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Rating action

Scope Ratings GmbH (Scope) has today affirmed the B+ issuer rating of Communication Technologies Kft. (CT) and assigned a Stable Outlook. Concurrently, Scope has affirmed the B+ rating on senior unsecured debt. Consequently, the under-review status for a possible downgrade has been resolved.

The affirmation reflects the improved transparency on the company’s expected operating recovery and improvement of credit metrics, stemming from the execution of a large framework contract expected to be closed with the Hungarian Police Headquarters for electronic offender monitoring over the next few years as well as earnings contributions from integrated ventures such as Blackcell. Moreover, the affirmation reflects eased concerns about the company’s compliance with financial covenants and the provision of rating-relevant information.

The full list of rating actions and rated entities is at the end of this rating action release.

Key rating drivers

Business risk profile: B+ (unchanged). The business risk profile is supported by the company's good profitability, with an average EBITDA margin* of 33% and an average return on capital employed of 20% for the period from 2022 to 2024, with medium volatility. Although the company showed outlier EBITDA margins in 2022 and 2023 due to the delayed EU funds, the sale and service of equipment contracted in the Hungarian Police Headquarters tender is expected to start in H2 2024, leading to normalised EBITDA margins of around 30% for the forecast years.

The assessment continues to be hampered by the company's small size in a niche market, resulting in a small market share in the IT security market, and the company's low diversification. It is exposed to a single country and industry, coupled with high customer concentration. These aspects also negatively impact the company's moderate service strength, which is characterised by low churn rates and a high proportion of recurring revenues.

Financial risk profile: BB+ (revised from A-). Within Scope’s review of CT’s credit ratings, the agency has significantly lowered the assessment of its financial risk profile, thereby reflecting significant volatility in its credit metrics as a function of fluctuating EBITDA and the company’s general vulnerability to external market developments.

Following weak operating performance in 2022, the company's EBITDA recovered in 2023, thereby restoring leverage metrics (debt/EBITDA of 4.0x and FFO/debt of 22% in 2023) which have been compliant with the leverage-related covenant (debt/EBITDA should not exceed 5.0x for two years in a row). With anticipated improvements from significant cash inflows from the renewed contract with the Hungarian Police Headquarters which is expected to support operating cash flow starting in H2 2024 and other effects, such as expected cash contributions from the acquisition of UK-based IT-security company Blackcell group, Scope projects further improvement of leverage for 2024 (debt/EBITDA 2024 and FFO/debt of 3.0x and 25%). Consequently, Scope anticipates that the company should not be at risk breaching its leverage related covenant over the foreseeable future.

More negatively, Scope highlights the temporary strain from the company’s negative free operating cash flow, either due to weakened operating cash flow as in 2022 and 2023 or due to significant investment as in 2024. Such strain is expected to ease beyond 2024 only, when the return from investments and new contracts are expected to provide more room for deleveraging.

Despite the negative developments of leverage and cash flow cover, Scope flags the company’s retained position regarding interest coverage. Even in transitional years like 2022 and 2024, interest coverage – as measured by EBITDA/interest – remains robust at a level of more than 7.0x. Going forward, Scope expects solid coverage of annual interest payments of just about HUF 100m, which provides good comfort to the company’s credit profile.

Liquidity: adequate. Liquidity remains adequate, supported by the company’s limited exposure to maturing debt over the next two years. While no debt maturities require coverage in 2024, the HUF 2.0bn bond starts amortising in Jan 2025 with an amount of HUF 100m (5% of bond volume). Scope projects solid coverage, considering the low amount of refinancing needs and a sufficiently high cash buffer (>HUF 1.0bn expected at YE 2024) as well as positive free operating cash flow expected in 2025.

Scope highlights that CT’s senior unsecured bond issued under the Hungarian National Bank’s Bond Funding for Growth Scheme has a covenant requiring the accelerated repayment of the outstanding nominal debt amount (HUF 2.0bn) if the debt rating of the bond stays below B+ for more than two years (grace period) or drops below B- (accelerated repayment within 10 days). Such a development could adversely affect the company’s liquidity profile. The rating headroom to entering the grace period is zero notches. Moreover, Scope expects full compliance to the aforementioned leverage-related covenant over the next two years.

Supplementary rating drivers: credit-neutral. Overall, supplementary rating drivers are deemed credit-neutral. Despite the company’s small scale and concentration risks, Scope has not adjusted the issuer rating downwards for peer context as the standalone credit assessment is deemed appropriate in the B rating category. Nonetheless, Scope flags some concerns about governance, such as transparency and key person risk which could evolve as credit-risks (credit negative ESG factors). However, such risks, are sufficiently reflected in the assessment of the company’s standalone credit assessment, not requiring any additional rating adjustments.

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

Outlook and rating sensitivities

The Stable Outlook reflects Scope’s expectations that CT resumes growth of its operating business, bolstered by a solid execution of the core contract with the Hungarian Police Headquarters and smooth integration of acquired ventures. Such development is expected to ensure robust interest coverage of more than 7x and smooth refinancing.

The upside scenario for the ratings and Outlook is:

• Rating upside is deemed remote in light of the company’s small size and general vulnerability to unforeseen developments but could be considered once the company has grown significantly and reduced concentration risks with core customers

The downside scenarios for the ratings and Outlooks are (individually):

• Growth trajectory well below expectations, resulting in weakened credit metrics such as an EBITDA/interest coverage below 4.0x or debt/EBITDA moving to close to 5.0x
   
• Renewed concerns about covenant compliance

Debt rating

Scope has affirmed the B+ rating on senior unsecured debt, in line with the issuer rating. Scope projects an ‘average’ recovery for senior unsecured debt, i.e. the senior unsecured corporate bond, in a hypothetical default scenario in 2025 and therefore aligns the debt rating with the issuer rating.

Environmental, social and governance (ESG) factors

Scope flags some concerns about governance, such as transparency and key person risk which could evolve as credit-risks. While Scope acknowledges that the company has recently improved regarding the provision of credit-relevant data and insight, the company remains less transparent than peer which is associated to its small size. Moreover, considerable key person risks exist given the importance of CT’s key personnel to negotiate contracts and to drive the development of the company.

All rating actions and rated entities

Communication Technologies Kft.

Issuer rating: B+/Stable, affirmation

Senior unsecured debt rating: B+, affirmation

*All credit metrics refer to Scope-adjusted figures.

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 and/or Outlook, (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.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

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 these 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/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings and/or Outlook were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Barna Gáspár, Director
Person responsible for approval of the Credit Ratings: Philipp Wass, Managing Director
The Credit Ratings/Outlook were first released by Scope Ratings on 19 January 2022. The Credit Ratings/Outlook were last updated on 22 January 2024.

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, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use/exclusion of liability
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