Fitch Ratings has assigned Rolta Americas LLC's proposed US dollar senior unsecured notes an expected rating of 'BB-(EXP)'. The notes will be unconditionally and irrevocably guaranteed by India's Rolta India Limited (Rolta; BB-/Stable) and are therefore rated at the same level as Rolta's foreign-currency senior unsecured rating of 'BB-'. The final rating of the proposed notes is contingent upon the receipt of documents conforming to information already received.
Rolta will use about 75% of the proceeds of the notes to refinance its existing secured debt and the balance for general corporate purposes. The notes will rank pari passu with the issuer's existing and future senior unsecured indebtedness. Rolta Americas LLC is a wholly owned subsidiary of Rolta, a diversified company with interests in information technology (IT) and geospatial services. The company has changed its financial year-end from June 30 to March 31. The ratings factor in Rolta's financial results for the nine months ended March 2014.
The terms and conditions of the proposed bond are similar to Rolta LLC's 10.75% US$200mn guaranteed senior notes due 2018, except that in the proposed notes the interest reserve account is removed, the fixed charge coverage ratio is lowered to 2.5x from 3.0x, and Rolta's guarantee on the notes is reduced to 1.5x the bond issuance amount from 2.0x. Fitch believes that the lower fixed charge coverage ratio does not affect the proposed bond's rating given that the agency's negative rating guidance on leverage is effectively tighter than the revised terms. The removal of the interest reserve account and the lowering of the guarantee amount, while potentially negative for bondholders in the event of default, are not viewed as material in light of the company's current profitability levels, ability to generate positive FCF going forward, and rating level of 'BB-'.
Key Rating Drivers
Low Ratings Headroom: Rolta's funds flow from operations (FFO)-adjusted leverage of 3.7x at end-March 2014 (FY13: 4.1x) is close to the 4.0x threshold above which Fitch may consider a negative rating action. We expect its leverage to remain stable around 3.5x during FY15-16 as a decline in capex/revenue to 12%-13% (9MFY14: 29%) would offset a likely deterioration in operating EBITDAR margin to 33%-35% (FY14: 37.3%) resulting in free cash flow (FCF) margin of 5%-6% (9MFY14: -9%).
Likely Lower Profitability: Rolta is gradually shifting its business from a high-margin but capital-intensive model to a lower-margin, lower-capex model. Fitch expects annual capex to decrease to around INR3.5bn-4bn during FY15-16 in line with the company's plan to generate new products, the development costs of which would be expensed rather than capitalised. Management expects annual capex to fall to INR2bn during the same period. Rolta invested about INR45bn, or 56% of its revenue, during FY11-14 mostly to acquire intellectual properties, intangible assets and to develop demonstrations and prototypes.
Changing Revenue Mix: Operating EBITDAR margin is also likely to fall due to a change in the product mix with a higher revenue contribution from Rolta's IT services business, which contributed 72% of FY14 revenue (FY09: 55%) and typically generates relatively lower operating EBITDAR margin of 28%-30%. The geospatial segment, which generates margins of 50%-55%, contributed 28% of FY14 revenue.
Reasonable Barriers to Entry: Rolta's 'BB-' ratings benefit from its niche-market strategy, established market position in engineering and geospatial services and innovative product portfolio in IT services, which are reasonably differentiated from traditional IT companies. Rolta's geospatial segment has high entry barriers with limited competition in geospatial services including 3D mapping, surveying and image processing to various federal and local governments, utilities, telcos, and infrastructure and defence agencies.
Subordination of Notes: Fitch views positively Rolta's financial strategy to raise unsecured debt at Rolta LLC to refinance existing secured debt at operating companies. The agency notes that Rolta's existing USD200m senior note holders are subordinated to secured debt, which constitutes 70% of total debt at end-March 2014. Fitch does not notch the senior unsecured notes one level down from the IDR given reasonable recovery on unsecured debt, growing cash generation and management's stated strategy to replace secured debt with unsecured debt.
Positive FCF starting FY15: Fitch expects Rolta to start generating positive FCF of INR1.5bn-2bn or 5%-6% of its revenue during FY15-16 as operating cash generation should be stable and capex is lower. During FY15, Fitch forecasts that Rolta will generate about INR10bn of EBITDA which would be sufficient to cover its interest and tax of INR3bn-4bn and a similar amount on capex. Rolta is likely to stick to its dividend policy of distributing 20% of its net income.
Negative: Future developments that may, individually or collectively, lead to negative rating action include
- FFO-adjusted leverage at above 4.0x. However, Fitch expects the company to maintain leverage below 4.0x during FY15-18, driven by a decrease in capex and stable FFO growth.
- Further subordination of unsecured creditors from existing levels would lead to a downgrade of the issue rating.
- Rolta's IDRs are constrained by the small scale of its operations. As such, Fitch does not foresee any positive rating action over the medium term.
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