Rating Action Overview

• Our ratings on Voyage Australia Pty Ltd. (Voyage), the company bidding for Australia-based telecommunications provider Vocus Group Ltd., reflect the group's growing market position in the enterprise and government segment, infrastructure and service offering, cash flow generation, and credible deleveraging path. The company's smaller size and scale compared to industry peers, competitive markets, low margin retail division, and leveraged capital structure constrain the ratings.
• Voyage intends to issue A$2 billion worth of secured term loan B (TLB) issuances to refinance its capital structure and partly fund its buyout by Macquarie Infrastructure and Real Assets (MIRA) and Aware Super (Aware), which we view as strategic owners of Vocus.
• On May 17, 2021, S&P Global Ratings assigned its preliminary 'BB-' long-term issuer credit rating to Voyage. We also assigned our preliminary 'BB-' long-term issue rating to the proposed TLB facilities issued by the company.
• The stable outlook reflects our expectation that the transaction will complete in its current form and that Vocus will grow its market position in the enterprise network services industry while limiting pressure on its balance sheet. We expect the company's S&P Global Ratings adjusted debt-to-EBITDA ratio to fall below 5.0x during fiscal 2022 and beyond.

Rating Action Rationale

The bid for Vocus via Voyage is a 50% joint venture between MIRA and Aware. Our preliminary rating assumes that the transaction will complete in its current form. Should shareholders approve the scheme of arrangement, the implementation date is expected to be in mid-to-late July 2021. We refer to Voyage and Vocus interchangeably for the purposes of our forward-looking analysis.

We view the Vocus Network Services (VNS) division as core to the group's growth prospects. Driven by increasing data and bandwidth consumption, connectivity, and security, we assess that the VNS division delivers the highest margins amongst the group (about 36%) compared with both the retail (about 11%) and New Zealand (about 19%) divisions. In our view, VNS is well-positioned to grow its market share through value-added adjacent services including public cloud, cybersecurity, and collaboration services.

Vocus is Australia's fourth-largest telecommunications provider. That said, we view Vocus as materially smaller in scale compared to major industry peers: Telstra Corp. Ltd. (A-/Stable/A-2); Singtel Optus Pty Ltd. (A-/Negative/A-2); and TPG Telecom Ltd. (unrated). Unlike its major competitors, Vocus is not a mobile network operator, which we believe presents both opportunities and challenges as the Australian telecommunications landscape evolves.

Vocus' quality network infrastructure is complemented by NBN Co.'s decision to make available its last-mile wholesale access network to enterprise resellers. This somewhat offsets the scale disadvantages and capital intensity of deploying fiber infrastructure. Although margins are likely to be modest, it should allow smaller-scale operators to more effectively compete in the enterprise market, which Telstra has traditionally dominated. Moreover, we believe Vocus can enhance its margins by providing value-added adjacent services and leveraging its existing infrastructure assets.

Vocus' enterprise business benefits from a good degree of revenue and earnings visibility. Stable churn levels and recurring contracted revenues typically ranging between two and five years provide good earnings visibility. Nevertheless, we view the enterprise business as competitive with potentially lumpy contract exposures. In addition, the undifferentiated nature of certain wholesale fiber services requires the group to offer value-added customer solutions to support its overall profitability.

In our view, VNS' exposure to sticky enterprise and government contracts underpins its competitive advantage. The largest of the group's enterprise and government clients (about 46% of VNS revenues) are government agencies, followed by clients across the resources sector, communications, banking, manufacturing, and healthcare, with no single client contract contributing to more than 5% of group revenues. We view government contracts as more sticky given security clearances, approvals, and minimum performance standards. In addition, we believe the group's exposure to more volatile resource end-markets is prudently managed. The company's wholesale and international (W&I, about 50% of VNS revenues) clientele includes internet service providers, managed service providers, and domestic and international carriers.

The company operates a sizable intercapital, metro, and regional fiber network.  We view this infrastructure as providing stable returns, albeit with margins that reflect a degree of infrastructure competition and undifferentiated service offering. Moreover, we believe NBN Co.'s recent indication that it might overbuild instead of sourcing dark fiber from private operators could place some incremental pressure on margins, should it occur. The company has two subsea cables (totaling 6,720 kilometers): ASC, which connects Australia, Singapore, and Indonesia; and NWCS, between Port Hedland and Darwin, which links offshore oil and gas facilities in the Timor Sea. The company has a track record of large infrastructure contracts related to high-capacity, subsea cables for regions that rely on remote connectivity and communication.

Management has made steady progress in simplifying its legacy cost structure and operational complexity of various business systems. This includes the consolidation of networks, business support systems, billing systems, and enhancing service efficiency through digitization. That said, we believe further improvements are to be made over the next two to three years with cost-savings associated with digital enablement, network rationalization, and the company's continued Future State network site rollouts and migrations.

The company's smaller scale, modest market share, and low-margin retail division weigh on its business risk. Vocus faces pressure from larger and better-capitalized competitors with formidable fixed and mobile network infrastructure, affording them the ability to offer a broader array of products and services. In addition, we believe that large scale competitors have the balance sheet capacity to lower prices in response to competitive threats. That said, we note that industry peers are heavily focused on building out their 5G mobile product offerings, while Vocus remains focused on growing its wholesale, enterprise, and government network services business. We believe Vocus' smaller scale is somewhat offset by a greater degree of agility, as evidenced by an outsized share of recent enterprise contract wins.

Vocus' retail segment is exposed to intense competition, adverse NBN reseller charges, as well as secular declines associated with legacy, fixed voice revenues. Vocus' retail business is likely to remain a relatively low-margin business (about 11%). However, we believe Vocus' retail division enables value-added opportunities for the broader group. Further, management has focused on stabilizing the division's revenue decline and has implemented cost reduction initiatives. In our opinion, Vocus is likely to undertake a strategic review of the retail segment at some stage following completion.

Further, we view industry consolidation amongst Vocus' customer base remains somewhat of an earnings risk. Larger players that acquire smaller operators (such as NBN resellers) could affect Vocus' existing contracts, cash flows, and network utilization rates if customers consolidate their network requirements or shift data traffic to alternative networks. That said, we believe a substantial part of the consolidation has already occurred and Vocus can manage this risk appropriately with renewals in the enterprise and government market.

Vocus is seeking to issue a A$1.85 billion first-lien TLB facility and a A$150 million delayed draw TLB facility over the coming months. The company also has a A$150 million senior secured revolving credit facility that will rank pari passu with the proposed TLB facilities. Any foreign currency amounts, such as U.S. dollars or euros, raised under the TLB facility will be issued by Vocus and swapped into Australian dollars. The issue rating is based on the proposed terms and conditions of the facilities.

We view MIRA and Aware as strategic owners with long-term investment horizons and a patient approach to capital.  Macquarie Infrastructure and Real Assets and its managed funds (MIRA) and Aware Super Pty Ltd. as a trustee of Aware have entered into a scheme implementation deed with the Vocus group to acquire 100% of the share capital of Vocus for a purchase consideration of A$4.6 billion, with a combined equity contribution of A$2.75 billion. We do not anticipate either owner will pursue shareholder returns until a greater degree of scale and market position is attained.

We believe the company has a credible deleveraging strategy over the next two to three years.  We expect Vocus' S&P Global Ratings adjusted debt-to-EBITDA to start at about 5.0x at transaction close, before deleveraging below 5.0x during fiscal 2022 and beyond. We anticipate the company will reduce leverage primarily through EBITDA growth via improving gross margins in its VNS business and decreasing operating costs through the implementation of its Future State cost-out initiatives.

Further, we forecast the company will generate positive free operating cash flows that it will likely reinvest into its core VNS business. We expect the company's capital expenditure (capex) to remain at about 11% of revenues with investment in enterprise network capabilities. That said, noting the owner's growth aspirations, it is possible that limited amounts of free operating cash flow could be generated. Under a scenario where growth capex is higher than base case expectations, we would still expect a deleveraging path, albeit one biased toward earnings growth rather than reductions in absolute debt. Either way, we do not anticipate material negative free operating cash flow for any prolonged period.

Vocus' large infrastructure projects could result in lumpy cash generation. This could add to some cash flow volatility depending on the pattern of contract wins. We note that the company has meaningful deferred revenue balances as a result of the upfront receipts from fiber payments that are capitalized, and expensed when infrastructure is deployed.

Outlook

The stable outlook reflects our expectation that the transaction will complete in its current form and that the company will increase its market position in the enterprise network services industry while limiting pressure on its balance sheet. We expect Vocus' S&P Global Ratings adjusted debt-to-EBITDA ratio to deleverage and sustain below 5.0x during fiscal 2022 and beyond.

Downside scenario

We could lower the rating if we expect Vocus to sustain debt to EBITDA above 5.0x either as a result of debt-funded growth or weaker than expected earnings.

Upside scenario

We consider an upward rating action as unlikely in the near term. However, we may raise the rating if we believe the group can sustain its debt to EBITDA less than 4.0x and we consider its shareholders' financial policies supportive of an improved financial risk profile.

Company Description

The bid for Vocus via Voyage is a 50% joint venture between MIRA and Aware. Vocus was founded in 2008.

Vocus is the fourth-largest full-service telecommunications provider by revenue in Australia and New Zealand. VNS provides network connectivity, data centers, cloud platforms, security, and workplace collaboration to enterprise, wholesale, and government clients.

Vocus also owns and operates a sizable intercapital fiber network (15,020km) and metro and regional fiber (9,500km) in all major Australian cities. Vocus operates an extensive fiber network in New Zealand, providing network connectivity, broadband, voice, energy, and mobile access across business, government, wholesale, and consumer markets, with 4,200km of intercapital fiber. Vocus' retail division is primarily a reseller of broadband, mobile, voice, and energy products.

Vocus reported revenues of about A$1.8 billion and EBITDA of about A$382 million in fiscal 2020.

Our Base-Case Scenario

• Australia real GDP growth of 4% in 2021, 3.3% in 2022, and 2.6% in 2023. New Zealand real GDP growth of 4.2% in 2021, 3.0% in 2022, and 2.9% in 2023.
• Single-digit revenue growth in fiscals 2021, 2022, and 2023 driven by VNS revenue growth from incremental market share gains across enterprise and government and W&I as well as increased demand for network connectivity, partially offset by declining retail division revenues.
• Group EBITDA margins forecast in the low-20% range over the next three years supported by cost-saving initiatives, partially offset by retail division margin pressure.
• Capex between 9% to 11% of revenues at approximately A$168 million in fiscal 2021, A$211 million in fiscal 2022, and about A$195 million in fiscal 2023.
• Subscriber acquisition costs: To enhance comparability among telecom operators, we adjust reported financial statements when a telco capitalizes subscriber acquisition costs.
• We treat all cash as accessible and available for debt repayment.
• No dividend distribution to shareholders.
• No material debt-financed acquisitions.

Based on these assumptions, we arrive at the following adjusted credit measures for fiscals 2022 and 2023:

• Adjusted debt-to-EBITDA ratio starting at about 5.0x, before deleveraging below 5.0x during fiscal 2022 and beyond;
• Ratio of funds from operations (FFO)-to-debt between 15% and 18%;
• EBITDA interest coverage of more than 4.5x; and
• Positive ratio of free operating cash flow to debt.

Liquidity

We assess Vocus' liquidity as adequate, reflecting our expectation that the company's liquidity sources will cover its uses by at least 1.2x over the 12 months ending June 30, 2022. We expect net sources and uses of liquidity to remain positive even if EBITDA were to decline 15%. Vocus holds bank facilities and maintains solid relationships with major domestic and international banks. Vocus' debt issuance into the TLB markets is the first issuance for the group.

Post recapitalization, we expect Vocus to have the following sources and uses of liquidity for the 12 months ended June 30, 2022:

Principal liquidity sources:

• S&P Global Ratings' assumed pro forma cash balance of about A$50 million;
• An undrawn A$150 million revolving credit facility; and
• Our forecast adjusted cash FFO of between A$260 million and A$310 million.

Principal liquidity uses:

• Annual debt amortization of about A$20 million a year;
• Modest working capital outflows;
• Capex of between A$170 million and A$250 million; and
• No distributions to shareholders.

Covenants

Compliance expectations

The revolving credit facility has a springing maximum first-lien leverage ratio covenant of 7.55x that comes into effect when the facility is 40% drawn. We expect Vocus to maintain adequate covenant headroom. The proposed term loans have no maintenance covenants.

Issue Ratings - Recovery Analysis

Key analytical factors

The preliminary 'BB-' issue ratings on Vocus' proposed A$1,850 million TLB facilities and A$150 million first-lien (TLB) delayed-draw facilities are in line with the issuer credit rating on the company. The '3' recovery rating reflects our expectation of meaningful recovery prospects (55%) should a payment default event occur.

At the time of hypothetical default, we expect adverse competitive industry conditions to cause steep declines in demand for Vocus' services with multiple contract cancellations. As a result, Vocus' revenue significantly declines, impairing its ability to meet its cash interest payments. In this hypothetical scenario, we believe Vocus' ability to meet its financial obligations would be impaired. We assume that the hypothetical default scenario would occur in 2025.

We value the company as a going concern because we believe that following a payment default, the company is likely to be reorganized due to the longer-term value in its established brands, extensive network scale, and recurring revenue business model with multiyear contracts. We have applied a 6.0x valuation multiple to an estimated distressed emergence EBITDA of around A$209 million to estimate a gross enterprise value of about A$1,252 million. The net enterprise value after administrative costs is about A$1,189 million.

Simulated default assumptions

• Simulated year of default: 2025
• Jurisdiction: Australia
• EBITDA at emergence: A$209 million
• EBITDA multiple: 6.0x
• Gross enterprise value: A$1,252 million

Simplified waterfall

• Net enterprise value at emergence (after 5% administrative costs): about A$1,189 million
• Estimated secured first-lien claims (revolving facility [85% drawn] including prepetition interest): approximately A$2,125 million
• Recovery expectations: 50%-70% (rounded estimate: 55%)
• Recovery rating: '3'

*All debt amounts include six months of prepetition interest.

Ratings Score Snapshot

Issuer Credit Rating: BB-(prelim)/Stable/--

Business risk: Fair

• Country risk: Very Low
• Industry risk: Intermediate
• Competitive position: Fair

Financial risk: Aggressive

• Cash flow/Leverage: Aggressive

Anchor: bb-

Modifiers:

• Diversification/Portfolio effect: Neutral (No impact)
• Capital structure: Neutral (No impact)
• Liquidity: Adequate (No impact)
• Financial policy: Neutral (No impact)
• Management and governance: Satisfactory (No impact)
• Comparable rating analysis: Neutral (No impact)

Stand-alone credit profile: bb-

Issuer credit rating: bb-

Related Criteria

• General Criteria: Group Rating Methodology, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers, Dec. 7, 2016
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• Criteria | Corporates | Industrials: Key Credit Factors For The Telecommunications And Cable Industry, June 22, 2014
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Ratings List