Scope Ratings (Scope) has today upgraded the issuer rating of Spanish-based Tecnocom, Telecomunicaciones y Energía, SA and consolidated companies (Tecnocom or the group) to BB+ from BB. The rating outlook remains Positive, thanks to Tecnocom’s planned acquisition by Indra Sistemas, SA (Indra; not rated by Scope).

The rating upgrade is primarily driven by the group’s strong deleveraging in 2016 (SaD/EBITDA 2016: 0.6x against 2.1x in 2015) and the prospects for further deleveraging, with the early cash-financed redemption of the EUR 35m MARF bond bolstered by further margin improvements and strong free cash flows. The rating, however, remains to some extent constrained by: the cyclicality of the group’s industry, information and communications technology (ICT); persisting high dependence on economic developments in its core market of Spain; and its limited corporate size.

Scope positively views a takeover by the leading Spanish-based ICT provider Indra, as this can reduce the major credit weaknesses of Tecnocom, such as limited outreach and diversification outside of Spain, without significantly harming the combined financial risk profile of the entity.

Key rating drivers

Tecnocom’s credit weaknesses expected to reduce with Indra takeover. Firstly, Scope notes that the combined business risk profile of Indra and Tecnocom is stronger than that of Tecnocom as a standalone entity. This is primarily due to i) the greater corporate size in terms of combined revenues and combined EBITDA, ii) the stronger exposure to more stable sectors such as governments, healthcare, and traffic/transport, which implies a large share of recurring income and resilience to economic cycles, iii) higher diversification outside of the Spanish market, and iv) the high likelihood of margin stabilisation with the integration of the complementary businesses, allowing for scaling effects and synergies.

Secondly, Scope believes that Indra’s acquisition of Tecnocom will not significantly harm the combined group’s financial risk profile. This is because Indra will i) integrate Tecnocom, which will almost be net cash at the time of the acquisition and ii) finance the takeover through cash and newly issued stock (combination of EUR 2.55 in cash and 0.1727 shares of newly issued Indra stock in exchange for each share of Tecnocom) without issuing new debt. From Scope’s perspective, the group’s combined leverage will be kept below 2.5x.

High industry-inherent risks partly offset by Tecnocom’s operating flexibility. Tecnocom’s rating is to some extent constrained by high industry-inherent risks, characterised by the early cyclical patterns of ICT services as well as medium entry barriers. Therefore, the group’s cash flows could be negatively impacted once the investment cycle of customers has peaked. However, Scope notes that Tecnocom’s robust profitability grants it the flexibility needed to address this potential issue by quickly adjusting its cost base, if required.

Strong position and long-lasting business relations in core market of Spain. Although Tecnocom is still a relatively small player in terms of revenue (EUR 411m in 2016), Scope regards its market position to be very solid. Ranking among the top-three ICT providers in Spain, the group benefits from its niche market position through its methods of payment processing for financial institutions. Scope highlights the group’s excellent outreach, not only to large blue-chip customers with a high credit quality (i.e. 22 of the IBEX 35 companies), but also to government authorities. Although the majority of service level agreements must be renegotiated and extended annually, besides some multi-annual agreements, Scope believes the group’s expertise and reputation result in a high portion of recurring business with major customers. According to estimates, over 80% of annual revenues come from these long-lasting relations, many of which span more than 10 years. This evidences not only Tecnocom’s quality of service and unique selling points particularly in payment processing, but also the high exit barriers for customers (it is difficult for customers to quickly switch ICT providers or migrate IT systems).

Full coverage of ICT services helps to improve outreach to end-markets. Scope positively views Tecnocom’s product portfolio, which encompasses the full spectrum of ICT products and services. This allows the group to address a wide range of industries, including banking and insurance. While Tecnocom has consistently had a high exposure to major financial institutions (51% of revenues in 2016), it has recently increased its footprint in other industries such as telecommunications, media and energy (21% of 2016 revenues), industrials (18%), and public authorities (10%).

High dependence on core market of Spain constitutes Tecnocom’s major credit weakness. Scope notes that Tecnocom lags behind its own plans regarding its continued diversification outside its core market of Spain. With 81% of 2016 revenues generated in Spain, the group remains vulnerable to shocks in the country’s economic recovery, particularly within its banking sector. An accelerated expansion into the Latin American market (14% of 2016 revenues) would therefore enhance its credit strength. Given the stronger growth potential of emerging markets in Latin America, Scope expects Tecnocom to reduce its dependence on Spain in the coming years. In light of the planned integration into Indra, which already generates about one-quarter of its revenues in Latin America, Scope believes Tecnocom can largely benefit from the cross-selling activities of the future group’s salesforce to accelerate its business outreach in this region.

Improving profitability bolstered by increased efficiency. Despite the ICT sector’s inherent cyclicality as well as pressures from competitors, Tecnocom’s EBITDA margin is regarded as robust. This is a result of the ‘capital light’ business model, which flexibly adjusts to projected demand. Bolstered by the group’s efforts regarding efficiency and the J-curve effect from new contracts, Tecnocom’s recurring EBITDA margin reached a new record of 7.4% in 2016 (up from 5.4% in 2015).

Strong improvement of key credit metrics. Scope highlights the strong improvement of Tecnocom’s financial risk profile over the past few years. The group has strongly deleveraged over the past few years, thanks to the group’s robust operating cash flows, comparatively low capex, and limited dividend distributions. Tecnocom’s leverage (measured as Scope-adjusted debt/EBITDA of 0.6x as of December 2016 against 2.1x at YE 2015) and EBITDA/interest coverage (6.9x in 2016 against 4.1x in 2015) fully justify the rating upgrade.

As the group has signalled the early redemption of its EUR 35m MARF bond in H1 2017 – two years ahead of its original maturity – with its cash buffers (EUR 58m at YE 2016), Scope expects Tecnocom’s financial risk profile to improve further, owing to the annual interest savings of about EUR 2.3m. For 2017, Scope expects Tecnocom’s leverage in terms of SaD/EBITDA to remain below 1.0x and its EBITDA/interest coverage to remain above 6.0x. Scope believes Tecnocom will become net cash by YE 2018 on a standalone basis.

Financial risks further mitigated by robust liquidity. Tecnocom’s liquidity measures are regarded to be strong over the next two years, even with the cash-financed redemption of the EUR 35m MARF issue. As liquidity ratios stand well above 200%, refinancing risks are, in Scope’s view, very limited. These levels are due to operating cash flows expected at above EUR 20m annually; access to undrawn – mostly rolling – credit and factoring lines of more than EUR 50m; and an unrestricted cash cushion of above EUR 20m at YE 2017. Consequently, Scope believes Tecnocom is in a comfortable position to redeem upcoming debt maturities in 2017 and 2018 (excluding rolling credit lines).

Outlook

The Positive Outlook reflects Scope’s expectations about the future parent-subsidiary relationship with Indra, whose creditworthiness is expected to be stronger than Tecnocom’s on a standalone basis.

A rating upgrade could be warranted if the takeover is executed as scheduled without significantly harming the combined financial risk profile of the combined group (SaD/EBITDA of the combined group remaining below 2.5x; EBITDA/interest coverage remaining above 6.0x).

The Positive Outlook could be lowered if Scope were to expect an increase for the combined group’s leverage (SaD/EBITDA) to above 3.0x on a sustainable basis.
 
Regulatory disclosures

Important information
Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013

Responsibility
The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Chief Executive Officer: Torsten Hinrichs, Dr Stefan Bund, Dr Sven Janssen.

Rating prepared by: Sebastian Zank, Lead Analyst

Rating committee responsible for approval of the rating: Olaf Tölke, Committee Chair

Rating history
Date | Rating action | Rating
24 March 2016 | Outlook change | BB Positive Outlook
24 March 2015 | Affirmation | BB Stable Outlook
24 March 2014 | Initial rating | BB Stable Outlook

The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.

Information on interests and conflicts of interest
The rating was prepared independently by Scope Ratings but for a fee based on a mandate of the rated entity. The issuer has participated in the rating process.
As at the time of the analysis, neither Scope Ratings AG nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings AG or any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of information for the rating
- Website of the rated entity
- Audited annual financial statements of the rated entity
- Interim financial statements of the rated entity
- Detailed information provided on request
- Data provided by external data providers
- External market reports
- Website of the Indra Sistemas SA
- Audited annual financial statements of Indra Sistemas SA
- Press reports/other public information

Scope Ratings considers the quality of the available information on the evaluated company to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.

Methodology
The methodology applicable for this rating (Corporate Rating Methodology) is available on www.scoperatings.com. The historical default rates of Scope Ratings can be viewed on the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.
Examination of the rating by the rated entity prior to publication
Prior to publication, the rated entity was given the opportunity to examine the rating and the rating drivers, including the principal grounds on which the credit rating or rating outlook is based. The rated entity was subsequently provided with at least one full working day, to point out any factual errors, or to appeal the rating decision and deliver additional material information. Following that examination, the rating was not modified.

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