Fitch Downgrades Colombia Telecomunicaciones' IDRs to 'BB-'; Outlook Negative

CHICAGO--()--Fitch Ratings has downgraded Colombia Telecomunicaciones S.A. E.S.P.'s (ColTel) Long-Term Foreign Currency and Local Currency Issuer Default Ratings (IDRs) to 'BB-' from 'BB'. Fitch has also downgraded the company's USD750 million senior notes due 2022 to 'BB-' from 'BB' and its USD500 million subordinated perpetual bond to 'B' from 'B+'. The Rating Outlook on the IDRs is has been revised to Negative from Stable.

KEY RATING DRIVERS

The rating downgrades reflect ColTel's cash flow deterioration and weakening liquidity profile during the LTM period ended June 30, 2016. This contrasted with Fitch's previous projections of positive free cash flow for 2016 - 2019. Fitch expects negative FCF generation to remain uncurbed amid ARPU erosion and relatively weak EBITDA performance, as an increasing proportion of cash must be used to meet PARAPAT yearly payments, which are expected to account for over 30% of its EBITDA generation during 2016 - 2019.

The Negative Outlook reflects Fitch's view that this weakening trend will continue given the intense competitive pressures impacting the company's profitability and the increasing proportion of cash to be consumed by PARAPAT payments in the next years. PARAPAT scheduled payments together with CAPEX execution is expected to lead to an average negative Free Cash Flow of approximately COP 152 billion per year between 2016 and 2019.

The company's financial flexibility has been reduced following the breached of its leverage covenant in its 2022 notes, which limits additional maximum permitted debt to USD 300 million, of which it had already drawn USD 50 million as of June 2016. The shrinking headroom for additional debt will limit the ability of ColTel to execute planned capex in non-traditional services, which hurts its competitive position and diminishes its cash flow generation capacity, as traditional services revenues continue to contract.

Future ratings actions will largely depend on the company's strategy to improve its capital structure. Fitch believes that a sizable capital injection would be necessary for the company to achieve a sustainable capital structure and turn around its weak cash flow generation. ColTel's ratings will be downgraded to the 'B' category should the company fail to show any measures to improve its weak financial position in the near term.

EBITDA Contraction

ColTel's EBITDA contracted by 9% during the six month period as of June 2016, compared to the same period in 2015, driving the EBITDA margin from 35% in June 2015 to 30% in June 2016. This steep contraction in profitability is explained by a 13.5% increase in costs, which far surpassed the revenue increase of 5% during the period. A fierce competitive landscape has continued to pressure ARPU evolution while the peso depreciation and rising inflation have impacted the company's cost structure. Fitch expects the current falling EBITDA margin trend to continue in the near future, given the expectation of a slow diversification from voice revenues to non-traditional services, driving ColTel's margins to an average below 32% in 2016-2019.

Suppressed Cash Flow Generation:

ColTel's negative FCF generation is unlikely to turn around in the short to medium term due to high cash outflow burden to fund capex needs and PARAPAT payments. ColTel's CFFO fell to COP 600 billion as of LTM June 2016, compared to COP 710 billion in FY2015, a weakening trend expected to continue in FY2016 due to falling EBITDA and PARAPAT payments. ColTel's PARAPAT payments are scheduled to be COP 497 billion in 2016 and COP 509 billion in 2017, which Fitch expects to consume more than 30% of the company's EBITDA generation during the period, which is forecast to be around COP1.5-1.6 trillion. ColTel's capex is expected to remain high in 2016 at around COP1 trillion. These expenditures are necessary to shore up its network competitiveness and will result in a negative FCF of around COP 400 billion, a substantial deviation from Fitch's previous projection for the year (+ COP 17 billion). Fitch expects FCF to remain negative in 2017 - 2019 based on the assumptions that the company's operational profitability remains pressured and that no capitalization takes place in 2017.

High Leverage

ColTel's leverage is high for the rating category. Fitch's calculation of net debt to EBITDA (including PARAPAT debt, 50% of the perpetual bond and the hedging of FX risk) increased from 4.8x in December 2015 to 5.3x in June 2016, while its leverage ratio calculated under the 2022 USD 750 million senior bond covenant (which includes 100% of the perpetual bond, excludes the PARAPAT debt but adjusts EBITDA by subtracting LTM PARAPAT payments), increased from 3.8x to 4.4x during the same period. The leverage deterioration, independently of how it is calculated, points to a precarious capital structure, which cannot be improved given the ongoing CFFO contraction trend as a result of high PARAPAT payments and relatively weak EBITDA generation. Fitch expects ColTel's leverage to remain around 5.4x in 2016 - 2019 as it struggles to meet its financial obligations while optimizing its capex plan given the financing constraint imposed by the incurrence covenant of the 2022 senior bond.

Limited Financial Flexibility

ColTel's financial flexibility has diminished following its breach of the 3.75x leverage incurrence covenant under the 2022 Bond indenture (March 2016) and as a result can only take additional debt to a maximum of USD300 million. As of June 30, 2016, USD50 million out of the permitted USD300 million additional debt was drawn out from its credit facilities. The limited headroom for additional debt imposes a material financial constraint, especially as the company plans to start executing its Fiber to the Home (FTTH) investment strategy during the fourth quarter of 2016.

Weakening Competitive Position:

Fitch expects the current falling CFFO trends to temper the company's ability to implement its CAPEX strategy to support network upgrades, which would result in a weaker competitive position. With no additional available funding, Fitch expects ColTel's capex intensity to fall from an average of 23.8% in 2012-2015 to approximately 15% in 2016 - 2018. The company plans to optimize its capex primarily focusing on deploying its fiber-to-the-cabin network (FTTC) and slowly begin to deploy its fiber-to-the-home (FTTH) network by the end of 2016, which would delay any meaningful diversification from the traditional and less profitable services to the higher ARPU non-traditional business segments. ColTel had yet to show meaningful growth in its high ARPU products, such as broadband and HD-TV, to improve its EBITDA and achieve higher revenue diversification. The contribution from its pay-TV service remained at just 5% of total sales as of June 2016, significantly lower than its 10% target.

Equity Falls Back to Negative

ColTel's equity has fallen once again into negative territory as of June 2016 (-COP 696 billion once the perpetual bond is adjusted for 50% equity credit) pointing to the need to find a structural and permanent solution to the capital structure of the company. ColTel was already forced to implement a major restructuring of the PARAPAT obligation in 2012, when it became evident that EBITDA performance was not sufficient to absorb PARAPAT payments agreed to in the Investment Agreement signed between Telefonica, the Nation and ColTel in 2006. The EBITDA underperformance during 2006-2011 led the Nation to assume 48% of the total PARAPAT consideration (estimated then at USD 3 billion) and leaving ColTel to assume the remaining 52%. However, the remaining PARAPAT obligation following the restructuring has proven to be too large an obligation for ColTel's cash generation capacity, which continues to exert pressure on the company's results, as evidenced by a negative net income of COP 235 billion during the six month period as of June 2016.

In 2015 ColTel adopted the IFRS accounting standard which required registering the PARAPAT obligation on its balance sheet. This drove the company's equity position in to negative territory, requiring the issuance of a deeply subordinated bond to bring back the equity position to positive numbers. However, the continuing deteriorating financial results have again determined a negative equity position as of June 2016, begging the need for a structural solution that ensures a sustainable capital structure.

KEY ASSUMPTIONS

--No Capitalization takes place;

--PARAPAT payments are not restructured;

--CFO weakens;

--FCF remains negative in 2016-2019;

--Leverage with and without PARAPAT remains above 5x and 3x respectively.

RATING SENSITIVITIES

Considerations that could lead to a negative rating action (rating or Outlook):

--Failure to improve its current precarious capital structure and liquidity profile;

--Continued profitability deterioration due to competitive pressures and slow growth in its non-traditional business segments;

--Negative FCF generation amid persistently high PARAPAT payments;

--Adjusted net leverage, excluding the PARAPAT liability, to remain above 3x on a sustained basis;

--Adjusted net leverage, including the PARAPAT liability, to remain above 5x on a sustained basis.

Considerations that could lead to a positive rating action (Rating or Outlook):

--A positive rating action is unlikely absent any material improvement in the company's capital structure.

LIQUIDITY

ColTel's liquidity has weakened considerably as of June 2016 when cash balances (including short term investments) fell to COP53 billion (COP 293 billion in FY2015), representing just 7% of short term debt obligations of COP 750 billion, an amount that includes COP503 billion associated with the PARAPAT consideration. ColTel reported COP 1,3 trillion in available lines of credit of which it is permitted to use up to the equivalent of USD 250 million (COP 750 billion) during the second semester of 2016.

FULL LIST OF RATING ACTIONS

Fitch has downgraded the following ratings:

Colombia Telecomunicaciones S.A. ESP

--Foreign currency IDR to 'BB-' from 'BB'; Outlook to Negative from Stable;

--Local currency IDR to 'BB-' from 'BB'; Outlook to Negative from Stable;

--USD750 million senior notes due 2022 'BB-' from 'BB';

--USD500 million subordinated perpetual bond to 'B' from 'B+'.

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/site/re/869362

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1010823

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Contacts

Fitch Ratings
Primary Analyst
Alvin Lim, CFA, +1-312-368-3114
Director
Fitch Ratings, Inc.
70 W. Madison St.
Chicago, IL 60602
or
Secondary Analyst
Julio Ugueto, +571-307-5180 ext. 1038
Associate Director
or
Committee Chairperson
Joseph Bormann, CFA, +1-312-368-3349
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Alvin Lim, CFA, +1-312-368-3114
Director
Fitch Ratings, Inc.
70 W. Madison St.
Chicago, IL 60602
or
Secondary Analyst
Julio Ugueto, +571-307-5180 ext. 1038
Associate Director
or
Committee Chairperson
Joseph Bormann, CFA, +1-312-368-3349
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com