Alpha Circle Sdn Bhd - 2011

MARC has assigned ratings of AA-ID and AID with a stable outlook to Alpha Circle Sdn Bhd's (Alpha Circle) RM345.0 million Senior Musharakah Medium Term Notes (Senior MMTN) programme and RM35.0 million Junior MMTNs respectively.

The issuer, a wholly-owned subsidiary of NERS Sdn Bhd (NERS), will onlend the proceeds raised from the issuance of the notes to its parent for the purpose of refinancing existing indebtedness and to fund project-level capital expenditure and working capital requirements in respect of a long-term concession to supply and maintain the National Enforcement and Registration System (project). Accordingly, the notes are dependent on the credit profile of the project to service and repay the notes.

Under the privately financed public infrastructure (PFI) concession granted by the federal government, NERS is responsible for the design, supply and maintenance of a secured registration system for foreigners.

The focus of MARC's analysis is on key rating drivers of a PFI project in an operating phase. The rating agency notes the elimination of pre-operation commissioning risk with the completion of the project's first phase with the successful roll-out of the registration system. MARC's credit risk assessment also considers the concessionaire's exposure to volume risk; the project earns its revenue based on the number of foreign worker work permits issued by the Department of Immigration.

The assigned ratings reflect the adequacy of NERS' projected revenue stream to meet debt service and structural features of the financing which partly offsets the risks of lower-than-projected foreign worker registrations and the high initial leverage at Alpha Circle. The ratings also consider the credit strength of the Government of Malaysia as payer under the concession agreement, straightforward nature of operations and corresponding low to moderate performance risk, and average recovery prospects in the event of early termination of the concession.

The two-notch rating differential between the junior and senior notes reflects the junior notes' lower ranking in priority of payment and security.

Unlike PFI projects with availability-based revenue streams, NERS derives its revenue from monthly invoices issued to the government on the basis of work permits issued by the Department of Immigration, including extensions. The amounts paid to NERS do not represent a direct cost for the government in that the registration charges are passed on to foreign workers through the foreign worker levy. MARC considers the sensitivity of project revenue to a change in the number of registered foreign workers due to economic cyclical factors or a change in government policy on foreign labour employment as the project's chief risk.

Available data as of end-August 2011 places the number of registered legal and illegal foreign workers at 1.0 million and 1.3 million respectively, which NERS has taken as the basis for its assumption of 1.88 million work permits issued in Year 1 of its operations. MARC believes that the actual number of work permits issued could fall short of the base case projections and draws comfort from the project's ability to service its obligations under a downside scenario where the number of work permits issued to foreign workers is held constant at 1.88 million throughout the tenure of the notes. The rating agency's financial analysis incorporates the intermediate- to long-term risks associated with the government's stated intent to reduce Malaysia's dependence on low-skilled foreign workers which presently account for 63% of the total foreign workforce.

The cash flow waterfall under the issue structure requires a minimum monthly amount of RM3.75 million to be transferred into the Finance Service Account (FSA) from the Project Account during the first five years from the date of initial issuance. MARC views this as protection for noteholders in that priority in payment is given to building up the FSA ahead of operating expenses and dividend distributions. The rating agency considers this structural feature as an important risk mitigant given the project's high initial leverage. Paid-in capital and junior notes to be taken up by project sponsors collectively account for only 10% of the issuer's capitalisation.

MARC considers the operational risks of the project to be low to moderate in light of the project's low complexity, and the satisfactory support provided by NERS' key software and hardware suppliers. The aforementioned factors moderate risk posed by residual implementation risks associated with the project's second phase and longer term performance risk arising from the  project's limited, but thus far successful operating history.

The financial compensation that would be due to NERS under an early termination of the concession or expropriation scenario would be the net present value of foregone future cash flows which are estimated by applying an assumed growth rate to a base volume of annual foreign work permits issued in a year. MARC assesses the adequacy of financial compensation under an early termination or expropriation scenario as average based on its analysis of required minimum annual foreign worker permit volumes to pay down debt in full.

The revenue uncertainty posed by the project's short operating history limits its near-term upside rating potential. Should actual annual foreign worker permit volumes fall short of projections, downward rating pressure could develop. Conversely if actual annual foreign worker permit volumes meet or exceed projections, project cash flow coverage levels could increase upside rating potential.

Major Rating Factors

Strengths

• Receivables collection directly from Malaysian government;
• Project importance to Malaysian government’s foreign workforce registration policy; and
• Implementation risk mitigated as project has commenced operations.

Challenges/Risks

• Changes in Malaysian government policy on foreign labour employment;
• Susceptibility of foreign worker registrations to domestic economic conditions; and
• Operations and maintenance risks associated with data storage and retrieval of the project.