OREANDA-NEWS. Fitch Ratings has affirmed Polish telecom group P4 Sp. Zo.o's (P4 or Play) Long-term Issuer Default (IDR) and National Long-term ratings at 'B+' and 'BBB- (pol)' respectively. The Outlook is Stable. A full list of rating actions is available at the end of this commentary.

The ratings take into account Play's strong operating performance, a competitive but rational mobile market, strong cash flow growth and deleveraging. Near term risks associated with its capital structure constrain a higher rating at this stage. Uncertainty surrounds the shareholders' ownership plans, whether they will list or sell the business, or refinance the current capital structure including the Topco PIK.

KEY RATING DRIVERS
Solid Operational, Financial Performance
Play's financial performance is strong; achieved against the backdrop of a competitive market, discerning consumers and complex spectrum auction. Its service offer is targeted at the consumer and small and medium-sized enterprise (SME), with the company having developed a strong brand, well understood tariff structures and strong retail distribution channel.

Despite a maturing market, the company continues to acquire by far the highest number of mobile portability customer transfers. As the challenger in a four-player market, Play had an impressive subscriber market share of 25% at end-2015, with equally strong financial performance. The company's emphasis on simplicity and service quality has underpinned an ongoing shift in the subscriber mix, with post-paid customers accounting for 50% of the base at end-2015 (end-2014: 47.3%). This has a significant positive impact on blended average revenue per user (ARPU) and profitability.

Recapitalisation, Releveraging Risk
Play's strong revenue and cash flow has allowed the company to deleverage strongly. Funds from operations (FFO) adjusted net leverage at end-2015 was 2.5x (end-2014: 4.1x). A PLN1.7bn spectrum payment in 2016 is expected to result in the metric rising to 2.9x by end-2016, yet comfortably below Fitch's 4.0x upgrade guideline.

The shareholder's approach to capital structure is somewhat opportunistic though; a EUR415m PIK note, with pay-if-you-can interest (which is being serviced on a cash pay basis), was issued at Play Topco in 2014 and used to make a shareholder distribution. The shareholders' plans with respect to the refinancing of the restricted group - all bonds become callable in 2016 - and the PIK; remain unclear. Fitch includes the cash pay interest on the PIK within our fixed charge cover ratio.

Fitch estimates a refinancing that includes the Topco PIK would push FFO-adjusted net leverage to 4.0x by end-2016, subject to the delivery of management's public guidance; while the prospect of 700MHz spectrum acquisition in 2017 or beyond could put further pressure on this metric. Speculation over a potential sale of the business continues, although this is somewhat protected by a change of control provision. This allows bondholders to put the bonds if a post-acquisition structure results in a net debt/EBITDA of more than 3.5x. In Fitch's view, this broadly protects against a transaction resulting in a rating lower than B+. An alternative to a sale of the business, if the shareholders are intent on extracting value from the growth of the business, a recapitalisation, either within the restricted group or through a further PIK, is a possibility. These uncertainties prevent an upgrade at this stage.

Developed and Rational Market
Poland's mobile market is mature with an increasingly evenly weighted market share spread among the four mobile network operators (MNOs). A measured, rather than aggressive, approach by Play, has led to its strong performance. Orange's mobile market performance has also been good - it leads the market in post-paid customers with a share of 27.1% at end 2015. In contrast, T-Mobile and Plus (Polkomtel) are delivering far weaker incremental customer share performance. Orange is investing in fibre and offering triple play services, as is the unconsolidated cable sector.

Limited Quad-Play Risk
At this stage Fitch does not view quad-play or the need to offer convergence as a near-term threat to Play. This may change over the medium term. Music and video streaming are the key drivers of data usage in 4G markets generally. Fitch considers Play's LTE (4G) coverage and spectrum holdings to be competitive. Other MNOs in the market are better placed to offer quad-play and, financially at least, better able to acquire and exploit mobile TV content should consumer demand materialise more widely. Plus (owned by the main satellite TV operator) has an obvious competitive advantage in content.

Strong Financials, Balance Sheet Uncertainty
Strong financial performance is evident in Play's 2015 revenue and EBITDA growth of 22% and 44% respectively. An EBITDA margin of 28.8% is strong, following the market share gains delivered by Play's market challenger strategy. These results have been achieved through a combination of effective management as well in our view competitors' lack of appetite for a value-destructive price war.

Play delivered a free cash flow (FCF) margin close to 13% and FFO lease adjusted net leverage 2.5x at the restricted group level in 2015. Both metrics are supportive of a higher rating than the current 'B+', while Fitch believes revenue and cash flow visibility is solid. However, uncertainty over future balance sheet capitalisation acts as a constraint to a higher rating at this stage.

Spectrum & Roaming Agreements
Play successfully acquired 800MHz and 2.6GHz spectrum in the recent frequency auctions. The auction was protracted and the outcome generally regarded as expensive, with Play's allocation costing PLN1.7bn (EUR385m equivalent), close to 1x Fitch's 2016 forecast EBITDA. Fitch considers the company's spectrum holdings to be competitive, and that management are not inclined to pay any price for frequencies on offer. It is, however, in Fitch's view likely to participate in any future 700MHz auction, frequencies that are expected to become available in 2017 or 2018. Given recent experience and the general attractiveness of lower frequency spectrum, further near-term and relatively expensive spectrum acquisition cannot be ruled out.

Play has so far adopted a hybrid owned infrastructure / network roaming approach to network coverage, with roaming agreements in place with each of the other three MNOs; its anchor agreement being with T-Mobile. Fitch considers the approach cost-effective, reducing capital intensity. Although contract renewal and price inflation (the T-Mobile agreement is due for renewal in 2020) is a risk, the existence of three agreements suggests these arrangements are also attractive to the other MNOs and that this risk is somewhat limited. Fitch believes the cost of in-fill network construction would be limited if renegotiation of these agreements proves unattractive.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Play include:-

- Revenue growth of around 10% in 2016, slowing to 3% per annum by 2018
- EBITDA margin rising to and stabilising at around 30% by end-2016,
- Capex of PLN550m-PLN600m per annum (excluding spectrum) or 10% of revenue in 2016, falling to around 9% thereafter
- Low dividends (or equivalent form of distribution) starting in 2016 but sufficient to service interest on the Topco PIK
- No assumptions are made with respect to refinancing the PIK note within the restricted group, or 700MHz spectrum acquisition. These are both near- to medium-term risks.

RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to positive rating action include:
-Clarity over the shareholders' intentions with respect to long-term financial policy. The business is currently performing operationally and financially in line with a higher rating.
The following metrics would be important for an upgrade to be considered:
- Continued strong subscriber metrics and ongoing shift in the subscriber mix to post-paid, with subscriber acquisition cost and post-paid 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 result in FFO-adjusted net 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 higher

Future developments that may, individually or collectively, lead to negative rating action include:
-A more intense competitive environment, pressuring revenue and profitability. An expectation that convergent services are 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-adjusted net leverage consistently above 5.0x, which would result in a downgrade to 'B.'
- Fixed charge cover, including cash pay interest on the Play Topco PIK note, consistently below 2.5x, which would result in a downgrade.

LIQUIDITY
At end-2015 Play had cash of PLN1.6bn, an undrawn revolving credit facility of PLN400m and local bank lines amounting to PLN200m, which together are sufficient to cover the PLN1.7bn spectrum payment made in February 2016. Fitch expects Play's liquidity to remain solid given its bank line availability and strong underlying cash flow.

FULL LIST OF RATING ACTIONS

P4 Sp Z.o.o
--Long-Term Issuer Default rating: affirmed at 'B+'; Outlook Stable
--National Long-term rating: affirmed at 'BBB- (pol)'; Outlook Stable

Play Finance 2 S.A.
--senior secured notes: affirmed at 'BB-'/'RR3'/ 'BBB (pol)'

Play Finance 1 S.A.
--senior notes: affirmed at 'B-'/'RR6'.