DBRS Confirms Manitoba Tel at BBB and R-2 (high)

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

DBRS believes that Manitoba Tel’s ratings remain appropriate despite a decline in overall EBITDA caused by (1) greater competition, technology substitution and migration, which adversely affected its high-margin legacy voice and data services and (2) the impact of the slow pace of economic recovery on the Company’s Allstream segment. These factors have outpaced continued expansion in growth services in both divisions, as well as significant cost-efficiency measures undertaken in 2010.

DBRS has factored in a higher business risk profile for Manitoba Tel since its 2004 acquisition of Allstream Inc., which gave the Company higher exposure to enterprise services versus its peers. Despite some meaningful improvement in the Allstream division since the acquisition, this business has continued to experience significant cyclical pressures. Lower pricing and volumes in legacy data and long-distance voice services, and the impact from the migration of Rogers Communications Inc. and AT&T Inc. traffic on to their own networks, has offset improvements in the segment’s converged IP services. As well, this segment experienced a decline in unified communications and security business due in part to the recession and the slow pace of economic recovery as many enterprises experienced lower business volumes and delayed purchase of these services. This market also remains highly competitive.

Going forward, DBRS believes that the Allstream division should benefit from the economic recovery in 2011 as Manitoba Tel’s customers, who are generally under multi-year contracts, increase volumes as demand rebounds. The segment should also be favourably affected by a general return among enterprise customers to contemplating decisions to transition toward advanced IP-based networks. However, if this division does not experience growth, DBRS would be concerned about possible structural changes in this business.

The operating performance of Manitoba Tel’s MTS division remained relatively stable as growth areas and cost efficiencies partly offset competition and technology substitution factors. Growth in subscribers for wireless and digital television, combined with cost-cutting efforts, offset access line erosion at MTS, which has nonetheless remained relatively stable and better than 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 (over 50%). DBRS believes that Rogers Wireless may be challenged to beat Manitoba Tel on a retail basis and will not be able to bundle multiple services like Manitoba Tel.

Manitoba Tel is investing in strategic initiatives such as its wireless high-speed packet access (HSPA) network overlay and its fixed-line fibre-to-the-home (FTTH) undertaking to boost its competitive advantage and grow market share. This could enhance the Company’s business and financial profiles. High levels of capital spending on its HSPA network were substantially complete in 2010, with an expected launch on March 31, 2011. The new network will provide MTS division customers with significantly faster mobile download speeds. The Company also plans to accelerate deployment of its FTTH initiative starting in 2011. Once completed, fibre is expected to have passed 120,000 homes in Manitoba in 20 communities.

From a financial risk perspective, DBRS notes that Manitoba Tel has managed to maintain a healthy balance sheet, despite incurring negative free cash flow during 2010, stemming from peak levels of capex spending on the HSPA network overlay and on billing system upgrade programs. DBRS does note that the Company has an additional source of funds with its non-capital tax losses, which are expected to continue to preclude it from paying cash taxes for the next several years. This, along with cash on hand, was sufficient to cover funding requirements precluding any additional debt financing, keeping financial metrics in line with the assigned BBB rating.

In the near term, free cash flows before working capital are expected to be at breakeven levels as capex requirements will decrease due to the near-completion of the HSPA overlay initiative and the 35% decline in dividend payments starting in Q3 2010. While there is ample liquidity under credit lines to repay significant upcoming long-term debt maturities of $220 million in 2011, the Company is not expected to incur any incremental debt in 2011. As such, the Company will likely refinance and term out existing maturities through its MTN program.

With modest improvements in EBITDA and cash flow from operations, DBRS expects Manitoba Tel’s credit metrics to remain commensurate with a BBB rating, keeping the financial profile healthy. DBRS expects that debt-to-EBITDA will remain below 2.0 times, cash-flow-to-total debt around 0.40 times and EBITDA coverage should improve to above 9.0 times.

DBRS notes that, in recent months, there has been significant regulatory activity in the Canadian communications industry, which could have a considerable impact on the industry’s business risk profile. As decisions are made on the legislative front, DBRS will assess any potential effects on the communications industry in general and on Manitoba Tel.

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

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