OREANDA-NEWS. Fitch Ratings has affirmed Russia-based telecom company OAO MegaFon's (MegaFon) Long-term Issuer Default Rating (IDR) at 'BB+' with a Stable Outlook. A full list of rating actions is available at the end of this commentary.

OAO MegaFon's business and financial profile corresponds to the mid-'BBB' rating level, in view of the company's established market positions, strong free cash flow (FCF) generation and low leverage. This rating is then notched down twice for corporate governance issues - both country-wide and at MegaFon level.

KEY RATING DRIVERS

Strong Market Positions
MegaFon is the second-largest mobile operator in Russia by subscriber and revenue. The company has gradually increased its market share over the last five years. We believe that MegaFon's market positions are sustainable in the long run and the company will likely focus more on improving the monetisation of its subscriber base rather than on further subscriber acquisition. Historically, MegaFon has invested more than its peers, resulting in strong territorial coverage and quality network. Prior years' capex and the consequent high quality of its network should continue to help the company maintain its strong market position.

Growth to Slow Down
We estimate that MegaFon's revenue for 2015 will be largely flat, in line with the general market trend. Russian mobile market is mature with a penetration of 167% at end-1Q15 and further meaningful increase in the number of subscribers is unlikely. Growth in data consumption will likely remain a key driver of average revenue per user (ARPU) although it might be mitigated by intense competition and a weak economy.

Rational Competition
The Russian mobile market is competitive among the four national facilities-based mobile operators, driven primarily by marketing efforts and the quality of services rather than by prices. As a result, operators' ARPUs were stable or growing for the last five years.

The consolidation of Tele2 Russia's and Rostelecom's mobile assets (T2 RTK Holding) has only had a modest impact on the market so far. Competition is likely to intensify when the joint venture T2 RTK Holding rolls out its operations in Moscow in 2H15. However, the entry of the fourth operator to the Moscow market may be challenged by its low brand awareness, a competitive pricing environment and the high quality of existing networks.

Russia's Largest LTE Portfolio
MegaFon controls more spectrum than any other operator in Russia, which guarantees it a high data capacity for years to come. The company has the largest share in mobile data revenues, estimated at 37.5% in 2014. However, any strategic advantages of having more spectrum over peers may only be realised in the long-run as currently its mobile ARPU is close to main peers'. The currently available frequencies intended for LTE remain under-utilised in Russia, due to low LTE device proliferation.

Strong FCF Generation
MegaFon is likely to retain its ability to generate strong pre-dividend FCF with low double-digits margins. Increased inflation will put modest pressure on EBITDA but the margin will likely remain strong at above 40%, supported by cost efficiency measures.

The depreciation of the rouble weighs on Megafon's forex-denominated capex, although past heavy investments in the network mean the company can be flexible with future capex. In our view, Megafon's organic development and the current dividend policy of paying the higher of 50% of net income and 70% of cash flow may be financed from strong internally generated cash flow.

Moderate Leverage Sustainable
Funds from operations (FFO) adjusted net leverage was 1.9x at FYE14, which we expect to rise to 2.1-2.2x over the next four years, leaving comfortable headroom below the downgrade trigger of 3.0x. Our forecast leverage corresponds to a net debt/EBITDA of 1.2x-1.3x, within Megafon's target of 1.2x-1.5x. The expected rise in FFO adjusted net leverage in 2015 is driven mostly by inflation pressures on EBITDA and increased interest expenses.

Shareholding a Risk
Fitch views corporate governance at Megafon as average. This is reflected in Fitch's application of the standard two-notch discount for corporate governance weaknesses in Russia and at the issuer level, including major shareholder-related risk. While MegaFon has put in place appropriate board practices and internal controls key risks relate mainly to the potentially negative influence of MegaFon's majority shareholder, USM Holdings. The latter company is a non-transparent private holding company controlled by Alisher Usmanov.

KEY ASSUMPTIONS

-Largely stable revenue over the next four years
-Capital expenditures at 20% of revenue in 2016-2018
-Stable EBITDA margin above 40%
-Gradually rising interest payments as historically low interest debt is refinanced with more expensive debt
-Dividends at RUB40bn in 2015 and declining in 2016-2018, in line with current dividend policy
-No M&A

RATING SENSITIVITIES

Negative: Future developments that may individually or collectively lead to negative rating action include

- A sustained increase in FFO-adjusted net leverage to above 3x, which, combined with liquidity and refinancing risks, may lead to a downgrade.
- Competitive weaknesses and market share erosion, leading to significant deterioration in pre-dividend FCF generation.

Positive: Future developments that may individually or collectively lead to positive rating action include
- Stronger strategic positioning in the Russian market while maintaining robust financial performance and cash flow generation. This may be demonstrated by a pronounced mobile market leadership in spite of a fourth mobile operator entry and/or by a wider package offer of telecom services to most of its customer base, including wire-line broadband services. However, we believe both are remote prospects over the medium-term;
- A stronger ring-fence around MegaFon, protecting it from potential negative shareholder influence.

LIQUIDITY AND DEBT STRUCTURE

The company's RUB84bn of cash and equivalents at end-1Q15, combined with undrawn credit facilities (RUB27bn), comfortably cover its 2015-2016 debt repayments. The company's exposure to foreign currency is low with 75% of debt denominated in RUB (including through FX hedges) at end-1Q15. Forex risks are partially offset by the currency structure of its cash and deposits (more than 60% of cash, cash equivalents and short-term investments is in hard currencies). MegaFon's debt maturity profile is even with no annual repayments exceeding 25% of total debt at FYE14.

FULL LIST OF RATING ACTIONS

Long-term foreign currency IDR: affirmed at 'BB+', Outlook Stable
Long-term local currency IDR: affirmed at 'BB+', Outlook Stable
Short-term foreign currency IDR: affirmed at 'B'
National Long-term Rating: affirmed at 'AA(rus)', Outlook Stable
Senior unsecured rating: affirmed at 'BB+'/'AA(rus)
Bonds issued by MegaFon Finans LLC and guaranteed by MegaFon: affirmed at 'BB+'/ 'AA(rus)'