Standard & Poor’s assessment of PLDT

Philippine Long Distance Telephone Co.’s "satisfactory" business risk profile reflects the company's strong market position and good profitability in a competitive and matured market. The Philippine cellular telecom market has become a duopoly after PLDT's acquisition of Digital Telecommunications Philippines Inc. (Digitel) in October 2011. Competition intensified in the second half of 2011, with increased bucket plans and unlimited on-net offers on products such as voice and text. However, we expect competition in the cellular market to ease over the next 12-18 months. We expect the less profitable data and broadband segment to propel growth given the saturation in the cellular segment and limited growth potential of the fixed-line voice segment. We expect PLDT to retain its position as the leading integrated telecommunications service provider in the Philippines. As of March 31, 2012, the company had a subscriber base of about 66.1 million in the wireless market, 2.2 million (including 0.3 million of Digitel) in the fixed-line segment, and 3.0 million in the broadband segment. Together with Digitel's subscribers, PLDT's subscriber market share was about 65 percent across all segments. We expect the Digitel acquisition to further strengthen both PLDT's competitive position in the cellular segment and its growth opportunities in broadband services. We expect PLDT's operating performance to remain weak in 2012. The company's revenues declined 1 percent in 2011, despite consolidating Digitel (for two months). This is because of the decline in voice and messaging revenues despite a volume increase stemming from the popularity of unlimited and bucket plans. PLDT's EBITDA margins declined 385 basis points to 52.7 percent because of weaker margins at Digitel, intensified competition, and higher marketing expenses including subsidies. PLDT plans to invest P6 billion in TV5 and Cignal TV through MediaQuest Holdings Inc. (not rated). Though not in the telecom business, this investment in content will complement PLDT's existing broadband business and will only have a marginal negative impact on PLDT's operating and financial metrics. This investment is in addition to company's indirect 24 percent ownership of Philippine utility company, Manila Electric Co. (B+/Stable/). We assess PLDT's financial risk profile as "intermediate." We expect the company's positive free operating cash flow and financial ratios to remain strong. Our view considers PLDT's higher cash capital expenditure of P31 billion in 2011 and plans to increase it to P38.1 billion in 2012. The spending is part of the two-year network modernization program the company started in 2011. PLDT has maintained its dividend payout ratio at 100 percent. As of April 30, 2012, First Pacific Group (not rated) owns 25.6 percent of PLDT, Nippon Telegraph & Telephone Corp. (AA/Stable/A-1+) through its subsidiaries owns 20.3 percent, and JG Summit Group (not rated) owns 8 percent. The public holds the rest. Base-case scenario Standard & Poor's base-case scenario for PLDT assumes the debt-to-EBITDA ratio of about 1.6x, debt-to-capital ratio of about 48 percent, and the ratio of funds from operations (FFO) to debt above 50 percent over the next three years. Our forecast considers the addition of MediaQuest's debt in 2012. Our projections are based on the following assumptions: Revenue would grow by about 16 percent in 2012 primarily on account of full-year Digitel consolidation and half-year MediaQuest consolidation. Revenue growth rate would fall to 4 percent in 2013 after full-year MediaQuest consolidation and to about 2.5 percent in 2014. This is based on our expectation that subscribers will continue to grow, but growth would be partly offset by a fall in average revenue per user (ARPU) due to competitive pressure. EBITDA margins will gradually rise from about 47 percent in 2012 to 49 percent in 2014 after factoring in the weaker margins at Digitel, the loss-making MediaQuest, gradual easing of competitive pressure, and benefits of synergies and operating efficiency. Capital expenditure will increase to about 22 percent of revenue in 2012 and 2013 and then gradually decline to below 20 percent of revenue in 2014. We have assumed an investment of P6 billion in MediaQuest during mid-2012. We have assumed 100% dividend payout ratio. Liquidity We assess PLDT's liquidity as "strong," as defined in our criteria. We expect the company's sources of liquidity to exceed its uses by more than 1.5x over the next 12 months. We anticipate that PLDT's net liquidity sources will remain positive even if EBITDA declines by 30 percent. Our liquidity assessment is based on the following factors and assumptions: Liquidity sources include cash and short-term investments of P47.0 billion, and unused credit facilities of about P6.9 billion as of Dec. 31, 2011. The sources also include our projected FFO of about P65 billion over the next 12 months. Uses of liquidity include debt maturities of about P23 billion as well as maintenance and other capital expenditure of about P20.0 billion and projected dividend of about P20.0 billion, which we expect the company to incur and distribute, respectively, even in case of stress. The company also has significant headroom in its covenants. PLDT's foreign currency risk exposure is moderate, in our view. As of Dec. 31, 2011, 48 percent of the company's total consolidated debt is foreign currency-denominated, of which about 32 percent is unhedged. Interest rate risk is limited because more than 73 percent of PLDT's debt is based on fixed rates. Outlook The positive rating outlook on PLDT reflects the positive outlook on the sovereign rating. It also reflects our expectation that PLDT's operating performance will be stable and that the company will generate positive free operating cash flows in at least the next two years. We could raise the foreign currency rating on PLDT if we raise the 'BB+' T&C risk assessment for the Philippines. We could revise the outlook to stable if the outlook on the Philippines foreign currency sovereign rating is revised to stable from positive. We could also revise the outlook to stable if PLDT's credit profile deteriorates, due to shareholder return initiatives that weaken financial ratios. A debt-to-EBITDA ratio of more than 3x could indicate such deterioration. We could also downgrade the company if it significantly expands into sectors that are exposed to the uncertain operating and regulatory environment in the Philippines.