Mergers, Acquisitions and Financial Results

International credit ratings agency Moody's Investors Service has downgraded South Africa's third mobile operator Cell C's Corporate Family rating and related debt issues. Moody's also assigned a negative outlook to all ratings.

Moody's said in a statement released late on Thursday that Cell C's corporate family rating has been downgraded to B3 from B2, and EUR400 million senior secured notes due 2012 have been downgraded to B3 from B2.

In addition, US$270 million senior subordinated notes due 2015 have been downgraded to Caa2 from Caa1. The outlook on all ratings was changed to negative from stable.

Moody's said the rating actions result from weakness in the company's business and financial profile relative to initial expectations. The weaker position is due to a combination of the intense competitive environment in South Africa, and pressure on operating margins resulting largely from increases in commissions and incentives necessary to defend and attempt to grow market share, it said.

As a result, debt protection levels have weakened and, in Moody's opinion, have exposed Cell C's creditors to potentially higher default risk and lower expected recovery levels.

The downgrades and negative outlook reflect Moody's concerns that Cell C needs to re-establish a plan that addresses the deterioration in financial and operating performance in order to grow its subscriber base, reduce high churn rates and improve its financial and liquidity position in the near term.

A weakening of the rand against the Euro and US Dollar resulting in increased interest payments under its high-yield bonds could result in further financial pressure for the company, Moody's added.

Moody's noted that there is an increased likelihood that the Revolving Credit Facility of 500 million rand may be drawn to fund operating expenditure and interest payments as a result of the weakening cash position.

Furthermore, the weakness in operating performance has resulted in decreased operating cash flow, which in turn has caused leverage for the year ended December 2005 to spike to approximately 10x Total Debt to EBITDA, using Moody's standard analytic adjustments (prior to an adjustment for capitalisation of subscriber acquisition costs), it said.

"Considering this rating action, there is little short-term potential for upward rating movement," it said.

Moody's continued that as Cell C is weakly positioned in the B3 category at present, a continued decline in the company's liquidity profile resulting in substantial reliance on external financing, failure to reduce the current high rates of subscriber churn, further pressure on EBITDA margins as a result of pursuing or defending market share, or further Rand weakness which causes interest payments to increase substantially, are likely to result in further negative rating action.

Prospectively, pressure to return the negative outlook to stable could occur once Cell C demonstrates that it can present a business plan that addresses the deterioration in financial and operating performance to demonstrate it can gain market share without negatively impacting operating margins; begin improving its generation of free cash flow; demonstrate a track record of improvement in leverage such that Debt/EBITDA trends towards 8.5x on a sustainable basis; reduce the current high rates of churn; and stabilise and grow its subscriber base on a sustainable basis.