DBRS Confirms Manitoba Telecom Services Inc. at BBB and R-2 (high), Stable Trends

DBRS has today confirmed Manitoba Telecom Services Inc.’s (MTS or the Company) Issuer Rating and Medium-Term Notes rating at BBB and its Commercial Paper at R-2 (high), with all trends remaining Stable. The ratings continue to be supported by the Company’s incumbent position, advanced networks and steady subscriber base in Manitoba. The ratings also reflect an intensifying competitive environment in wireless communications, the Company’s limited scale and future growth prospects, and the steady erosion of local access lines.

MTS’s consolidated revenues and earnings have declined in recent years primarily because of the legacy declines within its Allstream division, which have outweighed gains made in the Company’s IP-based services. In 2013, consolidated revenues declined approximately 4.1% to $1.6 billion. Allstream revenues fell 11% to $674 million, primarily reflecting the aforementioned legacy declines and the negative impact of a prolonged regulatory process relating to the proposed Allstream transaction. In contrast, MTS segment revenues (ex-Allstream) increased 1.5% to $995 million as wireless and broadband internet growth offset declines in traditional wireline businesses. Largely as a result of the one-time negative impact of the rejected Allstream sale, EBITDA declined to $551 million in 2013 from $585 million the year prior. Excluding these non-recurring charges, EBITDA remained relatively stable year over year at $587 million. The Company’s normalized EBITDA margins improved as a result of operating efficiencies and lower leasing costs at Allstream because of proprietary network expansion.

MTS’s financial profile remained consistent with the current rating category in 2013 based on the Company’s stable cash-generating capacity and modestly declining debt levels. DBRS took comfort in MTS’s decision to indirectly fund $125 million of its pension solvency deficit last year through the issuance of common stock as opposed to debt. As debt levels decreased in proportion with EBITDA, gross debt-to-EBITDA at the end of 2013 was relatively stable at 1.68 times (x) (1.93x adjusting EBITDA for capitalized wireless subsidies), compared with 1.72x (1.93x adjusting EBITDA for capitalized wireless subsidies) for the same period prior.

Going forward, DBRS expects the Company to focus on improving the top line trajectory of Allstream while continuing to grow revenues and operating income from its IP-based services. MTS’s 2014 revenue is expected to remain consistent with 2013 levels at between $1.6 billion and $1.7 billion. Modest market growth, progress with its fibre-to-the-home services and stronger IP revenue growth at Allstream should mitigate declines in legacy wireline segments. DBRS notes that revenue growth over the longer term remains uncertain given the increasing levels of competition in the mature Manitoban market. Operating margins on a consolidated basis are expected to improve modestly in 2014 as a result of cost cutting, a continued movement toward higher-margin IP-based services and economies of scale with regards to the Company’s on-net services. As such, DBRS expects MTS’s consolidated EBITDA in 2014 to range between $580 million and $600 million.

The financial profile of MTS is expected to remain within a range consistent for the current rating category over the near to medium term. Cash flow from operations should increase to approximately $450 million in 2014 given the lack of restructuring expenses and pension plan contributions as compared with 2013. Capital expenditures are expected to increase moderately to between $300 million and $320 million as MTS continues to develop its long-term evolution network and transition Allstream’s business model toward higher-margin IP-based services. Dividends are also expected to increase nominally, with cash dividends of approximately $100 million (when adjusted for dividend reinvestment plan issuance). As such, DBRS forecasts that the Company should generate approximately $40 million of free cash flow before changes in working capital in 2014. The Company may direct its free cash flow toward pension solvency deficit payments (if and when required).

MTS maintained a relatively conservative gross debt-to-EBTIDA ratio of 1.55x (1.79x, adjusting EBITDA for capitalized wireless subsidies) for the last 12 months ended March 31, 2014. Despite the Company’s conservative leverage, DBRS believes MTS’s ratings are currently positioned at the mid to low end of its respective rating categories because of an intensifying competitive landscape in a relatively mature market. As such, a material deterioration in credit metrics, particularly free cash flow after dividends as a percentage of debt and gross debt-to-EBITDA, resulting from a significantly weaker-than-expected operating performance and/or meaningfully more-aggressive-than-expected financial management could result in pressure on the ratings. DBRS will continue to carefully monitor the operating performance and financial management of MTS, particularly in the context of an evolving competitive environment.

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

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.