Press Release

DBRS Confirms Manitoba Telecom Services at BBB, R-2 (high), Stable Trend

Telecom/Media/Technology
December 19, 2008

DBRS has today confirmed the ratings of Manitoba Telecom Services Inc.’s (MTS or the Company) Commercial Paper at R-2 (high) and Medium-Term Notes at BBB. The trend on both ratings is Stable. This confirmation reflects MTS’s business risk profile that includes its increasingly competitive incumbent operations in Manitoba and its highly competitive national enterprise operations under the Allstream brand. This business risk profile remains supported by a strong financial risk profile.

Despite the fact that MTS’s business risk profile is higher than its peers due to its mix of businesses, the Company does benefit from diversity in its two operating segments, Consumer Markets and Enterprise Solutions. In addition, DBRS believes that while the shift to more competitive growth services in Consumer Markets is manageable, MTS has also begun to better position its Enterprise Solutions division for future EBITDA growth.

DBRS notes that MTS continues to experience competitive pressure in its incumbent residential operations in Manitoba (Consumer Markets), although the Company has been able to stabilize and hold the rate of access-line erosion steady for the past couple of years through bundling its services (up to five services, including its home alarm service). This has reduced customer turnover and driven its market share of new services such as digital video to a healthy level (over 30%). Along with cost efficiencies, the Company’s growth services continue to more than offset the pressure on its legacy services (local and long distance) as a result of competition and technology substitution. All of these factors continue to drive strong EBITDA margins of just under 50% for Consumer Markets, which is strong for any incumbent telco operator.

DBRS believes that after a number of years of pressure in its Enterprise Solutions division, MTS is in a better position to achieve EBITDA growth going forward. This pressure was driven by a multi-year conversion to advanced IP-based services (with lower EBITDA margins initially) and intense competition, which more than offset sizable cost and efficiency initiatives. While all of these factors are expected to continue, DBRS believes that MTS will reach an inflection point in 2008 and stem EBITDA pressure. This should put MTS in a position to unlock the inherent operating leverage in Enterprise Solutions with continued customer and revenue growth. EBITDA may remain stable in 2009, depending on new customer wins, which may not be as robust as in the past given the current economic pressure. The Company is expected to achieve additional efficiencies in 2009, which should help to hold EBITDA at least steady and maintain EBITDA margins above the 20% level. These levels would remain reasonable versus MTS’s peer group.

On the whole, the Company’s cost-cutting initiatives have benefited both segments and allowed it to continue to improve its overall EBITDA margins, which, at just under 35% on a consolidated basis, are reasonable given the business mix. However, MTS’s EBITDA margins remain slightly below its peers in Canada, which on a consolidated basis have EBITDA margins at or near the 40% level.

From a financial perspective, MTS has managed to continue to improve its key credit metrics, despite slightly higher debt levels in 2008, as EBITDA and cash flow from operations continued to improve modestly. The Company used free cash flow and some borrowing in 2008 to help to finance its AWS spectrum investment of $48.6 million – a much more modest level than what had been considered by MTS prior to the auction that began in May 2008.

DBRS notes that for 2009, MTS has forecast overall revenue and EBITDA growth of up to 2%, with its Enterprise division holding steady and possibly contributing to this growth (for the first time since this division was acquired in 2004). Additionally, MTS has doubled its cost-reduction program and expects savings to reach $35 million to $45 million for 2009. DBRS believes that these expectations are reasonable but that growth in Enterprise Solutions could be dampened given economic pressure outside of Manitoba.

DBRS expects these factors, along with a lower capex level, to drive improved free cash flow. This free cash flow, with cash tax savings, is expected to be used for possible wireless network investments (contemplating a HSPA overlay in Manitoba); higher cash pension contributions; and one-time costs to implement its cost-reduction plans. Any excess free cash flow thereafter could be directed to share repurchases or debt reduction in 2009.

Finally, DBRS believes that MTS has, after recently increasing its credit facility from $350 million to $600 million and extending the term to 2012, better positioned itself to cover its debt maturities through to the end of 2010. This will give the Company greater flexibility to hold off on further notes issuances in the current difficult credit environment.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Telecommunications which can be found on our website under Methodologies.

This is a Corporate rating.

Ratings

  • US = Lead Analyst based in USA
  • CA = Lead Analyst based in Canada
  • EU = Lead Analyst based in EU
  • UK = Lead Analyst based in UK
  • E = EU endorsed
  • U = UK endorsed
  • Unsolicited Participating With Access
  • Unsolicited Participating Without Access
  • Unsolicited Non-participating

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