OREANDA-NEWS. Fitch Ratings has assigned a Long-term rating of 'B+' to Colombia Telecomunicaciones S.A. E.S.P.'s (Coltel) proposed perpetual subordinated (hybrid) notes issuance. Coltel expects to use the proceeds from the issuance to refinance existing financial debt.
The hybrid notes will be deeply subordinated to senior and unsecured debt, and rank senior only to Colombia Telecomunicaciones' ordinary shares.

The proposed notes will be rated 'B+', two notches below Colombia Telecomunicaciones' 'BB' IDR, which reflects the securities' increased loss severity and heightened risk of nonperformance relative to the senior obligations. The hybrid securities will receive a 50% equity credit given the ability of the company to defer interest coupons and compound arrears of interest at the rate of interest on the notes. The notes have a non-call period of at least five years and will reset for an interest rate equal to the relevant Five Year Swap after the initial non-call period plus the initial margin and step up.

KEY RATING DRIVERS

Coltel's ratings reflect its enhanced competitive position from the merger of the fixed and mobile operations. The ratings also positively reflect the reduced payment obligation to Patrimonio Autonomo de Activos y Pasivos de Telecom (Parapat), and increased financial flexibility through the restructuring of the terms of the operating contract in 2012. Implied support from the parent, Telefonica SA (rated 'BBB+' by Fitch), which owns 70% of the company, is also incorporated in the ratings given its strategic/operational importance to the parent's Latin America operation.

The ratings are constrained by a high level of competition, the projected weak cash generation in the short- to medium-term due to high capex for network upgrades, and its weak liquidity profile. Also, the existing Parapat-related obligation continues to pressure the company's cash flows and leverage. With the adoption of International Financial Reporting Standards (IFRS) the Parapat obligation will be register in the company's balance sheet as debt, which will increase leverage and drive the company's equity into negative territory. The company plans to address this situation by the issuance of the hybrid note and the recognition as equity of asset reappraisal and fiscal credits.

Short-term Increase in Leverage: Coltel's financial leverage is likely to increase in 2015 given its high capex plan, weak EBITDAR growth and the incremental balance debt from the Parapat obligation. Reflecting the present value of this commitment in the balance sheet the company's debt-to-EBITDAR ratio would increase to above 5x from 2015 and remain at this level in the coming years. Fitch considers Coltel's liability to Parapat under the new restructuring conditions as a softer debt for leverage analysis purposes given the potential flexibility in payments under the stress scenario. Parapat is a long-term financial obligation ending in 2028.

High Capex; Negative Free Cash Flow (FCF): The company has embarked on a sizable capital expenditure program from 2014 for its mobile/fixed network upgrades, mainly including 4G, as well as the license payments. Coltel expects to invest a total of COP3.600 billion during 2014 - 2017, which should be primarily funded by cash flow from operations (CFFO), which is expected to cover about 90% of investments during the period; Fitch expects the company's FCF to remain slightly negative. Given the plans for significant investment, shareholder distributions are not likely during 2014-2017. The company's capex and opex are not exposed to the volatility in exchange rate.

Coltel's 2014 EBITDA COP1.400 billion an increase of 5% from the 2013 level of COP1.291 billion, mainly due to a better revenue performance and the maintenance of the EBITDA margin despite increase in payments to Parapat amid the decreasing trend in ARPU as a result of competitive pressures. The Parapat payments accounted for approximately 7% of revenues in 2014 and 10% from 2015 thereafter, which is an increase from 3% in 2013. In addition, the merger between Tigo and UNE could add more pressure to the competitive landscape. As a result, Coltel's EBITDA is projected to gradually fall below 30% over the medium term from 31% in 2014.

Weak Liquidity: Coltel's liquidity position is weak as it has increased its short-term debt to fund its capex and the license payment obligations. This, along with current debt maturities, resulted in the short-term debt level reaching COP352 billion, compared to its cash balance of COP80 billion as of December 31st, 2014. The proceeds of the perpetual note will be used entirety to refinance its existing debt. The company has been able to roll over its short-term debt with available credit facilities and CFFO. The debt at the end of 2014 was COP4.060 billion.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
--Annual revenue growth of 2.7% from 2015 - 2018
--EBITDA margins declining to around 30% in 2015 and 28% for 2017 due to competitive pressures and lower ARPU.
--Perpetual note proposed issuance of approximately \$500 million with equity credit of 50% and which proceeds will be entirely used for refinancing existing debt.
--Parapat obligation of COP3.973 billion.
--Capex to be funded primarily from internally generated funds. Fitch expects 2015 capex of 18% of revenues and 16% for the coming years.

RATING SENSITIVITIES

Factors that could trigger a negative rating action include:
--Increased competitive pressures leading to erosion in its market positions and operating margins;
-- Higher-than-expected capex leading to weak cash generation over the medium- to long-term, resulting in its on-adjusted net leverage including equity credit failing to decrease below 5x on a sustained basis. In addition, failure to improve its liquidity could pressure the ratings. Fitch changed its ratings sensitivities to include the equity credit from the proposed hybrid instrument.
Credit quality factors that could lead to a positive rating action include:
--Positive rating action is unlikely in the short- to medium-term given the expected increase in leverage due to high capex. Factors that could potentially lead to a positive rating action include positive FCF generation which enables a reduction in leverage towards 3.5x on a sustained basis.