DBRS Confirms MTS at BBB and R-2 (high), Stable Trend

DBRS has today confirmed the ratings of Manitoba Telecom Services Inc.’s (MTS or the Company) Medium-Term Notes at BBB and its Commercial Paper program at R-2 (high). The trend is Stable. DBRS notes that MTS’s ratings continue to reflect its higher business risk relative to its peers. This includes a healthy incumbent business in Manitoba (although this segment faces competition from cable operators and other wireless carriers) and the Allstream national enterprise business, which is highly competitive and is in transition from legacy to IP-based services for national enterprise customers.

The operating performance of MTS’s incumbent segment in Manitoba (54.1% of total revenue) remained relatively stable as growth areas (wireless and high-speed Internet) and cost efficiencies partly offset factors such as competition, technology substitution and higher costs associated with the sale of these new services. Growth in subscribers and average revenue per user (ARPU) for wireless, digital television and high-speed Internet services, combined with cost-cutting efforts, continued to offset access line erosion at MTS, which has nonetheless remained relatively stable and better than the Company’s peers (at below the 5% level) due to strong uptake on its service bundles. As such, this segment has maintained its EBITDA margins at over 50%, which is strong for the telecom sector.

DBRS notes that MTS is well positioned from a network and technology perspective, covering 95% of Winnipeg with its fibre-to-the-node (FTTN) network and 97% of the province’s population with its evolved high-speed packet access (HSPA+) wireless network. These networks allow MTS to offer competitive high-speed Internet, IPTV and wireless services. The Company has also undertaken a multi-year fibre-to-the-home (FTTH) initiative in 2010 and expects to service more than 120,000 homes in 20 communities within the province by the end of 2015. This includes communities with less than very high bit rate digital subscriber line (VDSL) service, which could be deemed less competitive than cable. With roughly two-thirds FTTH coverage in one market to date (Selkirk), MTS has penetrated one-third of eligible households with its Ultimate TV service -- a strong share for such a new network.

While factors such as competition and technology substitution persist, and new services continue to require upfront costs (balanced by further operating efficiency initiatives), DBRS believes that MTS should remain competitively well positioned in terms of its product portfolio. This includes the ability to sell five communications services (four traditional, including alarm service) against cable operators’ triple-play packages that do not include wireless services and other wireless carriers that do not have fixed-line bundling capability in Manitoba.

DBRS notes that MTS’s Allstream segment (46% of total revenue) continues to face structural challenges in terms of transitioning away from legacy voice and data services toward IP-based services. However, while pressure on this legacy business remains ongoing, the Company has more recently focused on efficiency initiatives and placing more of its traffic on-net. These efforts, along with some cyclical improvements in terms of returning volumes after the recent economic slowdown, appear to be paying off. DBRS notes that after many years of pressure, Allstream has experienced EBITDA growth in the latest nine months. While revenue pressure in legacy services remains ongoing, it appears to be slowing as IP revenue growth continues and as legacy traffic from AT&T Inc. and Rogers Communications Inc. continues to decline. This segment is showing signs of improvement but will not likely stabilize until revenue pressure abates. Over the next few years, this business is likely to reach an inflection point, in terms of revenue stability, where IP revenue growth outpaces legacy revenue declines.

From a financial risk perspective, DBRS notes that MTS has managed to maintain a healthy balance sheet after capex levels peaked in 2010, stemming from its wireless HSPA overlay which required additional incremental borrowing. With a return to modest levels of positive free cash flow in 2011 (including cash tax savings), debt levels were somewhat reduced using cash on hand. This has kept MTS’s credit metrics healthy for its BBB rating and provides a balance for a higher business risk profile. DBRS notes that MTS’s liquidity remains sufficient to manage upcoming maturities over the medium term. DBRS notes that while MTS has gained some flexibility related to its pension deficit funding, in terms of now having the ability to fund deficit payments with letters of credit, a more permanent shortfall in its pension plan (the latest estimate is a $315 million deficit at September 30, 2011) could cause funding beyond its current free cash flow levels.

DBRS believes that MTS is well placed at the BBB rating given its mix of businesses and its healthy financial risk profile. DBRS may have concerns should the business risk increase and/or free cash flow turn sharply negative, requiring additional borrowing.

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

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