U.K. Fiber Infrastructure Services Provider euNetworks Assigned Preliminary #B# Outlook Stable

Stocks and Financial Services Press Releases Thursday November 30, 2017 18:54
PARIS--30 Nov--S&P Global Ratings

PARIS (S&P Global Ratings) Nov. 30, 2017--S&P Global Ratings today assigned its preliminary 'B' long-term corporate credit rating to U.K.-based fiber infrastructure services provider, Stonepeak Spear Newco (UK) Ltd. and its financing subsidiary euNetworks Holdings Ltd. (together, euNetworks). The outlook is stable.

At the same time, we assigned our 'B' preliminary issue rating to the proposed EUR300 million senior secured term loan B that will be borrowed by Stonepeak Spear UK Newco and subsequently pushed down to euNetworks Holdings Ltd. The preliminary recovery rating on the loan is '3', indicating our expectations of meaningful recovery (50%-70%; rounded estimate: 55%) in the event of a payment default.

The preliminary ratings are subject to the completion of the acquisition of euNetworks by Stonepeak Infrastructure Partners as presented to us, the successful issue of the proposed facilities, the repayment of existing debt, and our satisfactory review of the final documentation. Accordingly, the preliminary ratings should not be construed as evidence of final ratings. If S&P Global Ratings does not receive the final documentation within a reasonable time frame, or if the final documentation departs from the materials we have already reviewed, we reserve the right to withdraw or revise our ratings. Potential changes include, but are not limited to, the use of proceeds, interest rate, maturity, size, financial and other covenants, and the security and ranking of the senior secured term loan and revolving credit facility.

In our analysis, we factor in euNetworks' reported negative free operating cash flow (FOCF), owing to the group's significant upfront investment to deploy its fiber network and coverage, as a rating constraint. The negative FOCF is partly offset by temporarily high debt to EBITDA in 2017, adjusting for the envisaged leveraged buyout, that should decline subsequently on continued EBITDA growth. In our rating, we also incorporate our view of euNetworks' good, albeit niche, positioning in the fast-growing datacenter connectivity segment, its small size, and its largely fixed-cost base, offset somewhat by the group's competitive network and longstanding relationship with its demanding and quality-oriented customers.

A London-based, pan-European provider of low-latency and high-bandwidth infrastructure services, euNetworks focuses on providing high bandwidth solutions to clients in the financial services, communications, content, and media spaces through its network of about 1,900 kilometers (km) of metro-fiber and almost 19,000 km of long-haul fiber. The group derives approximately 80% of its revenues from high-margin focus products, including wavelengths, dark fiber, and to a lesser extent Ethernet. Colocation and Internet services generate most of the remaining 20%.

Our view of euNetworks' business is supported by the group's strategic focus and leading position in the fast growing European datacenter connectivity market, working with data-hungry large enterprises, carriers, and content/cloud providers. The group has a competitive network of both metro- and long-haul fiber routes that connect more than 300 datacenters in Europe, of which 92 are among the identified 102 main European datacenters. While the capillarity of its network, as measured by total kilometers covered, is not as broad as other competitors, euNetworks' routes leverage strategic locations and are characterized by a wider number of fibers per ducts that support large data and bandwidth transport capacity. Consequently, the group generates higher average revenues per route than peers and grows at above-market rates. Operations are fairly diversified by customer--with the top-15 customers generating less than 30% of annual revenues--and by region as the group expands in Europe. euNetworks' business model provides recurring revenues and a large contractual revenue backlog, thanks to multiyear contracts. This model translates into healthy profit margins, which are improving as revenues grow and further cover the fixed-cost base. Lastly, the group does not engage in speculative network developments. Rather, it focuses on growth from new customer contracts, although there is a lag between its upfront investment and its income profile, given that it focuses its business model on monthly recurring revenues.

These strengths are partly offset by euNetworks being a niche player, with single-digit overall market share. Moreover, it faces competition from larger and better capitalized companies that could upgrade and diversify their existing networks over time. We also see a risk that current customers might move their networks inhouse. The group's small size is a rating constraint. It generated about EUR125 million of revenues and almost EUR60 million of S&P Global Ratings-adjusted EBITDA in 2016. Loss of a key customer could materially change the group's revenue and profitability patterns, but we have not seen this happen to date. What's more, in line with the rest of the industry, euNetworks faces pressure on prices of data transport, although we understand this only happens at contract renewal and is usually offset by volume growth due to higher data traffic. Lastly, we think the group's contract length is on average shorter than some of its rated peers' offering similar solutions, partly as a result of its euTrade ultra low-latency business, which carries shorter contract lengths. Although we acknowledge that its contract renewal rate is high, euNetworks' revenue prospects could decline if it faced heightened competition.

Our view of euNetworks' financial risk is primarily constrained by its reported negative FOCF. Network deployment requires large upfront investments that are not matched by a similar revenue and cash generation profile, given that the group receives monthly recurring payments from customers. As a consequence, in our base case, we expect breakeven reported FOCF only by 2019, which prevents the group from deleveraging through voluntary debt amortization before that date. Moreover, we assess euNetworks' capital structure as highly leveraged due to adjusted leverage (debt to EBITDA) calculated at above 5.0x in 2017, adjusting for the envisaged leveraged buyout, and then decreasing to about 4.9x in 2018. An additional rating constraint is the group's currently ultimate ownership by private-equity firm Stonepeak Infrastructure Partners, which we consider a financial sponsor. Still, we view positively that a meaningful portion of the group's acquisition price has been financed with new equity from the sponsor. We also understand that the focus of both the sponsor and management is on network deployment and deleveraging.

The stable outlook on euNetworks reflects our view that increasing bandwidth demand for datacenter connectivity from large and data-hungry companies will support solid revenue growth of 10%-15% and sound adjusted EBITDA margin of about 50% over the next 12 months. These positives, however, are offset by our expectation of reported negative FOCF and adjusted leverage at about 5.0x.

We are likely to raise our rating on euNetworks if EBITDA growth results in higher absorption of capex, resulting in stronger credit metrics and a reduction in adjusted leverage. This would occur if FOCF to debt improves to about 3% and if adjusted leverage approaches 4.5x on a sustainable basis.

We could consider lowering our rating if the pace of euNetworks' revenue and EBITDA growth slowed or if liquidity markedly deteriorated. These events could occur amid increased competition that would accentuate pressure on prices, with volume growth not materializing or the group facing a loss of a major customer.


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