Fitch Ratings has revised India based Shyam Telecom Limited's (STL) outlook to Negative from Stable while affirming its National Long Term rating at 'Fitch BBB (ind)'. A list of additional rating actions is provided at the end of this commentary.

The Outlook revision reflects Fitch's expectation of an adverse and indirect impact on STL's business of the recent cancellation of telecom licenses of Sistema Shyam TeleServices Limited (SSTL, an associate company of STL) in 21 telecom circles (all except Rajasthan circle).

STL's financial performance is tied to SSTL's operational performance; hence, any operational setback to the SSTL could lead to a negative impact on STL's financial performance. In FY12 (year end March), STL generated 89% of its revenue and 84% operating profits by selling code division multiple access (CDMA) mobile devices to SSTL's subscribers through a dealer network.

In case, SSTL fails to win back most of these cancelled licenses, STL's revenue and profit will fall down significantly. However, some comfort is drawn from STL's established dealer network, which can be leveraged to quickly launch new products in the market.

The ratings factor in the company's strong financial performance in FY12. Revenue increased 17.6% yoy to INR7,966m and EBITDA margins to 1.4% (FY11: 0.7%). Net financial leverage (adjusted net debt to EBITDA) improved to 1.1x (2.7x) and EBITDA net interest coverage to 5.4x (2.4x).

Fitch also notes that the company has low working capital requirements, mainly because of the long credit period offered by its suppliers. The ratings also factors in STL's comfortable liquidity position, as reflected by the moderate utilisation of its working capital facilities and continued support from founders through interest bearing unsecured loans.

The ratings are, however, constrained by STL's low margins, its presence in a highly competitive Indian mobile handset market, and the overcrowded nature of the local handset trading business. The latter can lead to margin erosion or lower than expected sales.

Negative rating guidelines include a significant scaling down of SSTL's operations affecting STL's profitability and/or deterioration of the latter's net financial leverage above 4.0x on a sustained basis.

Conversely, the Outlook will be revised back to Stable on continuation of SSTL's operations at a reasonable scale or successful implementation of an alternate business strategy by STL to reduce risk emanating from its complete dependence on SSTL leading to net financial leverage below 4.0x on a sustained basis.

Incorporated in 1992, STL has changed its product mix several times in past years, which included radio frequency (RF) equipment and other telecom equipment. It derives most of its revenue from the trading of CDMA devices for SSTL and the rest from manufacturing RF products for domestic and export purposes.