Fitch Affirms Wind at 'B+', Outlook Stable, Upgrades Instrument Ratings
The rating actions reflect that the proposed merger of WIND and 3 Italia should result in an enlarged entity with a stronger operating profile and lower leverage. Greater scale from a higher mobile market share should improve the company's ability to compete. A 'BB-' rating for the merged entity is possible over the medium term as the integration process is completed and leverage falls. CK Hutchison Holdings Ltd. (A-/Stable), parent company of Italian mobile operator 3 Italia, and VimpelCom Ltd. (BB+/Stable), parent company of WIND, received regulatory clearance to form a 50/50 joint venture (JV) of their telecommunication businesses in Italy on 1 September 2016.
KEY RATING DRIVERS
Stronger Strategic Position in the Italian Market
A merger of WIND and 3 Italia will create a stronger operator in the Italian market. The new company will control slightly above one-third of the country's mobile subscribers and revenues, making it a closer peer for Vodafone (BBB+/Stable) and Telecom Italia (BBB-/Stable), both of which also have approximately one-third of the market.
The enlarged company is likely to significantly benefit from its larger scale. It will be able to increase the absolute size of its infrastructure capex, which would allow it to quicker patch the current gap in terms of LTE coverage and improve the quality of its network. It will be better positioned to compete in the corporate segment, the so far almost uncharted territory for both merging operators. Its larger size will also make it easier to absorb the financial impact of future spectrum investments, including potentially into 700 MHz frequencies that are likely to become available after 2020.
Unlikely Disruptive Impact Of New Operator
Iliad agreed to launch a new facilities-based operator in Italy, but is unlikely to become a fiercely disruptive player in this market, in our view. After years of intense pricing wars in Italy, the current mobile average revenues per user are already among the lowest in Europe, limiting the scope for further pricing pressure. The new operator will need to address issues of low brand recognition and the lack of own distribution platform. Its fixed-mobile bundling options will be limited as it will depend on fixed-line infrastructure providers for non-mobile service elements of its bundles. However, the visibility of Iliad's strategic plans in the Italian market remains low, which increases market risk for all operators.
The combination of WIND and 3 Italia should result in significant synergies, with a likely positive impact on margins over the next three years. With integration costs estimated at significantly below the targeted opex synergies run-rate, a positive impact on EBITDA generation is likely to be achieved in the next one to two years. In addition, management expects capex synergies of approximately EUR200m per year. However, their net impact on cash flow may be dwarfed by the intention to increase absolute capex spend to around EUR7bn in the coming years.
Management is targeting EUR700m of opex and capex savings per year (before tax and integration costs) with 30% relating to capex and 70% to opex, 90% of which should be realised by the third year after the deal closing.
Substantial Remedy Proceeds
The agreed merger remedies package will bring in substantial one-off proceeds and additional revenue for the use of the JV's infrastructure and roaming over the next three to five years. These proceeds will be a significant contributor to the JV's deleveraging.
Iliad has agreed to acquire a spectrum portfolio for EUR450m with payments phased across 2017-2019. It has also made an undertaking to acquire or lease a few thousand mobile towers for an undisclosed amount. Iliad has also entered into a renewable five-year roaming agreement for the use of the JV's network. Taking into account that proprietary infrastructure roll-out is likely to take time, the new operator will initially heavily depend on the JV to carry voice and data traffic, implying substantial additional revenues for the JV.
Loss of Parental Support
WIND'S ratings no longer reflect shareholder support from Vimpelcom as strategic incentives for support have significantly diminished. Vimpelcom's shareholder interest is being diluted to 50% and any decisions regarding WIND need to be coordinated with the other shareholder. JV will have a stronger operating and leverage profile than WIND standalone, and its creditworthiness is less sensitive to expectations of shareholder support.
We expect the JV's leverage to significantly improve after the merger, compared with WIND'S net debt/EBITDA of 5.9x and funds from operations (FFO) adjusted net leverage of 6.6x at end-2015. The enlarged operator will have a better deleveraging capacity primarily driven by the gradual realisation of its expected opex synergies. Targeted opex synergies in the range of EUR500m are equal to almost a quarter of combined Wind/3 Italia EBITDA in 2015. The JV is likely to have more stable free cash flow (FCF) generation than Wind on a standalone basis, with FCF margin forecast by Fitch in the low-single digit range.
We project that the JV's leverage may improve to approximately 4.5x net debt/EBITDA and FFO adjusted net leverage slightly above 5x by end-2017, assuming moderate lease payments by 3 Italia. The largest positive impact on leverage will be from 3 Italia's EBITDA, which will be contributed to the JV on a debt-free basis. Additionally, 3 Italia's shareholders have agreed to inject EUR200m of cash, which will reduce leverage by 0.1x. Expected spectrum divestment proceeds are equal to 0.2x of combined Wind/3Italia EBITDA. We expect that the enlarged operator would benefit from organic revenue stabilisation, with merger synergies leading progressively to EBITDA margin and cash flow improvement.
We forecast that the JV's leverage may improve to a level inside the threshold required for an upgrade by the end of 2019. Management has a long-term net debt/EBITDA target of 3.0x for the enlarged entity.
Debt Structure After Closing
WIND's instrument ratings have been upgraded reflecting the company's stronger IDR on a standalone basis, i. e. without parental support. We do not expect that the proposed merger will trigger any change of control clauses of WIND's debt, nor will bond holders' consent be required for WIND's debt to be transferred to the merged entity.
However, under the terms of the proposed merger, WIND's existing debt will not immediately benefit from any guarantees from the combined entity. Therefore, Fitch's recovery expectations for WIND's instruments only reflect assets that are owned by WIND. The approach to recovery calculations may change depending on the financial and legal integration of the two companies once the deal has closed. Management plans to merge all assets into a single legal entity shortly after the deal closes. In particular, we will examine how the company's legal structure is adjusted so that existing debt holders benefit from the entire cash flow of the enlarged entity, as well as the terms of the subordinated shareholder loans from the JV's holding company to the operating subsidiaries.
No Refinancing Exposure Before 2019
WIND does not face any significant refinancing exposure before 2019 when EUR700m of its debt becomes due. We expect the company to generate sufficient internal cash flow to finance its capex, with any liquidity gaps covered by undrawn EUR400m RCF with a maturity in 2019.
Fitch's key assumptions within the rating case for WIND include the following:
-Successful completion of the merger of WIND and 3 Italia
-Flat organic mobile revenue in 2017-2019
-Mid - to low-single digits revenue decline in fixed-line segment in 2016 and 2017 with stabilisation from 2018
-EBITDA margin in the range of 32-35% in 2017-2019
-No dividends in 2016 and 2017
-Zero profit tax in 2017-2019 on the back of tax loss carry-forward
-Capex of EUR1.4bn per year in 2017-2019
Positive: Future developments that may individually or collectively lead to positive rating action include:
- FFO adjusted net leverage sustainably below 4.8x, driven by the successful integration of WIND and 3 Italia.
Negative: Future developments that may individually or collectively lead to negative rating action include:
-A deterioration in leverage beyond FFO adjusted net leverage sustainably above 5.5x.
-Continuing operating and financial pressures leading to negative FCF generation.
FULL LIST OF RATING ACTIONS
Wind Telecomunicazioni S. p.A.
Long-Term IDR: affirmed at 'B+'; Stable Outlook
Short-Term IDR: affirmed at 'B'
Senior credit facilities: upgraded to 'BB'/'RR2' from 'BB-'/'RR2'
Wind Acquisition Finance S. A.
Senior secured fixed and floating 2020 notes: upgraded to 'BB'/'RR2' from 'BB-'/'RR2'
Senior unsecured 2021 notes: upgraded to 'B'/'RR5' from 'B-'/'RR5'