EMPHATICALLY positive comments about the surprise takeover by PLDT and Globe of San Miguel Corp’s telecom assets at the beginning of the week have been rare, outside of the companies themselves, and for good reason: A consolidation of the telecom sector is exactly the opposite of opening the sector to more competition, which is what everyone believes is the best way to improve its performance.
Earlier this week, all three of the major credit ratings agencies issued opinions on the deal, and these are interesting because they take a look at the circumstances purely from the point of view of the companies. The consensus is the deal is generally positive for Globe and PLDT, but the ratings agencies are not exactly fulsome with their praise, which may just add to the growing skepticism of regulators and the Filipino public.
Of the three ratings firms, Fitch Ratings, which issued its assessment the same day the deal was announced, was the most favorable. It pointed out that the elimination of the possibility of new entrants to the sector for the foreseeable future would be a huge advantage for the local telco giants. More for Globe than PLDT, because Globe makes more of its revenue from mobile services than PLDT (76 percent versus about 63 percent for the latter), and is presumably better equipped to start the expansion needed to take full advantage of the newly acquired assets. In terms of risk, Fitch sees both companies “losing a little headroom;” in other words, pushing toward a debt-to-income level that would result in a credit ratings downgrade, but still remaining safely below the threshold.
Moody’s Investor Services focused on PLDT, and was a bit harsher in its assessment. “Philippine Long Distance Telephone Company’s (PLDT, Baa2 stable) acquisition of San Miguel Corporation’s (SMC, unrated) telecommunications business is credit negative as this partially debt-financed acquisition will cause its leverage to rise into the 2.5x range by year-end, which is at the upper end of leverage tolerance for its Baa2 issuer rating,” Moody’s explained. “Moreover, this comes at the time when PLDT’s operating performance is under pressure.”
While Moody’s retained PLDT’s Baa2 rating for now, its description of the factors that would result in either a ratings downgrade or upgrade imply that Moody’s is anticipating problems later on. ‘Downward pressures’ would be remaining at the current leverage level for too long, if the EBITDA margin drops below 40 percent, or retained cash flow declines to below 20 percent as a result of further acquisitions or “continued weak operating performance.”
About a possible ratings upgrade, Moody’s said, “positive rating action over the next 12 months is unlikely,” but didn’t completely discount the possibility if PLDT somehow puts on a phenomenal financial performance over the next year or so.
The third ratings agency, S&P, actually did downgrade PLDT’s credit profile in one relatively minor respect, while otherwise also retaining its main long-term corporate credit rating at BBB+. The company’s stand-alone credit profile (SACP), however, was reduced from ‘a-’ to ‘bbb+’, which S&P said was an acknowledgement of the higher leverage. The practical effect of that decision is minor indeed; it might, in some cases, lead to higher debt costs for PLDT, but will in any case have only a minor impact if any. But positive ratings action from S&P is even less likely than it is from Moody’s; S&P does not anticipate a change in less than 24 months, and does not anticipate an upgrade at all. The reason it does not is because of the transfer and convertibility (T&C) assessment for the Philippines, which caps PLDT’s (as well as other companies’) rating unless the sovereign rating is raised. Even then, S&P stipulates that PLDT would have to maintain a debt-to-EBITDA ratio below 2.0 for an extended period of time in order to see an upgrade.
The subtext to the views of the big three ratings agencies is that while the telco consolidation is not immediately risky, it pushes the two companies involved, and primarily PLDT, into a situation where it will be easier to fail than succeed. That is not exactly a glowing endorsement of a deal that many view with deep skepticism; to allay concerns, Globe and PLDT will have to act quickly to show some real progress in improving the country’s telecom service.