Outlook revised to Stable:

Fitch affirms SLT's Rating at 'B+'

Fitch Ratings has affirmed Sri Lanka Telecom PLC's (SLT) Long-term foreign currency Issuer Default Rating (IDR) at 'B+', and simultaneously revised the Outlook to Stable from Negative. Also, the agency has affirmed SLT's local currency IDR at 'BB-' with a Negative Outlook, National Long-term rating at 'AAA(lka)' with a Stable Outlook and its senior unsecured notes due in 2009 at 'B+' based on a recovery rating of 'RR4'.

The revision of the Outlook on SLT's foreign currency IDR (FC IDR) follows the revision of the Outlook on the Democratic Socialist Republic of Sri Lanka's FC IDR to Stable from Negative on October 9.

SLT's FC IDR continues to be constrained by Sri Lanka's FC IDR of 'B+'. Although SLT is majority-owned by the Government of Sri Lanka, Fitch notes the company's strong stand-alone financial profile and track record of limited cash returns to shareholders, and added that rating SLT above the sovereign's LC IDR is still appropriate.

SLT's ratings continue to reflect its established position as an integrated telecom operator with strong market shares in major operating segments. Despite pressure on profitability due to intense competition and weak macroeconomic conditions in Sri Lanka, SLT's cash generation continues to be strong. In the six months ended June 2009, SLT reported revenues and EBITDAR of Rs.23.58bn and Rs.7.9bn, (H108: Rs.23.6bn and Rs.10.4bn). Profitability as measured by EBITDAR to revenue slipped to 33.5 percent in H109 from 44.6 percent a year ago. SLT's traditional wire-line revenues (around a third of total revenues), a major source of operating cash generation, have come under pressure due to mobile substitution, churn and disconnections due to bad debts.

The Negative Outlook on SLT's LC IDR reflects risks stemming from a weak regulatory framework and opaque regulatory policies, intense competition and the still weak macroeconomic conditions in Sri Lanka. A new interconnection framework to be implemented in 2010 could add to pressures on SLT's margins and cash generation.

At the same time, SLT's capex will remain high during 2009-2010 leading to negative free cash flow generation. SLT's transition to a next-generation network is estimated to cost around Rs.7bn through 2011 and is a non-cash accretive investment. The company also expects to spend some Rs.3.5bn in improving telecom infrastructure in the northern and eastern regions following the end of the civil war. At the same time, some of SLT's new investments, namely, IPTV and Wi-Max operations are expected to take several years to break even, requiring SLT to fund their capex and operating losses in the initial years. Fitch expects these factors to further deteriorate SLT's margins and weigh on its cash generation. However, following several years of intense price competition, Fitch expects pressure on tariffs to ease with the implementation of the proposed interconnect framework, and hopefully aided by sufficient intervention by the regulator to ensure the financial health of operators.

The Stable Outlook on SLT's FC IDR and the National Long-term rating reflects Fitch's view that SLT can maintain an operating and financial profile appropriate for those ratings. SLT's leverage as measured by adjusted debt net of cash to EBITDAR was 0.4x at June 2009 (FY08: 0.1x). Fitch expects SLT's leverage to increase in the three years to 2011 due to negative free cash flow generation and pressure on earnings, but remain under 1.5x. SLT's cash reserves are adequate to repay the USD100m notes due in November 2009. SLT is yet to formalise its long-term funding plan, though Fitch notes that SLT's liquidity is supported by its good access to banks.

Negative rating action can be taken on the FC IDR and LC IDR if SLT's leverage is sustained above 2.5x and 1.5x, if there is sustained negative free cash generation beyond 2010, and if there are negative regulatory developments. As it is constrained by the sovereign, SLT's IDRs and their outlooks will also be affected by changes to Sri Lanka's ratings.