OREANDA-NEWS. Fitch Ratings has affirmed PT Telekomunikasi Indonesia Tbk's (Telkom) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs), as well as its foreign-currency senior unsecured rating at 'BBB-'. The Outlooks on the IDRs are Stable.

KEY RATING DRIVERS

Sovereign Constraint: Telkom's IDRs are capped by the Republic of Indonesia's IDRs (BBB-/Stable), due to government's majority shareholding (52.56% at end-June 2015). Telkom continues to be strategically important to the state as the fixed-line incumbent and largest wireless and broadband service company by revenue. The government, through its control of the company's board of directors, has a significant influence over the company and has veto rights over key operating and financial decisions.

Reduced Ratings Headroom: Telkom's ratings headroom, albeit high, will shrink as 2015 FFO-adjusted net leverage will deteriorate to over 1.0x (2014: 0.7x) due to continuous large capex needs and dividend commitments. Leverage will also be pushed up by a USD300m debt-funded acquisition of Guam's telecom and pay-television operator, GTA. However, Telkom is likely to retain its robust credit profile given its solid market position, high operating EBITDAR margin of over 50% and leverage that remains low.

Rising M&A Interest: Telkom is likely to search for M&A opportunities outside Indonesia given management's growth strategy, low leverage and access to capital markets. Telkom has, in the past, contemplated many M&A deals including buying out minorities in its subsidiary - PT Telekomunikasi Selular (AAA(idn)/Stable). However, we believe that a large debt-funded M&A transaction is unlikely given Telkom's conservative nature and lengthy approval process associated with being state-owned.

The acquisition of GTA could boost Telkom's international bandwidth business. GTA provides domestic wireless, fixed-line, broadband and pay-television services in Guam, which has a total population of only 160,000. The island's geographic location gives GTA a strategic role as a landing point in undersea cable traffic between Asia and the United States.

FCF Deficit: Fitch forecasts Telkom's 2015 cash flow from operations of IDR33trn-34trn will fall short of its capex (IDR23trn-24trn) and dividend (IDR12trn-13trn) commitments. 2015 capex/revenue is likely to be around 25%-26% as Telkom adds about 1,660-1,700 base transceiver stations (BTSs) each month - out of which over 90% are for 3G/4G expansion. Telkom is likely to commercially launch 4G services towards end-2015 once it gets government approval. We expect the company to continue to pay dividends of at least 65% of its previous year's net income.

Resilient Profitability: Telkom's operating EBITDAR margins (2014: 55%) although resilient, could decline due to greater competition and higher contribution from the less-profitable data segment. However, we expect data competition to stabilise in 2H15 as smaller telcos, including PT Smartfren Telekom Tbk (CCC(idn)) and Hutch Indonesia, are now focusing on profitability rather than market share.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Revenue to grow by low single-digit percentage in 2015 driven by data services.

- Operating EBITDAR margin to decline by 100-150bp due to data-led substitution of more profitable voice and text services and depressed data tariffs. (Please refer to "2015 Outlook: Indonesian Telecommunications Services", dated 11 November 2014 for details on Fitch's view on the industry.)

- Negative FCF with capex/revenue around 25%-26% and dividend pay-out of 65% of previous year's net income.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Upgrade in the sovereign's IDRs
- Weaker links between the government and Telkom

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Downgrade of the sovereign's IDRs.
- A significant increase in shareholder return and/or a major debt-funded acquisition.