Fitch rates Global Cloud Xchange 'B+'; Proposed Bond 'BB+(EXP)/RR1'

Fitch Ratings has assigned Global Cloud Xchange Limited (GCX) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) of 'B+'. The Outlook is Stable. Fitch has also assigned an expected 'BB+(EXP)' rating and an expected 'RR1' Recovery Rating to a proposed senior secured guaranteed notes issue by GCX Limited, a wholly owned subsidiary of GCX.

The notes are secured by the assets and equity interests of GCX and its key subsidiaries, and guaranteed by GCX and its key operating subsidiaries. The final ratings are contingent upon receipt of documents conforming to information already received by Fitch.

GCX plans to use the proceeds from the notes to fully repay its existing USD250m shareholder loan from its immediate parent, Reliance Globalcom B.V (RGBV), ultimately owned by Reliance Communications Limited (Rcom), India's fourth-largest telecom service provider by revenue market share. Part of the proceeds will also be used, together with a potential working capital bank loan, to finance capex related to its submarine cable networks. Once the notes are issued, GCX's debt would comprise mainly the notes, a proposed working capital loan and capital leases of USD50m.

Key Rating Drivers

High Entry Barriers: GCX's ratings factor in its position as the owner of one of the world's largest private undersea cable system with 68,698 km of cables. It also has an 83,432 km terrestrial cable network. Its combined undersea and terrestrial network provides it with a competitive advantage to sell network capacity and internet connectivity to telecom carriers, MNCs and SMEs. Significant entry barriers exist for any potential new competitors in the undersea cable industry, including high capital intensity, long lead times to build undersea cables, limited availability of 'rights of way', and complex and lengthy processes, both on the regulatory and commercial fronts, before revenue can be realised.

Industry Oversupply: Fitch expects GCX's operating EBITDAR margin to remain at around 25%-27% during the financial year ending March 2015 (FY15) through FY17 (FY14: 27%) due to tariff declines as the undersea cable industry remains oversupplied and intensely competitive. The agency expects industry capacity gains to consistently outpace fast-growing data demand as newer technologies allow for capacity to be significantly upgraded on existing networks. Intense competition could also negatively affect GCX's 'indefeasible rights of usage' (IRU) sales, affecting liquidity and cash generation. An undersea cable company typically receives cash upfront for a block of IRU sales but the revenue is recognised over the life of the contract, typically 15 years.

Strong Revenue and Cash Visibility: As at end-March 2014, GCX had about USD912m (1.8x of FY14 revenue) in contracted revenue to be recognized in the next three years. GCX has high revenue visibility given over 80% of its revenue is recurring in nature, backed by medium- to long-term contracts with its customers. However, there is a risk of lower profitability with new customer contracts going forward, as the undersea cable business typically faces double-digit percentage price erosion each year, and existing customers could switch to a lower priced network service provider at the time of contract renewal.

Generally Positive FCF: The Stable Outlook on GCX's ratings reflects its ability to generate positive free cash flows (FCF). Fitch expects GCX to generate FCF of around USD10m-20m after capex of around USD50-60m each year during FY15-18, except in FY16 when it plans to increase its capex to USD100m to build two new undersea cables - India-Singapore and Tokyo-Seattle. Fitch forecasts GCX to generate annual EBITDA of around USD130m during FY15-16.

Related Party Transactions: GCX was incorporated in March 2014, combining three entities - Flag Telecom (undersea cable business), Yipes Inc (Ethernet services) and Vanco (managed services). Before restructuring, the group had significant related party transactions, mostly with its immediate parent RGBV and ultimate parent Rcom. However, all related party balances have been netted off during the course of restructuring and a new management is in place to run the group independent of its parent.

Better Leverage; Small Size: GCX's FY15 forecast funds flow from operations (FFO)-adjusted net leverage of 3.5x is better than similarly rated peers mainly because it is forecast to pay lower dividends compared with its peers and due to its ability to generate positive FCF. Compared with GCX, Level 3 Communications Inc (B+/Stable) and Pacnet Limited (B/Stable) have higher leverage at 5.0x and 4.0x in 2014 respectively. Pacnet is of the same size as GCX while GCX's size and scale are much smaller than Level 3's (FFO of over USD1bn) with an average estimated FFO for FY15-16 of below USD100m.

Adequate Recovery on Proposed Bond: Fitch has assigned an expected 'BB+(EXP)' and RR1 rating, three notches above GCX's IDR, on the proposed senior secured guaranteed bond. The bond is guaranteed by all the key operating companies, which generate most of the group's revenue and EBITDA. The expected 'RR1' recovery rating assigned to the notes reflects an expected 100% value recovery for the notes' debt holders in the event of default, based on the agency's assessment of the going concern enterprise value of GCX's cable networks under a stressed situation. The rating on the notes is also underpinned by a clause in the bond document that limits the group's ability to pay dividends to its parent.

Rating Sensitivities

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

• Sustained negative FCF generation
• A deterioration in the operating environment and/or evidence of the parent accessing cash from GCX and negatively affecting GCX's credit profile resulting in FFO-adjusted net leverage rising to over 4.0x (FY15-16 forecasted: 3.5x).
• FFO interest charge coverage falling below 3.0x, both on a sustained basis. (FY15 forecast: 3.2x).
• A downgrade could also result if judgement in outstanding litigation in France requires GCX to pay USD82m of taxes.

Positive: Although an upgrade is unlikely in the next 12-18 months, future developments that may, individually or collectively, lead to positive rating action include:

• Consistent generation of positive FCF.
• A substantial increase in scale and absolute EBITDA generation.
• FFO-adjusted net leverage falling below 2.5x on a sustained basis.