MARC has affirmed its rating on Celcom Networks Sdn Bhd's (CNSB) (formerly known as Celcom Transmission (M) Sdn Bhd) RM5.0 billion Sukuk Murabahah Programme at AAAIS with a stable outlook.

CNSB is the owner of Celcom Axiata Berhad Group's (Celcom Group) network assets and serves primarily as a network service provider to parent company Celcom and fellow subsidiary Celcom Mobile Sdn Bhd (CMSB).

The rating reflects the credit strength of consolidated entity Celcom Group, premised on the strong intra-group support and significant financial and operational links between CNSB, Celcom and CMSB. MARC's support assessment is also underpinned by a letter of support from Celcom which commits the holding company to hold directly or indirectly a 100% equity interest in CNSB throughout the sukuk tenure. While the letter of support does not constitute a legally enforceable guarantee, it is nonetheless viewed by MARC as a strong indication of support by Celcom.

The affirmed rating and outlook are underpinned by Celcom Group's strong operating cash flow (CFO) generation capability, steady operating track record and its strong competitive position within the domestic wireless market. Celcom Group's market strength continues to be supported by its mobile network quality in terms of coverage and capacity. Somewhat moderating these strengths are (i) the high reliance on Celcom Group's upstream dividend payments at Axiata Group Berhad (Axiata), Celcom's parent, to fund the latter's regional expansions, (ii) its rather aggressive consolidated capital structure and (iii) intense competition in the mobile communications business which poses downside risks to its operating margins.

With 2012 revenues at RM7.65 billion, Celcom is the second largest player in the domestic mobile market.  Celcom has further consolidated its position as the market leader in the wireless broadband segment with positive growth in its subscriber base achieved in part by offering low monthly usage commitment plans. MARC notes that Celcom's subscriber base of 12.7 million is catching up with market leader Maxis Communications Berhad's 12.9 million revenue generating subscriber base as at end-2012. To sustain its market position and to accommodate the rapid growth of mobile data traffic, Celcom Group has been spending approximately RM800 million annually to upgrade its network infrastructure in the past two years. Celcom Group's ability to monetise the data traffic will be an important driver of its longer-term revenue growth. Celcom also has strategic partnerships with six mobile virtual network operators and DiGi Telecommunications Sdn Bhd and is planning to commence its home broadband service in the second half of 2013 in collaboration with Telekom Malaysia Berhad. In the near term, Celcom Group is likely to sustain its revenue streams and counter narrowing margins through continuous expansion of its voice, SMS and data traffic, introduction of new services and product bundles, and implementation of cost optimisation measures.

Celcom Group's financial performance measures continue to be consistent with the affirmed rating. In 2012, Celcom Group posted higher pre-tax profit of RM2.32 billion on revenue of RM7.65 billion compared to pre-tax profit and revenue of RM2.18 billion and RM7.14 billion respectively in 2011. Celcom Group added 701,000 subscribers to its subscriber base, ahead of the competition. As a result of the group's aggressive customer acquisition drive in 2012, Celcom managed to increase its revenue in spite of the termination of its domestic roaming arrangement with U Mobile Sdn Bhd (U Mobile) in September 2012. While the termination of service with U Mobile impacted average revenue per user (ARPU) which fell from RM51 in 3Q2012 to RM49 in 4Q2012, the overall financial impact on Celcom Group's consolidated financial performance was modest. U Mobile only contributes 2% of the group's revenue. The steep discounts offered on mobile phones resulted in a slight narrowing of the group's operating profit margin, combined with higher staff costs in 2012.

While Celcom Group's financial performance continued to be characterised by strong profitability and cash flow generation, its shareholders' funds and free cash flow turned negative after upstreaming dividends of RM3.09 billion to Axiata during the year. The negative consolidated shareholders' funds of RM644.1 million is attributed to the elimination of an intercompany gain from a sale of network assets to CNSB in 2010. The transaction had enabled Celcom to upstream high levels of dividends. Nonetheless, the stable outlook on the rating factors in expectation that Celcom's free operating cash flow generation for 2013 will be positive and the absence of large upstream dividend payments to Axiata in the near-term will assist the group to restore its cash flow protection and leverage metrics to levels more appropriate to its rating. Celcom's debt service capacity as measured by its CFO debt coverage of 0.67 times (2011: 0.49 times) remains strong.

Downward rating pressure could surface from a reduction in CNSB's strategic importance to Celcom Group which would warrant a change in its rating to reflect reduced intra-group support, increased exposure to parent credit risk which may require the rating to be brought more in line with Axiata's, and/or a material deterioration in Celcom Group's consolidated financial metrics.

Contacts: Koh Shu Yunn, +603-2082 2243/ shuyunn@marc.com.my; David Lee, +603-2082 2255/ david@marc.com.my.

August 28, 2013