DEN Networks Limited: Ratings Upgraded; Rating Watch Removed

Posted by ICRA

The rating upgrade factors in the significant improvement in the credit profile of DEN Networks Limited (DEN) emanating from a favourable change in its ownership and infusion of significant equity funds, coupled with favourable regulatory developments in its key operative segment of cable TV. In H2 FY2019, Reliance Industries Limited (RIL; rated invested nearly Rs. 2,700 crore (both though primary infusion and secondary market) in DEN and acquired a controlling stake (78.62%) in the company. RIL’s equity infusion of Rs. 2,045 crore led to significant
improvement in DEN’s capitalisation and coverage indicators as on March 31, 2019, and significant unencumbered cash balances.

The acquisition provided RIL’s ambitious fibre-to-the-home (FTTH) expansion strategy a significant boost with
instant access to DEN’s 8-million plus digital subscribers1 and its established local cable operator (LCO) network for lastmile connectivity. The strategic importance of investing in DEN was evidenced by strong managerial oversight, with three of DEN’s eight directors being senior officials from RIL, along with integrated treasury operations. Over the medium term, ICRA expects DEN’s focus to be on broadband expansion under the tutelage of Reliance Jio and receive need-based technical and operational support from the latter. DEN is also expected to enjoy significant financial flexibility, as a subsidiary of RIL, which is critical given its significant capex plans and repayment obligations over the next three years.

The ratings also derive comfort from expected synergistic benefits to DEN from RIL’s large scale of operations2 and a presence across the digital and media value chain3. This would enable it to navigate the competitive pressure from other multiple system operators (MSOs), direct-to-home (DTH) and telecom players through access to funds for rapid expansion, latest technology and improved bargaining power against equipment vendors, content providers as well as enhanced financial flexibility.

ICRA continues to take cognisance of DEN’s status as one of the largest MSOs in India. While the company witnessed decline in operating performance during FY2019 over the previous fiscal, favourable regulatory change in the cable TV industry are expected to drive performance over the medium term. During H2 FY2019, the New Regulatory Framework for Broadcasting and Cable services, notified by the Telecom Regulatory Authority of India (TRAI), finally cleared major legal roadblocks and came into effect. Barring transitioning issues over a few quarters, the new tariff regime offers revenue stability and significant profitability improvement for MSOs as content cost becomes pass-through. The rating is, however, constrained by expectations of subdued profitability and return indicators over the medium term, given RIL’s extensive broadband expansion plans, notwithstanding the competitive pressures on segment’s average revenue per user (ARPU) from telecom players (wireless broadband). This is likely to result in significant cash burn till the time synergies of scale start flowing through. In the cable segment, while the new tariff regime is expected to be a positive, teething issues are expected to continue during implementation and continued competition among MSOs, DTH players and internet-based over-the-top (OTT) services for acquiring a subscriber base.

Going forward, the ability of the company to quickly transition its cable TV subscribers to the new tariff regime and
expand the presence and penetration of its broadband business, while generating remunerative ARPUs and maintaining a comfortable capital structure, shall be the key rating sensitivities.

Outlook: Stable

The Stable outlook reflects ICRA’s expectation that despite near term volatilities emanating from the pay TV industry
from tariff order implementation, DEN will continue to benefit from its established market position and financial
flexibility from its strong parentage. The outlook may be revised to Positive if sustainable growth in profitability aided by rapid transition into new regime and monetisation of its digital subscriber base improves its financial risk profile. The outlook may be revised to Negative if cash accruals are lower than expected, or if any major debt capital expenditure or stretch in working-capital cycle, weakens liquidity.

Key rating drivers

Credit strengths

Strong parentage and a strategically important investment for RIL – DEN became a 78.62% subsidiary of RIL in H2
FY2019. Besides share purchase from existing promoters and public shareholders, RIL infused fresh preferential equity of Rs. 2,045 crore into DEN. Given its large subscriber base and established LCO network, DEN is one of the key players in RIL’s wired broadband and FTTH expansion plans, as it offers the latter last mile connectivity. Its strategic importance to RIL is evidenced by upfront investment to acquire a controlling stake and strong operational linkages established through appointment of three representatives on DEN’s board, alignment of ground-level broadband expansion strategy and integration of treasury operations, among others.

Improvement in financial profile – The company’s credit profile is characterised by low gearing, strong debt servicing
indicators and robust liquidity position following significant equity infusion. Notwithstanding the year-on-year decline in operating revenues (6%) and operating profits (34.4%) in FY2019, the backing of strong promoter supports DEN’s financial flexibility, which is critical, given its extensive capex plans and repayments over the medium term. Given its strategic importance, ICRA expects DEN to receive need-based operational and financial support from its promoters.

Established market position in cable TV industry; implementation of TRAI tariff order offers significant potential –
With ̴8.0 million billed subscribers across more than 250 cities, DEN is one the largest MSOs in the country. In October 2018, the Hon’ble Supreme Court cleared the way for the implementation of the Telecommunication (Broadcasting and Cable) Services (Eight) (Addressable systems) Tariff Order, 2017 (TTO), a new framework for the pricing of television channels offered to subscribers to bring transparency into channel pricing as well as in interconnection agreements among the various participants (MSOs and LCOs). At present, TRAI has stipulated a cut-off date of March 31, 2019 to fully migrate to the new tariff structure. Following some transition relating issues, significant benefits are expected to start flowing through to distributors from H2 FY2020. With digitisation related capex almost at an end, content cost becoming a pass through and a relatively fixed annuity income (viz., network capacity fee or NCF), the profitability implications for MSOs are expected to be substantial.

Synergistic benefits as part of RIL’s bouquet of media and digital businesses – As part of the Reliance Group, DEN will have access to latest infrastructure platforms and technologies, linkages to broadcasting businesses for quality content and several possibilities of offering integrated services, viz., cable, broadband, voice, network solutions, etc. Since RIL has also acquired controlling stakes in other MSOs, such as Hathway Cable and Datacom Limited, and a dominant stake in GTPL Hathway Limited, the Group now has a cumulative digital subscriber base (cable and wired broadband) of over 25 million. This will provide benefits of scale to DEN while negotiating with equipment vendors, content providers and lenders for competitive rates, thereby positively impacting profitability.

Credit Challenges

High upfront investments in broadband business against gestation losses may keep profitability and ROCE subdued– The strategic investment in DEN has been in line with RIL’s intended fixed line broadband strategy (under Gigafibre) of reaching 50 million homes across 1,100 cities. ICRA expects that DEN would deploy the equity funds received towards broadband expansion with RJio’s oversight. Given the sizable upfront investments coupled with intense competition from telcos (wireless broadband) and other industry players, DEN is expected to incur cash losses till the time subscriber base and penetration levels adequately scale up. This would likely keep the overall profitability (cable plus broadband) and return on investments subdued in the interim.

Intense competition in cable TV business from DTH and alternative media platforms; partially mitigated through
presence in broadband segment – Despite consolidation in the industry, cable TV—DEN’s primary operative segment— will continue to face competition from large MSOs and alternative distribution technologies like DTH. This may impact DEN’s ability to increase its subscriber base or force it to offer significant discounts on NCF. In addition, the industry is increasingly facing competition from internet-based alternative media platforms like the OTT services. While implementation of tariff order is a positive for cable distributors, providing inter alia revenue stability, its timely and successful implementation remains a monitorable factor over the near to medium term. Notwithstanding the same, DEN having diversified into broadband, and now becoming part of RIL’s extensive media and digital ecosystem, provide comfort.

Liquidity position

DEN had outstanding term loans of Rs. 394 crore as on April 30, 2019, most of which is repayable over the next three years (FY2020-FY2022). In addition, it had working capital borrowings of Rs. 58 crore as on April 30, 2019. Against the same, it had unencumbered cash and liquid investments of nearly Rs. 2,100 crore, making it a net cash company. Additionally, the release of margin money of 15-20% against the term loans, indicated by the lenders, is expected to provide additional liquidity of Rs. 115-120 crore. The company has sanctioned fund-based bank lines of Rs. 105 crore, with an average utilisation of 56% in the 12 months leading up to September 2018, which provides adequate cushion for existing scale of business. ICRA derives significant comfort from the company’s strong parentage and its strategic importance to the RIL Group, which lends considerable financial flexibility towards meeting any funding mismatch. ICRA has not factored in any organic/inorganic expansion plans, which may require additional funding support.―BCS Bureau