Fitch affirms Telecom's ratings at 'BB-'

Fitch Ratings yesterday affirmed Sri Lanka Telecom Plc's (SLT) Long-term foreign currency Issuer Default Rating (IDR) at 'BB-' (BB minus) with a negative outlook.

At the same time, the agency has affirmed SLT's Long-term local currency IDR of 'BB-' (BB minus), as well as its National Long-term rating at 'AAA(lka)' with Stable Outlooks, along with the 'BB-' (BB minus) rating on its senior unsecured notes maturing in 2009.

SLT's ratings reflect the company's strong positive free cash flow generation, its strong and improving financial profile and entrenched market position. SLT has a monopoly in wire-line services, which still accounts for nearly half of its revenues, and a dominant share of international long-distance and IP and data-related services.

In addition, Fitch notes that SLT has improved its market position in the fixed-wireless and mobile segments.

Notwithstanding the stagnant wire-line subscriber base following the introduction of fixed-wireless services by SLT and its competitors, and the new tariff scheme introduced (following a direction by the Supreme Court in relation to a case filed challenging its tariff revision in 2003) which will result in a 8-9% reduction in revenues, the traditional wire-line services are expected to account for a lion's share of SLT's revenue and cash flow generation over the short- to medium-term.

Although SLT's late entry into the fixed-wireless market is still reflected in its market share, the company has managed to rapidly increase its fixed-wireless subscriber base to improve market share to around 25% currently, from 10% in 2005. Its mobile market share too has increased, compared to some two years ago, to approximately 18% from 13%.

The mobile division's (Mobitel) contribution to revenue and EBITDA has increased to approximately 15% and 11% respectively in the first nine-months of 2007, from 10% and 5% respectively in 2005, although in terms of profitability, Mobitel still lags behind the market average.

Competition in the mobile and fixed-wireless markets is expected to increase further with the entry of India's Bharti Airtel (BB+/Stable) and the launch of fixed-wireless services by Dialog Telekom (AAA(lka)/Stable). Fitch anticipates some degree of margin pressure for SLT due to the increased competition and the trend of operators targeting low-income earners.

The agency also takes the view that market growth will be moderate over the medium-term from the high levels seen historically.

In addition, SLT's ratings consider the uncertainties stemming from the still developing regulatory environment and the influence the Government of Sri Lanka has over the company's financial and operating policies through its 49.5% holdings and majority board representation.

SLT has continuously generated positive free cash flows despite an annual capex of around USD80 million to USD100m and dividend payouts of approximately 30-35% of its net income.

Although SLT's overall profitability is expected to slip on account of the tariff revision on wire-line services and the reduction of fixed-wireless connection charges, Fitch expects SLT to still generate positive free cash flows over the medium-term.

Its credit metrics are exceptionally strong for its current ratings, with net adjusted leverage (defined as total adjusted debt net of cash divided by operating EBITDAR) of 0.2x and FFO gross interest coverage of 7.4x as at end-September 2007.

Fitch expects these measures to improve further with SLT continuing to generate positive free cash flows, supported by its strong liquidity of LKR18.0bn in cash reserves. When debt maturities peak in 2009 when the USD100m notes mature, SLT expects to repay the notes using its cash reserves.