are generally capped at same level as the IDR, even if they are secured.

KEY RATING DRIVERS

Higher Leverage than Peers: Rcom's 'BB-' IDR is constrained due to its higher leverage and weaker market position than average for Fitch's-rated Asian telcos. Fitch's forecast for Rcom's funds flow from operations (FFO)-adjusted net leverage of 4.8x for the financial year ended 31 March 2015 (FY15) is much higher than for its Indian peers. Market leader Bharti Airtel Limited's (Bharti; BBB-/Stable) leverage is around 2.5x and third-largest operator Idea Cellular Ltd's is around 3.5x. The forecast leverage assumes up-front payments in FY16 for licences acquired in the March 2015 spectrum auction.

Commitment to Deleverage: The ratings incorporate management's commitment to deleverage and Fitch's expectation that Rcom will manage its leverage below 4.5x during 2015-16. We believe that deleveraging will be mainly driven by an EBITDA expansion and a planned sale of non-core assets. Fitch acknowledges management's commitment to repay part of its USD6bn in net debt through the sale of assets, including its sub-sea cable subsidiary Global Cloud Xchange (GCX; B+/Stable), real estate and its pay-TV business. Management intends to achieve a target debt/EBITDA of below 3.0x by end-March 2017.

Weaker Market Position: Rcom's IDR is currently capped at 'BB-' given its market position as the fourth-largest telco in India, with a revenue market share of only 8% in the USD30bn Indian telecom services industry. The top three operators - Bharti, Vodafone India and Idea - collectively have about 70% revenue market share. However, Rcom's integrated approach and high cash generation visibility with large proportion of recurring and contractual revenue contribution from its wireless post-paid, enterprise, tower and sub-sea cable businesses mitigate its weaker market position.

Positive FCF on Low Capex: We believe that Rcom will generate at least USD200m in annual free cash flow (FCF) during FY16-18 as capex and interest costs decline following its debt reduction. We forecast that Rcom's FY15 cash flow from operations of USD700m-750m will be sufficient to fund its capex of around USD500m-550m and dividends. We expect Rcom to pay about USD400m-450m in interest and taxes. Rcom's lower capex/revenue ratio of 15%-16% (top three telcos: 20%) is mainly due to its infrastructure-sharing with Reliance Jio, part of Reliance Industries Ltd (RIL, BBB-/Stable), an under-utilised asset base, and a lower spectrum payment of USD173m (25% of USD693m) for March 2015 auction.

During FY14 and FY15, Rcom agreed to share around 43,000 towers and 120,000km of inter-city and 70,000km of intra-city fibre network with Reliance Jio for 17-20 years. Rcom's FY15 cash generation and leverage will benefit as it will receive an up-front cash benefit and recurring revenue each year from Reliance Jio. Under the agreement, Rcom has reciprocal access to existing and future tower and fibre assets of Reliance Jio, on similar terms.

Lower Spectrum Payments: Following the March 2015 auctions, Rcom has a pan-India 800MHz/850MHz footprint of at least 5MHz spectrum in 21 circles. It was least affected by the auction as it committed INR43bn (USD693m) to renew its expiring spectrum licences in four circles and to acquire additional spectrum. The three circles where it did not renew its 900MHz spectrum account for around 5% of its revenue. The company plans to transition subscribers in these circles to the 2100MHz and 800MHz spectrum, besides leveraging its intra-circle roaming arrangements with other telcos. In comparison, the top three telcos each committed about USD4bn-5bn to renew expiring spectrum licences. Also, we expect Rcom's future spectrum outlays to be minimal given the majority of its spectrum assets expire only in 2021.

Improving Competition: Rcom's ratings factor in a gradual increase in average revenue per user (ARPU) as we expect industry overcapacity to reduce and major telcos to increase tariffs during 2015 in response to high spectrum prices, inelastic demand and lower competition from smaller telcos. However, we believe that the benefits of improving voice tariff realisations will be diluted by a decline in data tariffs caused by the increase in competition in the data segment as Reliance Jio enters the market in 2015.

Price competition in the Indian telco industry has declined significantly since 2012, when three-four smaller operators exited or scaled-back operations after the Indian Supreme Court cancelled 122 licences. Further, during 2013-14, some pricing power returned to the top companies as high costs prevented the financially weaker bottom-six operators from acquiring spectrum in auctions.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Revenue to grow by mid-single-digit percentage in FY16 driven by improvement in ARPUs, increase in data services and income from assets leased to Reliance Jio.
- Operating EBITDAR margin to improve by 150-200bp (FY14:31.3%) driven by improving voice tariff realisation and growing economies of scale in data segment. (Please refer to "2015 Outlook: Indian Telecommunications Services", dated 10 November 2014 for details on Fitch's view on the industry.)
- Rcom to generate at least USD200m in annual FCF during FY16-FY18 with capex/ revenue ratio of around 15%-16%

- Effective interest rate of about 6.5%-7% over the Fitch base case.

RATING SENSITIVITIES

Positive: Although unlikely in the short term, future developments that may, individually or collectively, lead to a positive rating action include:
- Improvement in competitive environment leading to higher cash generation, resulting in Rcom's funds from operations (FFO)-adjusted net leverage improving to below 3.5x on a sustained basis.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Higher-than-expected competition and/or an indication of that management is less committed to deleveraging, resulting in funds from operations (FFO)-adjusted net leverage remaining above 4.5x on a sustained basis.