MOODY'S ASSIGNS B2 TO SENIOR NOTES OF ALESTRA S. DE R.L. DE C.V.
Moody's Investors Service assigned a B2 rating to Alestra S. de R.L de C.V.'s proposed $280 million senior notes, due 2006 and $285 million senior notes, due 2009 (both with a three-year interest escrow). Moody's has also assigned a senior implied rating of B2. The rating outlook is stable. This is the first time that Moody's has rated the company's debt.
The ratings reflect the company's exposure to the more volatile regulatory and economic environments of Mexico; a difficult competitive position, given the strength of the incumbent telephone provider, Telmex; and the amount of time required for the company to develop a meaningful amount of cash flow relative to its debt position. However, Moody's ratings also recognize the importance of the AT&T's 49% ownership position and Alestra's strategic importance to AT&T; the benefit of Alestra's other owners, Alfa and Bancomer; the significant improvement in the regulatory environment since September 1998; and the several corrective actions Alestra and its competitors have taken to minimize the high churn and bad debt rates occurring across the sector.
Structurally, the proposed bonds are expected to be the material debt of the capital structure. While the indenture allows for a considerable amount of additional debt, including senior secured debt, we do not expect these amounts to be necessary under the existing business plan. The expected $565 million in proceeds from the proposed issues largely refinances the existing bank debt of $266 million. Approximately $185 million of the proceeds will fund the interest escrow, resulting in only approximately $100 million in new money (after transaction fees) to fund working capital and capital expenditures.
The Mexican telecommunications market opened to switched, interconnected competition in 60 cities in January, 1997. Upon constructing its fiber-optic network, Alestra launched its switched service in those 60 cities by June, 1997. Since that time, Alestra has expanded geographically as regulation has allowed, currently competing in 139 markets. To date, there are ten companies in the Mexican market that own or have begun the construction of the fiber-optic networks. Telmex, the former monopoly service provider, is still the dominant provider. The next largest operators are Alestra and Avantel, S.A. (owned in part by MCI Worldcom), which are similar in size. Alestra reports that in terms of minutes of usage, it carries 8% of the domestic long distance traffic and 12% of the international long distance traffic in Mexico.
Alestra is strategically important to AT&T and AT&T's participation in Alestra is fundamental to the credit rating. Since the Mexico-US international telecommunication route is one of the largest in the world and since AT&T originates and carries a large portion of that traffic into Mexico, AT&T has a large incentive to decrease the costs of completing those calls in Mexico. Through Alestra, and given the increasing deregulation of the Mexican market, those termination costs should continue to decrease significantly. Additionally, AT&T needs to be able to provide its multinational customers with data services in Mexico as it does in other regions. Further, end-to-end control of the network is important in order to deliver the quality necessary for certain data services. Although AT&T is not contractually required to maintain its ownership stake over the medium term, we think the strategic value of maintaining the position will continue to be very high.
AT&T's importance to Alestra includes the strong, stable revenue stream from the AT&T traffic which currently makes-up approximately one-third of Alestra's total revenues. Also Alestra uses the AT&T brand name and receives operational support in developing the network, marketing and business management. Especially since the development of domestic traffic has been difficult and the regulatory environment has been challenging, we consider the AT&T contribution to be a critical stabilizing element for Alestra.
While the Alestra business plan has been well conceived, the results to date have been disappointing largely due to factors outside the company's control. Telecommunication regulations required fees to be paid to Telmex for interconnection and to subsidize local service, which has made competing economically difficult. However, in September 1998, regulatory posture began to change to be more supportive of competition. This has included reductions in certain fees and subsidies. While we are optimistic that the current regulatory trends will continue, we recognize that current efforts are new and there are long-standing interests who benefit by protecting Telmex' market position.
Alestra has been subject to very high customer churn and bad debt over the past year and, along with the industry, has taken appropriate measures to address these issues. Moody's recognizes that a fair amount of this is due to the early stage of deregulation in Mexico. We recall that similar issues occurred in the US in the 1980's. The industry has joined together to protect against unauthorized customer switching (slamming) and to track bad-debt customers, which should have a positive effect on future results. Still we expect that Alestra will continue to face considerable competition from Telmex. Regulators will need to be diligent to enforce fair, competitive business practices.
Although Alestra's results to date clearly have fallen short of their expectations, the equity owners have responded with support, including additional cash injections. Financially, the company has a good capital structure balance which is approximately 35% equity (pro forma this transaction). We expect positive cash flow (EBITDA) starting in the second quarter of 1999. However, we project that in a stable regulatory and economic scenario it will take four years for the debt-to-EBITDA ratio to reach five-times. Obviously by factoring economic and regulatory volatility into the projection, deleveraging takes longer to develop.
Alestra, based in Monterray, Mexico, owns its own network and is a provider of domestic and international long distance telecommunications services in Mexico.
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