OREANDA-NEWS. Fitch Ratings has affirmed India-based telecoms service provider Reliance Communications Limited's (Rcom) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) of 'BB-'. The Outlook is Stable. Fitch has simultaneously affirmed the 'BB-' rating on Rcom's USD300m 6.5% senior secured notes due 2020.

KEY RATING DRIVERS

Deleveraging is Likely: The affirmation factors in Rcom's commitment to deleverage in a timely manner by using the proceeds from the sale of its tower business by its subsidiary, Reliance Infratel Ltd (Infratel). Management has committed to repay a part of its USD6.1bn of debt and to achieve a target debt/EBITDA of below 3.0x by end-March 2017. We would likely downgrade the rating if the company is unable to demonstrate in a timely manner that it has the ability to pay down debt such that FFO-adjusted net leverage will fall to below 4.5x.

Excluding any non-core asset sales, Rcom's FFO-adjusted net leverage could remain high at around 5.5x, as we expect it to generate limited FCF due to stagnant EBITDA and a rise in capex requirements during the financial year ending 31 March 2017 (FY17). The company has insufficient liquidity to meet its obligations due in FY17, and will have to rely on banks to refinance facilities if it does not sell any assets. Rcom has breached some debt covenants, and hence has limited ability to raise further debt to improve liquidity. It has received waiver consents from most of its lenders for breach of covenants.

Asset Sale to Support Ratings: Rcom has a non-binding arrangement to sell Infratel's tower business to Tillman Global Holdings, LLC and TPG Asia, Inc. Should this transaction proceed and sale proceeds are used to pay down debt, Rcom's FFO-adjusted net leverage could improve to below 4.0x as the indicative enterprise value will more than offset the additional lease-adjusted debt.

Apart from the sale of tower business, Rcom is also considering deleveraging via a sale of its non-core assets, including its under-sea cable subsidiary Global Cloud Xchange (GCX; B+/Stable), real estate and its pay-TV business. However, progress on these asset sales has been slow to date.

Weak Market Position: Rcom's IDR is constrained by its weak market position as the fourth-largest telco in India with a revenue market share of around 8% and a subscriber base of mostly low-revenue customers. Rcom could face further challenges due to higher competition in the data market as Reliance Jio - part of Reliance Industries Ltd (RIL; BBB-/Stable) - enters the market in 2H16. However, Rcom's ownership of a pan-India spectrum in 800MHz/850MHz and its ability to offer faster 4G data services could help it fend off the competition, to some extent.

The top-three telcos - Bharti Airtel (BBB-/Stable), Vodafone India, a subsidiary of Vodafone Group Plc (BBB+/Stable), and Idea Cellular Ltd - have been gradually gaining market share and now account for about 70% of wireless revenue in India's telecoms market.

Negative FCF on Larger Capex: We forecast FCF will be limited in FY17 as Rcom needs to invest around INR40bn (FY16: INR34bn - excluding a one-off spectrum payment of INR11bn) on capex to support its fast-growing data traffic and to improve the quality of voice services. However, its capex/revenue of around 17%-18% will still be below than top-three telcos' average of 19%-20% due to its infrastructure and spectrum-sharing arrangement with Reliance Jio.

In January 2016, Rcom said that it would share and pool its 800MHz spectrum with Reliance Jio in 17 regions (known as "circles" in India). Rcom has future plans to share 800MHz spectrum in the remaining five circles. Spectrum sharing will give Rcom access to a wider band of spectrum and Jio's network to provide faster 4G data services and provide capex and operating costs savings. Rcom and Reliance Jio signed reciprocal infrastructure agreements during FY14-15 to share Rcom's 43,000 towers, 120,000km of inter-city fibre, and 70,000km intra-city fibre network for the next 17-20 years. Under the agreements, Rcom also has access to existing and future towers and fibre assets of Reliance Jio.

SSTL Acquisition: We believe that Rcom's acquisition of Sistema Shyam Teleservices Ltd (SSTL), the Indian mobile subsidiary of Russia's Sistema JSFC (BB-/Stable), in an all-stock deal is credit neutral for Rcom, at least in the short term. Rcom will benefit from additional nine million subscribers and INR15bn revenue and also will be able to extend the life of its 800MHz spectrum in eight Indian circles.

However, we believe that in FY17 incremental EBITDA from the acquisition will likely fall short of SSTL's annual spectrum cost of INR3.9bn - the cost of the spectrum SSTL acquired in the March 2013 auction will be paid annually over 10 years starting FY17. In the longer term we expect that growth in incremental EBITDA may make the transaction cash-flow positive. SSTL will pay off its existing debt before the acquisition.

Competition to Intensify: We expect competition to intensify as Reliance Jio enters the market with cheaper tariff plans and faster data speeds, and armed with sufficient spectrum and access to funds. We expect the industry blended monthly average revenue per user (ARPU) to fall due to a decline in data tariffs, which will more than offset the rise in data usage. Rcom's FY17 blended ARPU, however, is likely to decline by 1%-2% compared with a 5%-6% decline in the industry's blended ARPU. This is because Rcom's ARPU of INR140 is already lower than the industry average of INR170.

Weak Liquidity: Rcom's liquidity is dependent on its ability to refinance its maturing debt because its cash generation and unrestricted cash of INR22bn are insufficient to pay its short-term debt of INR143bn. Banks have been willing to lend on a secured basis with licences and immovable assets as collateral.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- The sale of Infratel's tower business will happen in a timely manner and Rcom will use the sale proceeds to reduce its debt.
- FY17 revenue to rise by 2%-3%, which will be below the industry average of 5% - due mainly to its loss of customers in five Indian circles.
- EBITDA margin to narrow by 100bp in FY17 to 31.5% due to competition, especially in data services. (Please refer to "2016 Outlook: Indian Telecommunications Services", dated 20 November 2015 for details on Fitch's view on the industry)
- Blended ARPU to fall by 1%-2% from INR140, which is below the industry average of INR170
- Industry revenue market share to decline to around 6%-7% from 7.5%-8%
- SSTL acquisition will be completed and consolidated from FY17. SSTL will have a lower FY17 EBITDA margin of 15% compared with Rcom's 32%.
- Effective interest rate of about 7.5%-8%.

RATING SENSITIVITIES

Negative: Developments that may, individually or collectively, lead to a negative rating action include:
- Inability to demonstrate on a timely basis that funds will be available to improve liquidity and pay down debt such that FFO-adjusted net leverage falls below 4.5x on a sustained basis;

Positive: Rcom's IDR has a limited upside as its business risk profile caps the IDR at 'BB-'.

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