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What are the 10 key factors that drive the downgraded rating from Fitch for Silknet?

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BM.GE
19.12.20 19:00
999
Fitch Ratings has downgraded JSC Silknet's (Silknet) Long-Term Issuer Default Rating (IDR) to 'B' from 'B+'. The Outlook is Stable – according to the news release issued by the Fitch Ratings.
 
Fitch Ratings identifies those 10 key drivers which have had the biggest impact on Fitch Ratings' current decision, including Lari’s devaluation and regulatory pressures on the pricing – as important factors.
 
In more detail, the logic behind these 10 drivers are below:
 
Leverage above Rating Threshold: “Fitch expects Silknet's FFO net leverage to increase to 3.5x by end-2020 from 2.9x at end-2019 and to gradually reduce to 3.1x by end-2022, assuming no further depreciation of the lari over that period. This leverage increase was driven by the lari's evaluation, negative EBITDA impact from the coronavirus pandemic and a considerable payment for a plot of land in Tbilisi. We estimate that the lari's devaluation in 2020 contributed at least 0.3x to the leverage increase. Our forecast assumes a GEL/USD rate of 3.3 (a spot rate at end-November 2020) over 2020-2023, compared with an average rate of 2.8 in 2019”.
 
Significant Foreign-Exchange (FX) Mismatch: “Silknet has a significant FX exposure, as a considerable portion of its debt and above 70% of its capex are denominated in foreign currencies, while most of its revenues are in local currency. The company hedges part of its debt with cross-currency swaps and by keeping most of its cash in US dollars. However, the unhedged portion of its US dollar debt was around 70% of the total at end-3Q20. Silknet's significant FX risk is reflected in our tighter leverage thresholds relative to peers”.
 
High-Risk Appetite: “We assess the company's financial policy as risky. Despite the lari's depreciation against the US dollar by more than 10% in 2019 and a further 15% in 2020 and the resulting rise in leverage, Silknet continued with its significant capex, including the land purchase. Capex (excluding the land purchase and content costs) was around 30% of revenue in 2019, which we expect to rise to around 26% in 2020”.
 
Material Related-Party Transactions: “Silknet's acquisition of the 20,000 sq. m plot of land in the center of Tbilisi from a related party has had a negative impact on the company's leverage. It plans to build a new headquarters on this land purchased for USD20 million paid over two equal installments in 2019 and 2020. We estimate that this purchase increased leverage by around 0.3x at end-2020. The fair value of the plot of land was assessed by an independent appraiser, Colliers International, in compliance with the company's bond documentation”.

Dominant Shareholder Influence: “Silknet's 100% shareholder Silk Road Group can exercise significant influence on the company as demonstrated by the latter bypassing formal restrictions on dividends when it guaranteed GEL35 million of its shareholder's loan in 2016 and the recent related-party transactions. This is reflected in our ESG Relevance score of '4' for Governance Structure. This has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors. Silknet's governance is commensurate with the 'B' rating category. Its outstanding USD200 million Eurobond documentation has restrictions on both shareholder distributions and shareholder's access to Silknet's cash flows, offering some creditor protection. Silk Road Group does not publicly disclose its financial results”.
 
Coronavirus Reverses Revenue Growth: “Silknet's healthy revenue growth of 6.5% in 1Q20, following a 3% decline in 2019 and stagnation in 2018, was reversed by the coronavirus pandemic. Revenue was hit by temporary lockdowns, closure of businesses and a sharp decline in tourism (over 10% of Georgia's GDP), which is a source of lucrative roaming revenue. Total revenue contracted 5.3% and 4.6% in 2Q20 and 3Q20, respectively”.
 
Gradual Recovery Post-Coronavirus: “We expect positive revenue dynamics observed in 1Q20 to resume in 2H21 as the pandemic's effect gradually wanes. Our base case envisages low single-digit revenue growth in 2021-2023, driven primarily by mobile data, as well as FBB, Pay-TV (including OTT services), and roaming revenue. Growth in mobile revenue will be underpinned by increasing data consumption as a result of 4G network upgrade in previous years and a steady rise in mobile internet users' penetration (below 65% in 3Q20 for Silknet). FBB revenue increase should be supported by the ongoing project of xDSL replacement with FTTH”.
 
Regulatory Pressures on Pricing: “Silknet has a limited ability to increase prices on its services. A rapid rise in tariffs risks triggering regulatory scrutiny and intervention, as was evident in 2019 when Georgian Communications Commission (GNCC) forced Silknet's rival, Magticom, to abandon the announced increase of its tariffs. Also, recent liberalization of the mobile market, which obliges the big-three mobile operators to provide their network access to mobile virtual network operators, might negatively affect Silknet's pricing power in the medium term”.
 
Stabilizing Market Positions: “Silknet's efforts to stop continued market-share erosion have started to pay off in 2020. Mobile market share by revenue increased to 36.5% in 9M20 from 35.8% in 2019 according to GNCC. In 9M20 Silknet accounted for 35% of Georgia's broadband market by revenue, a decline of only 0.3pp, compared with a market share loss of 1.3pp in 2019 and 2.5pp in 2018. However, the telecoms market in Georgia remains competitive”.
 
Negative but Improving FCF: “Our rating case envisages Silknet to continue generating negative free cash flow (FCF) in 2020, due to weakened revenue performance, continued high capex intensity, and payment of the second installment for the plot of land. We expect FCF generation to gradually improve by 2022, supported by post-coronavirus recovery and deceleration in capex”.