The credit rating agencies are frequently charged with taking rating action too late; for example, downgrading the debt rating of a company that the market has long since spotted is in difficulties, and whose bonds are already traded at junk yields. Sometimes, the rating agencies remain optimistic, and their optimism proves unjustified. Will that be the case with Partner Communications Ltd. (Nasdaq: PTNR; TASE: PTNR)?
The telecommunications company, controlled by Haim Saban, recently announced its intention of raising NIS 326 million through an expansion of existing bond series. Partner will use the proceeds of the offering to recycle existing debt and for regular operations. Standard & Poor's Maalot rated the offering ilA+, a rating awarded to Partner in 2015 (after a downgrade from ilAA-) and maintained since then. There is no doubt that the maintenance of this high rating despite Partner's financial position raises questions.
In the first quarter of this year, Partner switched to a negative free cash flow, the culmination of a long and continuous trend of erosion of its cash flow since 2012, when the Israeli mobile telephony market was opened up to genuine competition and a price war started. Close scrutiny of the rating report raises a reasonable suspicion that Maalot's analysts don't really appreciate the depth of the crisis in the sector and the true position of the companies operating in it.
Free cash flow is a significant measure for gauging the financial strength of a company and its ability to meet its debt repayments. It represents one of the main factors in determining a company's credit rating. Free cash flow can be used in a variety of ways, such as paying a dividend, acquiring companies, or repaying debt. In Partner's case, free cash flow is chiefly important for reducing its current debt, which at the end of the first quarter amounted to NIS 977 million.
The rating report states: "The company's free cash flow (an adjusted figure that Maalot calculates as part of its rating, consisting of current cash flow after capital investments) totaled NIS 635 million in 2017, compared with NIS 870 million in 2016. We estimate that the trend of erosion will continue, and that the company will report free cash flow of NIS 300-500 million in the next two years."
Maalot's analysts choose to cite the level of free cash flow in 2016 and 2017, but for some reason ignore the level in 2018. In that year, Partner's adjusted free cash flow was just NIS 124 million, representing erosion of 80%. It appears that the reason for ignoring 2018 is that the current rating is actually based on a rating report that Maalot issued in August 2018, and Maalot refers investors to it. At that time, there were no data on cash flow for 2018, but the data are now available to investors but are not referred to in the current report.
In addition, Maalot ignores the most significant black flag - in the first quarter of this year, the company recorded a negative cash flow of NIS 11 million, following negative cash flow of NIS 22 million in the fourth quarter of 2018 (one of the reasons for this could be the company's investment in fiber optics). The trend of erosion is sharp and clear. It is not clear how Maalot reached the conclusion that the erosion would stop and that Partner's cash flow would revive substantially in the coming quarters, and soar to NIS 300-500 million. How from a negative cash flow in the past two quarters do we jump to a cash flow of millions of shekels, when competition in the market is only growing more fierce?
Maalot does state that if Partner's liquidity profile weakens, there may be negative rating action, but it is sufficiently clear that the current profile is already significantly weaker than Maalot describes it as being. Meanwhile, Maalot says that the rating outlook is stable. An A- rating means that the rating agency believes that the borrower's ability to meet its financial obligations in relation to its debt, in comparison with other borrowers, is still good, if less so than at a higher rating. It must be said that yields on Partner's bonds - a debt of NIS 1.4 billion - are not high (1.3-3.3%), and it seems that, like Maalot, the capital market does not see a crisis.
It will be recalled that the Ministry of Communications recently set up a work group to monitor closely the position of the mobile companies and to deal with the crisis that would follow the collapse of one of them. The coming quarters will reveal who is right; whether there will indeed be a recovery in results, or whether investors will feel the pain of the horror scenario of the collapse of a telecommunications carrier in Israel.
S&P Maalot stated in response: "Maalot routinely monitors all ratings, and updates them as necessary."
Published by Globes, Israel business news - en.globes.co.il - on July 4, 2019
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