Fitch affirms Dialog Telekom at 'AAA(lka)'

RATINGS: Fitch Ratings affirmed the National long-term rating of Dialog Telekom Limited ("Dialog") at 'AAA(lka)'. The rating outlook is stable.

The rating reflects Dialog's leading position in Sri Lanka's cellular-mobile space with around 60% subscriber-share, its robust growth and strong operating cash flow generation.

At the same time, the rating positively considers the company's recent and impending investments that will transform it into a fully diversified telecoms services provider, although Fitch notes that investment related risks remain.

The agency also derives comfort from the strong operating track record of the management and potential shareholder support, particularly from Telekom Malaysia ("TM", rated 'A-' (A minus)/ Stable), which owns 87.67% of Dialog; Fitch believes TM's commitment to its operations in Sri Lanka is strong and Dialog will continue to be an important investment in its portfolio of international assets.

Despite the increasing competition in the cellular mobile segment, Dialog has been able to keep its market share broadly stable.

Although the pace of growth is moderating, the agency expects the cellular subscriber base to register robust growth over the next three years. Dialog's subscriber base grew by 45% (annualised) during the first nine months of 2006.

The net post-paid additions have reduced to around 5% of total net additions.

As per Fitch's estimates, Dialog's subscriber growth lagged behind the overall market growth for the first time in 2006.

This is largely a result of the substantial growth reported by some of its rivals following the launch of new tariff plans during the year that is likely to moderate in the near-term.

However, competition will further increase with rapid network expansion by most cellular operators. As some operators are vying for a larger market share, potential for tariff-based competition remain high; but the agency expects competition to be generally rational.

Dialog will offer fixed-wireless telephony, Pay-TV and wireless broadband service from early 2007. The fixed-wireless market is already highly competitive with three established players.

Despite its late entry, Dialog's entrenched brand image will allow it to be a strong contender in the fixed telephony market. Fitch also anticipates that the demand for Dialog's other new services will be robust.

However, cellular operations will continue to account for a large majority of Dialog's earnings and cash flow generation in the foreseeable future. Dialog's financial profile has continually improved as a result of strong operating cash generation.

Its leverage measured by net adjusted debt (net debt plus 8x operating lease rentals) to EBITDAR at end- September 2006 was 0.5x (1.9x at FYE01). Subscriber growth and related scale economies culminated in substantial margin improvements since 2003. Its Operating EBITDAR margin was maintained at around 54% in 2005 and during the first nine months of 2006.

However, its margins are likely come under some pressure with intensifying competition. Fitch expects revenue per minute of use to gradually reduce along with ARPU (average revenue per user) as the company penetrates into the lower-end of the market and tariff cuts are yielding lower increase in usage than experienced in the past.

Churn increased during the latter part of 2005 and early 2006, but has been contained to a large extent. In spite of the competition and tariff cuts, Dialog has been able to preserve its ARPU and broadly keep the subscriber acquisition costs stable.

The company's investment plan over the next three years is very heavy and is estimated at USD675 million (approximately 60% of sales), making the company substantially free cash flow negative over this period.

Broadly 70% of this is slated for cellular services where majority of the capex is related to radio network expansion and for related infrastructure. Fitch expects cellular related capex to show a marked reduction after 2009 as coverage related capex will reduce substantially.

Fitch notes that Dialog remains highly dependent upon its cellular business for cash flow generation and for servicing of debt obtained to fund its other businesses, some of which have relatively long pay-back periods.

Dialog's free cash flows will be further pressured by its dividend policy of distributing 40%-50% of annual earnings; however, Fitch expects the company to err on the conservative side of this range.