Fitch Ratings has downgraded Telefonica Moviles Chile S.A.'s (TMCH) Long-Term Foreign Currency Issuer Default Rating (IDR) and Local Currency IDR to 'BBB-' from 'BBB'.

In addition, Fitch has downgraded the senior unsecured bond of TMCH to 'BBB-' from 'BBB'. Fitch has also affirmed National Long-Term ratings and national senior issuances of TMCH and Telefonica Chile S.A. (TCH) at 'AA-(cl)'. Fitch has affirmed the short-term national rating of 'N1+(cl)' and equity rating of 'Primera Clase Nivel 4 (cl)' of TCH. The Rating Outlook is Stable.

The downgrade reflects a continuation of weak profitability and FCF, driven by a persistently difficult competitive environment in the telecom sector in Chile, that will make it challenging to reduce its net leverage from current elevated levels. The ratings also consider the group's leading market position and diversified service profile in the competitive Chilean telecom market.

Key Rating Drivers

Leverage Deterioration: TMCH's leverage continues to deteriorate, driven by reductions in EBITDA margins, higher connectivity service expenses in line with fiber optic growth and average revenue per user (ARPU) reductions. Fitch expects net leverage to remain elevated in 2023 at 3.1x (including the adjustment for receivables factoring) and show modest reductions going forward, derived from improvements in EBITDA margin, a reduction of capex intensity and minimal dividend distributions. Fitch expects the company's net leverage to show some improvements by 2025 but remain above 2.5x, consistent with a 'BBB-' rating. On a lease-adjusted basis, Fitch expects net leverage to be 4.1x in 2023 from 3.9x in 2022, trending toward 4.0x over the medium term.

Reduced Profitability: Despite the positive evolution of revenues with increases in the mid-single-digits in recent years, TMCH's Fitch-defined EBITDA margins fell to 15.9% in 2022 and 13.6% in the LTM ended June 2023 (from 20% in 2021). The 2021 sale of the company's 60% stake in Infraco pressured its EBITDA; opex expenses increased following the sale due to connectivity to Infraco's fiber optic network. Positively, this spinoff will imply capex reduction in fiber network deployment. Cost inflation and strong competition on pricing have caused margin contraction. Fitch expects a modest improvement in EBITDA margin in the medium term, due to quarterly inflation indexation in mobile and fixed tariffs along with some cost savings initiatives.

Challenging Mobile Environment: Fitch expects the mobile segment to grow modestly over the coming years as competition remains fierce in the four-player Chilean market. Mobile service revenues fell 1.1% in 2022. Fitch expects modest growth of 2.5% in 2023 due to the slight increase in customer base and growth in ARPU of approximately 2% from tariff adjustments to reflect high inflation and mix shift to postpaid from prepaid. While competitors WOM and Entel have made similar moves in inflation indexation, it remains unclear if Claro will follow suit as the operator has lost subscriber market share over the past two years.

Lower Capex Intensity and Dividends: TMCH's FCF should gradually improve due to decreasing capex levels, which Fitch expect to be around 11.5-13.0% over revenues for the 2023-2026 period (compared with 23% in 2021). This reduction is based on the end of a strong investment period in 5G network infrastructure committed in the bidding process and an expected reduction in fiber's expansion capex, now under Infraco's responsibility. Despite this, Fitch expects potential outflows of TCH to support part of Entel's fiber acquisition by Infraco (40% of TCH property) after approval by the antitrust authorities. In addition, Fitch expects the company to maintain a conservative dividend policy in the medium term.

Leading, Diversified Competitive Position: TMCH's diverse revenue streams offset its lack of geographic diversification, and it has solid market share in the fixed and mobile segments. TMCH is the second-largest mobile provider (26% of subscriber market share) and TCH is the largest broadband (32%) and second-largest pay TV (21%) provider in the country. Key competitors ENTEL (BBB/Stable) and WOM (B+/Negative) are focused on the mobile segment and VTR Finance N.V. (VTR; CCC-) is focused on the fixed segment. TCH has gained subscribers from VTR as customers in Chile continued to gravitate toward Movistar's faster and more reliable fiber broadband offering.

Broadband Drives Growth: Fixed-segment revenues have grown rapidly in recent years, driven by market share gains in broadband and pay-TV subscribers. Supported by its market-leading fiber broadband service offering, the company has surpassed VTR to become the industry leader in broadband internet. Furthermore, bundling offers and a strong IPTV product have allowed the company to grow its market share in pay-TV. While competition in fiber should increase as competitors expand their own fiber networks, Fitch anticipates that TCH will maintain its strong position in fixed telecom services. With broadband penetration in Chile still below the Organization for Economic Co-operation and Development (OECD) average, Fitch expects continued strong growth in broadband subscribers and revenue over the medium to long term.

Parent Subsidiary Linkages: TMCH and TCH have similar standalone credit profiles. Fitch equalizes the companies' ratings, given the shared operational and administrative functions, along with the material dividend remittances from TCH up to TMCH. The complementary nature of the companies' product portfolios further supports Fitch's assessment of strong strategic linkages. TCH and TMCH have weaker standalone credit profiles compared to their ultimate parent Telefonica SA (TEF; BBB/Stable). Fitch views legal, strategic, and operational incentives for support from TEF as low. TMCH and TEF are rated on a standalone basis, with no notching uplift from their ultimate parent.

TCH's Equity Rating: TCH's listed stock accounts for less than 1% of the company's equity. The rest is held by TMCH. The equity rating for TCH is Level 4(cl), given the low level of free float due to the majority stake ownership by TEF. This is mitigated by its solid solvency and long history in the Chilean stock market.

Derivation Summary

Compared with America Movil, S.A.B. de C.V. (AMX; A-/Positive), TMCH has a higher leverage profile. AMX's scale and geographic diversification are much higher than TMCH's, with a service footprint across Latin America, and AMX also maintains a stronger competitive position with market leadership in nearly all of its markets.

Compared with domestic competitors Empresa Nacional de Telecomunicaciones SA (ENTEL; BBB/Stable) and VTR Finance N.V. (CCC-), TMCH has stronger product diversification as the market leader in broadband internet and as the number two player in mobile, while ENTEL and VTR have a focus on mobile and fixed, respectively. TMCH also has similar leverage, although ENTEL demonstrates stronger margins and benefits from its geographic diversification into the Peruvian market and the larger scale of its combined operations. Compared with Chilean competitor WOM S.A (B+/Negative), TMCH has lower leverage, as well as greater scale and service diversification.

TMCH's leverage trend and FCF also compare favorably with sister companies Telefonica del Peru S.A.A. (BB-/Negative) and Colombia Telecomunicaciones S.A. E.S.P (BBB-/Negative). Fitch expects competition to remain high in each market, although higher GDP per capita in Chile contributes to a more sustainable market than in both Peru and Colombia. Telefonica del Peru has much weaker profitability than the other two.

Key Assumptions

Mobile subscribers remaining near 8.0 million as the company's post-paid penetration continues to increase; slight recovery of blended mobile ARPU (service + handsets) to CLP9.3 thousand and CLP9.5 thousand in FY2023 and 2024, respectively (compared with CLP9.2 thousand at FY 2022) due to the decision of quarterly indexation of inflation and gradual conversion from prepaid to postpaid, but constrained by continued strong competition

Fiber homes passed increasing to around 4.3 million by FY 2024, with take up rate (homes connected/homes passed) near 35%, while pay-tv and fixed voice decline

Overall revenues growing in the low-single digit level. Growth is mainly driven by slight gains in ARPU growth

EBITDA margins below historic averages, in the range of 14% to 15% in the 2023-2026 period;

Capex intensity declining to a range of 11.5-13% level over revenues. Potential impacts on outflow related to support of Entel's Fiber Network acquisition by Infraco.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Net leverage improving to levels below 2.5x;

Improving profitability and achieving sustainable positive FCF generation while maintaining the company's market position.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A deterioration in market position due to competition and/or regulation, resulting in persistent negative FCF generation and impossibility to return to net leverage of 3.5x or lease-adjusted net leverage of 4.5x in the medium term;

A higher degree of financial integration between the units of Telefonica HISPAM (Chile, Colombia, Mexico, Peru, etc.) could result in a ratings downgrade if it involved increased leverage or cash movements;

Excessive shareholder distributions, including from cash flow from operations or from additional asset sale proceeds being distributed to the parent company. Increase in capex intensity to levels materially exceeding Fitch expectations.

Liquidity and Debt Structure

Adequate Liquidity: Telefonica Moviles Chile's commitment to a conservative financial profile, Fitch's expectation of positive pre-dividend FCF generation, and FX hedging all support the company's strong liquidity and flexibility. As of June 30, 2023, the company had cash and equivalents of CLP133 billion against short-term debt of CLP470 billion (including CLP130 billion of factoring debt accounted as ST debt). Subsequent to 2Q23, TMCH has already refinanced 100% of its non-factoring obligations in 2023, through the use of a bank loan and a local bond issuance. In addition, lower dividends and a more conservative capex approach will allow the company to maintain solid financial flexibility and extend its relatively short amortization profile.

Issuer Profile

Telefonica Moviles Chile is an integrated Chilean telecommunications provider that operates mobile and fixed-line platforms under the Movistar brand. The company offers mobile voice, mobile data, broadband internet, pay TV, and digital services to consumers, businesses, and government clients. The company is owned by Telefonica S.A.

Summary of Financial Adjustments

Adjustments of hedge currency derivatives on financial debt;

Adjustments for leasing;

Adjustments of factoring.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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