DBRS Confirms MTS’s Ratings at R-2 (high) and BBB, Stable Trends

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

DBRS believes that MTS’s ratings remain appropriate despite: (a) the modest pressure on EBITDA experienced in 2009 (driven by what DBRS believes is largely cyclical pressure in the Company’s Enterprise Solutions division while competitive and technology migration factors continued to pressure its high-margin legacy voice and data services); and (b) the expectation that its balance sheet could moderately be pressured in 2010 from current strong levels as a result of higher capex levels stemming from its network investments.

These factors in Enterprise Solutions outpaced continued expansion in growth services in this division, growth in Consumer Markets and significant cost efficiency measures undertaken in 2009 that DBRS expects should reach the upper end of the $50 million to $60 million range on an annualized basis by the end of 2009. However, DBRS does caution that should the drivers of this pressure in Enterprise Solutions turn out to be more permanent, this, along with pressure in Consumer Markets and a meaningful deterioration in the Company’s financial risk profile could lead to a trend change or possible pressure on MTS’s ratings.

DBRS has always factored in a higher business risk profile for MTS since its 2004 acquisition of Allstream which gave the Company higher exposure to enterprise services versus its peers. Despite some meaningful improvement in its Enterprise Solutions division since the acquisition, this business experienced a large portion of cyclical pressures in 2009 related mainly to lower volume of existing contracts due to the economy impacting demand, while the transition to converged IP and unified communications services continued. Additionally, this market continues to remain competitive. DBRS believes that this division should benefit from some form of economic recovery in 2010 as MTS’s customers, who are generally under multi-year contracts, increase volumes as their demand increases and as enterprise customers in general return to contemplating decisions to transition towards advanced IP-based networks. Additionally, DBRS notes that as part of MTS’s recent wireless network sharing agreement (on its planned High-Speed Packet Access (HSPA) network) with Rogers Wireless, Allstream could launch a wireless service for its enterprise customers outside of Manitoba. This would allow MTS to bundle wireline and wireless services for its Allstream customers. To the extent that this division did not experience growth or even stabilize in 2010 combined with significant customer turnover, DBRS would be concerned about the structural nature of this business.

This performance has been in contrast to MTS’s Consumer Markets division in Manitoba which continues to remain stable with growth areas and cost efficiencies offsetting competition and technology substitution factors. Despite some slower growth in subscribers in high-speed Internet, digital television and other services due to the economy and service maturation, this and cost cutting efforts offset access line erosion that has remained relatively stable and better that the Company’s peers due to strong uptake on its service bundles. As such, this segment has some of the strongest EBITDA margins in the industry. While there could be risks with MTS’s wireless network sharing agreement (to jointly build an HSPA network in Manitoba) with Rogers Wireless, DBRS believes that Rogers Wireless may be challenged to beat MTS on a retail basis and will not be able to bundle multiple services like MTS.

From a financial risk perspective, DBRS notes that MTS has always maintained a strong balance sheet despite the majority of its cash flow from operations being directed to its capex programs along with its steady dividend to shareholders. The Company has an additional source of funds with its non-capital tax losses that are expected to preclude it from paying cash taxes for the next few years which have generally allowed it to cover off pension deficit payments and restructuring costs. However, capex levels are expected to peak in 2010 with HSPA and billing system investment on top of regular maintenance and network expansion. This is expected to create a modest free cash flow deficit in 2010 which was pre-funded by a notes issuance in December 2009 and also covered near-term debt refinancing. While this is expected to take MTS’s financial risk profile to healthy from strong, DBRS continues to believe that debt-to-EBITDA will remain below 2.0 times and cash flow-to-debt above 0.40 times.

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

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

This is a Corporate (Telecom/Media/Technology) rating.