OREANDA-NEWS. Fitch Ratings has upgraded eircom Holdings (Ireland) Limited's (eircom) Long-term Issuer Default Rating (IDR) to 'B' from 'B-' and assigned a Stable Outlook. At the same time the agency has upgraded the company's secured bank debt and the 9.25% senior secured bonds due 2020 to 'B+' from 'B'.

The rating upgrade reflects our view that eircom has delivered the planned transformation of its operations; that revenues look increasingly likely to stabilise and that cost initiatives will improve operating cash flows.

While eircom's leveraged balance sheet is unusual for an incumbent telecom, the business transformation and stabilising revenue outlook is a significant achievement in a sector where top-line declines and margin pressure remain a risk.

Plans to increase its fibre investment moderate the potential to generate positive free cash flow (FCF) and reduce leverage in the near term. Fitch now expects funds from operations (FFO) net adjusted leverage to remain flat at 5.0x-5.1x between 2015 and 2016, compared with previous expectations that deleveraging would begin in 2016. This ratio is nonetheless consistent with the leveraged telecom peer group at the 'B' rating level.

KEY RATING DRIVERS

Operational Transformation Advanced
Management have, in Fitch's view, delivered on plans to transform the company's business profile. Investment in fibre is advanced with its VDSL network passing 1.1 million homes and on track to reach 1.6 million by mid-2016; more than 70% of Ireland's homes. LTE spectrum has been acquired and coverage achieved compares well with competitors

The launch of its TV product in 2013 has shown good early signs of take-up and eircom remains the only operator in the market with a viable quad-play offer at present, although this will change with the launch of cable operator UPC's MVNO mobile business. While market competition - in both fixed and mobile - is high, it will, in Fitch's view, remain rational. The consolidation of Three and O2 Ireland reduces the mobile market to a three-player market and could moderate competitive pressures.

Revenue & EBITDA Increasingly Stable
While year-on-year revenue trends remain negative but improving, sequential trends show increasing signs of stabilising, evident in both the fixed and mobile businesses. While market competition remains high and eircom continues to lose retail fixed accesses, it benefits from a growing wholesale business, capitalising on the depth and scope of its incumbent network, along with an improving mobile subscriber mix, ongoing cost rationalisation and improving margin trend.

While the Vodafone/ESB JV's announced fibre-to-the home (FTTH) plans present medium- term risks, both in terms of Vodafone's own convergent offer and potential for an alternative wholesale offer, eircom has reacted with a similarly dimensioned FTTH target and, in our view, is likely to deliver its plan sooner than the JV.

Capex Remains High, FCF Constrained
Eircom has announced plans for an FTTH network covering 500,000 homes - in Fitch's view a defensive reaction to the Vodafone/ESB JV. The advanced stage of eircom's fibre to the cabinet build - already passing 1.1 million homes - and the use of a single network supplier suggest that eircom is in a good position to install deep levels of fibre more rapidly than the JV; the latter is only expected to start network construction in 2H15.

Eircom conversely expects to launch FTTH commercially in August 2015. Increased investment will, however, impact eircom's FCF in both 2015 and 2016 at least, and likely to result in higher levels of spend than we had previously assumed. Our base case now does not envisage a mid-to-high single FCF margin till 2017, one year later than previously expected.

Medium-term Deleveraging
Higher capex spend over the next two to three years will constrain FCF with modest deleveraging now not expected in our base case till 2017. Higher capex is nonetheless in Fitch's view a necessary defensive action, which under eircom's previous private equity ownership it was unable to do.
In a fairly small but competitive market we feel that network investment, which should ultimately lead to a better customer experience (and wholesale offer), is important. Fitch does not view a potentially flat leverage profile between 2015 and 2016, as an impediment to the upgrade given the business and operational transformation that has been delivered.

KEY ASSUMPTIONS

-Stabilisation of revenues in 2016 - a combination of flat fixed line and low single-digit growth in mobile
-EBITDA margin stable to moderately improving, benefitting from an extensive headcount rationalisation and ongoing focus on efficiency; mobile to benefit from shift in the post-paid mix
-Capex to remain high through 2017, driven by FTTH investment plans - EUR290m in 2015; remaining above EUR250m in 2016, before trending down to 15% of revenues over the longer term
-Voluntary leaver and restructuring costs largely complete in 2015
-Zero dividends; IPO possible over a two-year horizon but not built into assumptions
-Liquidity largely provided by cash - EUR173m at end-December 2014; company expected to be modestly FCF-positive from 2016

RATING SENSITIVITIES

Positive: Future developments that could lead to positive rating action include:
-FFO net adjusted leverage approaching 4.5x and expected to remain at or below this level on a sustained basis
-FCF margin in the mid-to-high single digit range on a sustained basis
-Ongoing revenue stability and EBITDA improvement - most likely achieved through a stabilisation of fixed key performance indicators (KPIs) and improving mobile trends

Negative: Future developments that could lead to negative rating action include:
-FFO net adjusted leverage approaching 5.5x with an ongoing deteriorating trend accompanied by negative FCF, which would lead to a downgrade. This would imply the stabilisation so far achieved is not sustained and/or that competition is continuing to force higher levels of capex than envisaged in our base case. Deteriorating operating trends would be a greater risk.

-A material reversal in operating KPI trends - key measures being fixed access losses, overall broadband accesses and the mix in pre- and post-paid mobile customers. In our view it is important that momentum in overall (combined direct and wholesale) broadband access continues, while the shift in the post-paid mix will support further mobile margin expansion.