Fitch Affirms Telefonica Chile at 'BBB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed Telefonica Chile S.A.'s (TCH) long-term foreign-currency and local currency Issuer Default Ratings (IDR) at 'BBB+'. Fitch has also affirmed the company's national long-term rating at 'AA(cl)'. The Rating Outlook is Stable. A full list of rating action follows at the end of this release.

KEY RATING DRIVERS

TCH's ratings reflect its entrenched leading position in the Chilean fixed-line telecommunications market, strong brand recognition and network infrastructure, sound financial profile backed by solid operational cash flow generation. The ratings also incorporate its linkage to the parent, Telefonica S.A. (TEF), and TEF's another Chilean subsidiary Telefonica Moviles Chile S.A. (TMCH), also rated 'BBB+' by Fitch. TMCH offers complementary mobile telecommunication services and allows TCH to achieve synergies mainly in terms of costs and investments savings, brand unity, as well as sales coverage. The ratings are tempered by the intense competitive landscape, mobile-fixed substitution which has rapidly eroded fixed-voice service revenues, and the company's shareholder distribution policy.

Stable Growth Outlook:

Strong subscriber growth in the broadband and pay-TV services will be the key growth driver over the medium to long term as the penetrations of those services increase and help largely mitigate revenue losses in the traditional voice services. These services enable the company to provide attractive bundled products, which should also help prevent the churn of the voice customers and protect profitability. The broadband and pay-TV segments remain relatively under-penetrated compared to the mobile industry as the penetration rates were still less than 50% for both services. The company's voice revenue contribution out of the total sales has fallen to about 36% during the first half of 2015 (1H15) from 47% in 2012.

In 2014, a modest 0.6% revenue contraction was mainly due to the negative regulatory impact on the reduced fixed access charges and the elimination of the domestic long distance charges, amid lower demand for fixed-voice service, of which the revenues declined by an average 7% annually during 2012-2014. In the absence of any material regulatory measures during the 1H15, the company's revenues resumed growth by 4% compared to a year ago, supported by broadband and pay-TV which grew by 10% and 30%, respectively, during the same period. The company's EBITDA margin is forecast to remain relatively stable at around 33%-34% in 2015 and 2016 following a reduction from the 2014 level of 38% in 2014 partly due to a change in its accounting policy to record some of its equipment purchases as inventory rather than capex as per the previous practice. This would not have any impact on the actual cash flow generation.

Higher Capex Limits Free Cash Flow (FCF):

Fitch forecasts TCH's FCF generation to remain suppressed in the negative territory due to its high capex over the medium term. The company's annual capex budget, hovering at around CLP200 billion in 2015 and 2016 mainly to improve broadband and pay-TV competitiveness, would consume most of its cash flow from operations (CFFO) during the period. Shareholder distribution is likely to be kept at the legally-required minimum level during the period given the high investment needs. Despite some pressures on the cash flow generation, Fitch believes that these investments are crucial for the company's long-term growth strategy which has increasingly become centered on network quality to support its non-voice segment.

Sound Financial Profile:

TCH's financial profile is forecast to remain solid at the current rating level over the medium term despite the aforementioned continued negative FCF generation. Fitch projects TCH's net leverage ratio, measured by total adjusted net debt to EBITDAR, to increase to around 1.2x by end-2015, compared to 0.8x at end-2014, partly due to the one-off cash outflow related with the repayment of the outstanding intercompany payables of CLP76 billion to TMCH. The ratio is likely to trend upwards but should remain below 1.5x over the medium term, which is considered solid for the rating category.

During the last 12 months ended June 30, 2015, the company maintained a stable CFFO of CLP207 billion, broadly in line with the 2013-2014 levels, under the stable operating environment. Capex was high at CLP200 billion but the company has maintained a low dividend payment of CLP12 billion during the period, which was a significant reduction from about CLP80 billion-CLP90 billion during 2011-2012. TCH's net leverage stood at 0.9x as of June 30, 2015.

Equity Rating:

The equity rating for shares series A and B of TCH was affirmed at Level 4(cl), based on the low level of free float and market presence, due to the majority stake ownership by TEF, which is offset by its solid solvency condition and long history in the stock market.

KEY ASSUMPTIONS

--TCH to resume its revenue growth in the low-to-mid single digits in 2015 and 2016, following a modest contraction of 0.6% in 2014;

--EBITDAR margin to fall to around 34% in 2015 and 2016, from 38.5% in 2014;

--Negative FCF to continue over the medium term due to high capex, which is expected to increase toward CLP200 billion during the period;

--Net leverage to gradually deteriorate to 1.2x by end-2016 from 0.8x at end-2014.

RATING SENSITIVITIES

Negative rating action could be considered in case of material deterioration in the company's key operating and financial metrics due to intense competition, unfavourable regulatory impact, and higher than expected capex and shareholder distributions - all of which combined resulting in negative FCF generation and net leverage increasing to over 2x on a sustained basis.

Telefonica Chile S.A.'s ratings are not directly linked to the ratings of its parent, TEF. However, any significant deterioration in the parent's credit profile, to the effect that it results in multi-notch rating downgrades or in a material liquidity crunch for the parent, could place pressure on Telefonica Chile S.A.'s ratings. TEF is currently rated 'BBB+'/Outlook Stable.

Conversely, an upgrade of Telefonica Chile S.A.'s ratings to a higher rating level than its parent's rating would be limited given their strong linkages.

LIQUIDITY

TCH's liquidity profile is sound backed by its large readily-available-cash position, amounted to CLP98 billion, fully covering its short-term debt maturities of CLP5.8 billion as of June 30, 2015. The company's debt maturities are well spread and it does not face any significant bullet maturity until 2022 when its USD500 million (equivalent to about CLP315 billion) notes become due. TCH has good access to capital markets and its stable CFFO generation further bolster its strong liquidity position.

FULL LIST OF RATING ACTIONS

Fitch affirms TCH's ratings as follows:

--Long-term foreign currency and local currency IDRs at 'BBB+'/Outlook Stable;

--National long-term rating at 'AA(cl)'/Outlook Stable;

--National short-term rating at 'N1+(cl)';

--National Equity Rating at 'Primera Clase Nivel 4';

--Senior unsecured USD500 million notes due 2022 at 'BBB+';

--Local debt issuance programme series No. 576 and No. 577 and series F1-F2 and Q and R local bond issuances at 'AA(cl)'.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

National Scale Ratings Criteria (pub. 30 Oct 2013)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=720082

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=990577

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=990577

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Alvin Lim, CFA, +1-312-368-3114
Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Francisco Mercadal, +1-56-2-2499-3340
Associate Director
or
Committee Chairperson
Daniel R. Kastholm, CFA, +1-312-368-2070
Regional Group Head - Latin America
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Alvin Lim, CFA, +1-312-368-3114
Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Francisco Mercadal, +1-56-2-2499-3340
Associate Director
or
Committee Chairperson
Daniel R. Kastholm, CFA, +1-312-368-2070
Regional Group Head - Latin America
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com