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Rating action

Scope Ratings GmbH (Scope) has today placed Communication Technologies Kft‘s issuer rating of B+ and its senior unsecured debt rating of B+ under review for a possible downgrade.

Rating rationale

The rating action reflects, poor performance expected for 2023 and the uncertainty of the business plan for 2024 due to delays of purchase orders under the issuer’s most significant framework contract with the Hungarian police. Furthermore, the issuer’s expected Scope-adjusted debt/EBITDA soared due to revenues and EBITDA falling more than 70% in H1 2023 compared to H1 2022 which can potentially cause a financial covenant breach at YE 2023 (Scope-adjusted debt/EBITDA above 5x) resulting in debt acceleration of the senior unsecured bond.

On 3 August 2023, Communication Technologies announced to have signed¹ a much-expected tender process for HUF 27bn for electronic surveillance system for the Hungarian police over a period of 5 year, providing significant potential increase in revenues, and visibility, over the period. This framework contract makes close to 90% of the issuer’s revenue plan for 2024 and similar portion of its EBITDA which makes the business plan for 2024 uncertain, after delays in 2023.

Management has confirmed that the company has not yet recognised any revenue for equipment and maintenance for the Hungarian police as of end of December 2023, and uncertainty remains about when this will start in 2024. Scope notes that the equipment and service provided by Communication Technologies is unlikely to be replaced by another market participant or insourced by the police, while at the same time high governmental deficit in Hungary puts the size and timing of governmental orders at question.

This resulted in FY 2023 accounts, still to be finalized, potentially displaying a gross debt/EBITDA ratio closer (or perhaps above) 5x, for the second consecutive year (2022 depressed performance, including some one-off expenses, sent it already at 29.4x), which significantly increases the risk of a covenant breach, possibly triggering early repayment of the HUF 2bn bond.

Communication Technologies has announced also in November 2023 the acquisition of small newly established cybersecurity entity with no closed accounting year, Black Cell International² that is expected to result in an outflow that Scope estimate at around 10% of the value of the bond proceeds.

Liquidity, beyond the covenant issue, seems to be adequate for the time being with financial assets and cash of close to HUF 1.1bn as end of December 2023. Additionally, the issuer expects to replace HUF 540m cash deposit given to the police as performance guarantee with a bank guarantee resulting in partial release of the cash deposit. The liquidity assessment is based on management’s undertaking to delay any significant investment, including any substantial acquisition, until the Hungarian police contract starts generating cash flow.

Furthermore, Scope also notes some clarity and transparency issues related to quality and reliability of financial information received (improper financial disclosures, large differences between forecast and actual results and limited disclosure towards capital markets) together with key person risk that might result in a notching for governance issues (ESG factor: credit-negative governance factor).

One or more key drivers of the credit rating action are considered an ESG factor.

Under review placement

The issuer rating is under review for a possible downgrade. Scope will closely follow developments related to covenants, liquidity, development of purchase orders on recently closed contract, potential acquisitions and clarity and transparency, and aims to resolve the review as soon as possible, within three months at the latest or shortly after the publication of the audited financials for 2023 which is due latest by end of April 2023. Scope expects to obtain greater transparency via the provision by management of timely information on operations, liquidity, possible investments and timely preparation of the audited financials for 2023.

A downgrade of at least one notch might result from the company breaching the Scope-adjusted debt/EBITDA covenant of 5.0x in 2023 and/or inability to start generating cash flow form the contract with the police and/or weakening liquidity and/or in case concerns remain on clarity, on transparency or on quality of disclosures.

A rating confirmation could occur if the company is able to demonstrate that the police contract starts generating significant cash flow, the company has full compliance with all covenants, maintains adequate liquidity and follows a disciplined acquisition policy.

An upgrade is remote and would require an improved business risk profile and the company providing a strong visibility on improving credit metrics.

Scope highlights that Communication Technologies Kft.’s senior unsecured bonds (ISIN HU0000361324) issued under the Hungarian Central Bank’s bond scheme have accelerated repayment clauses requiring repayment of the nominal amount (HUF 2.0bn) of the issued bond and triggers cross default with any other bank debt if the rating deteriorates (two-year cure period for a B- rating, repayment within 10 days below B-), or if a financial covenant (debt/EBITDA as calculated by the rating agency cannot exceed 5.0x in two consecutive years) is breached or if any of the other covenants are breached (ie. change of control).
 
Rating driver references
1. 3 August 2023 press release signature police contract
2. 27 November press release Black Cell International acquisition

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for these Credit Ratings, (General Corporate Rating Methodology, 16 October 2023; European Business and Consumer Services Rating Methodology,15 January 2024), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.

Solicitation, key sources and quality of information 
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity, and Scope Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and the principal grounds on which the Credit Ratings are based. Following that review, the Credit Ratings were not amended before being issued.
 
Regulatory disclosures
These Credit Ratings and are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings are UK-endorsed.
Lead analyst: Jacques de Greling, Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings were first released by Scope Ratings on 19 January 2022. The Credit Ratings were last updated on 23 January 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings. 

Conditions of use/exclusion of liability
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