S&P: Swiss Matterhorn Telecom Holding Upgraded To 'B+' On Improved Credit Quality; Outlook Stable

S&P Global Ratings today raised its long-term issuer credit rating on Switzerland-based telecommunications group Matterhorn Telecom Holding S. A. (Matterhorn or the group) and its subsidiary Matterhorn Telecom S. A. to 'B+' from 'B'. The outlook is stable.

At the same time, we raised our issue rating on Matterhorn's senior secured debt to 'B+' from 'B'. The recovery rating is unchanged at '3', indicating our expectation of meaningful recovery prospects (50%-70%; rounded estimate: 55%) in the event of a payment default.

We have also raised our issue rating on the group's senior unsecured notes to 'B-' from 'CCC+'. The recovery rating remains at '6', indicating our expectation of negligible recovery (0%-10%; rounded estimate: 0%) in the event of a payment default.

The upgrade follows Matterhorn's continued positive EBITDA and free operating cash flow (FOCF) generation in 2017 thanks to the group's continued focus on cost efficiencies. This is despite a moderate rise in capital expenditures (capex), given the group's investments in accessing Swiss fiber-to-the-home (FTTH) networks. The group's cost-effective approach offset planned, although slowing, revenue deterioration given that growth in post-pay subscriber base did not compensate for lower mobile termination rates and lower average revenues per user (ARPU), since almost all its customer base has been transferred to Matterhorn's current offering. We also note that management's and shareholders' financial policy will be less aggressive than before, but remain opportunist in the medium term. We now anticipate that the group will allocate cash flow generation for financing activities and debt reduction.

We have reassessed Matterhorn's financial risk profile to aggressive from highly leveraged. The improvement stems from stronger EBITDA, voluntary debt repayment of about €50 million in September 2017, and sustained cash flow generation that we expect will continue, despite additional investment in backhauling and fiber network access. This leads us to forecast, in 2018-2019, adjusted debt to EBITDA at or below 5x and FOCF to debt sustained above 5%.

We also factor in greater clarity on the group's financial policy, and that management and shareholders are now striving to achieve a net reported debt to EBITDA (leverage) of between 3.5x and 4.0x. We therefore believe that the group will use cash on the balance sheet to access the FTTH network, invest in its mobile network, and reduce debt, supporting credit metrics in line with the 'B+' rating. While we think that the group's financial policy may remain opportunist in the medium term, should the group materially deleverage--through organic cash flows in particular--we think that it will likely keep its adjusted leverage within the thresholds for the current rating.

Matterhorn's management has worked closely with its owner, private holding company NJJ Capital, to streamline the group's structure and operations and substantially lower its cost base. Matterhorn launched a simplified post-pay offering in 2015, rationalized its commercial, marketing and IT approach, focused on the direct distribution channel (either physical or online), and re-insourced network maintenance tasks. As a result, the adjusted EBITDA margin improved to 49.1% in 2017 from 29.8% in 2015, alongside stronger FOCF on lower capex and better collections. Furthermore, we view positively the group's reduced churn rate and the uptick in its post-pay subscriber base since third-quarter 2015. We also believe that the group benefits from a nationwide and good-quality 4G network, supported by ongoing and targeted investments, and can leverage significantly larger spectrum per user than peers to underpin its data-rich contracts. Finally, we view the recent launch of a fixed product as a key step for the group to grow and compete in a more converged market. Nevertheless, there is uncertainty on Matterhorn's ability to ramp up its fixed activities without denting profitability and cash flow generation.

We continue to assess Matterhorn's business risk profile as significantly weaker than its two main competitors, the dominant incumbent Swisscom AG and the No. 2 Sunrise Communication Holdings S. A. Matterhorn remains at No. 3, with a post-pay subscriber market share of about 16.5%. Although decreasing, the subscriber churn rate remains slightly higher than that of peers, and its ARPU has decreased following the introduction and almost complete transfer of its customer base to Matterhorn's Plus offer. We therefore believe that, for Matterhorn, maintained margins and improved credit metrics will hinge on a continuous demonstration of its ability to gain post-pay subscribers, and to at least maintain its current level of costs and capex efficiency in order to offset increasing competition in the Swiss telecom market and the structural decline of pre-pay ARPUs. We also think that operational performance and execution risks related to the launch and operation of fixed product exist. We think that Matterhorn's performance will hinge on a successful ramp-up of its fixed offer among its current mobile customer base and its ability to attract new customers to mitigate annual fixed commitments to be paid to access the FTTH network.

The stable outlook on Matterhorn reflects our view that the group will sustain its recently strengthened EBITDA margin, continue to expand its post-pay mobile customer base, and ramp up its fixed product on new and converged customers. We also take into account our assumption that Matterhorn will use cash on the balance sheet to invest in its network and to reduce debt. This should translate into an adjusted debt-to-EBITDA ratio of 5x in 2018 and lower thereafter, and FOCF to debt remaining above 5%.

We could consider a negative rating action if Matterhorn failed to sustain the current level of profitability or successfully monetize its recently launched fixed product. In particular, we could lower the rating if margins and FOCF were to decline, for example, due to increasingly aggressive behavior by the group's principal competitors that results in a contraction of its post-pay base or underperformance of its fixed offer that does not compensate for contractual investments to access network. This would translate into adjusted debt-to-EBITDA exceeding 5.0x on a prolonged basis, and FOCF to debt of less than 5%. A downgrade could also result from a more aggressive financial policy.

We see a limited likelihood of an upgrade over the next 12 months, due to increasingly competitive fixed and mobile markets in Switzerland that will hamper strong deleveraging prospects beyond our base case. We also consider Matterhorn's contracted investments to access fixed networks will constrain FOCF generation. However, we could raise the rating if Matterhorn's financial profile were to substantially strengthen beyond our base case, including adjusted leverage sustainably approaching 4.0x and FOCF exceeding 10%. Any upgrade would also likely require increased visibility on the owner, private holding company NJJ Capital, and its capital structure, as well as a more conservative financial policy.
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