Fitch Affirms Russia's T2 RTK at 'B+'; Outlook Stable
The ratings reflect significant increase in capex and consequently the pressure on free cash flow, resulting in limited leverage headroom over the next two years. The company is undertaking an ambitious expansion project rolling out operations in new regions as well as upgrading its existing networks to 3G and 4G. T2R is a successful discounter mobile operator in Russia with a lean and efficient business model.
KEY RATING DRIVERS
T2R is actively building 3G and 4G networks and launching operations in new regions, including Moscow, taking advantage of its nationwide spectrum portfolio after the merger with Rostelecom's mobile assets in 2014. As of end-October 2015 the company has launched 3G/4G networks in 56 regions of Russia.
Modernisation of networks should lead to increasing consumption of data and translate into higher average revenue per user (ARPU). The company's strong track record in launching operations in new regions adds credibility to its plans. However, the large scale of new geographic expansion, especially into the highly competitive Moscow market, presents significant operating challenges and execution risks, in our view.
The upcoming launch of commercial operations in Moscow at end-October 2015 is an important milestone in the company's development. The Moscow mobile market had more than 40 million subscribers and 216.4% penetration rate as of end-1H15 and is the most lucrative region in Russia where mobile network operators (MNOs) generate a large share of their EBITDA. The market has the highest penetration of smartphones among Russian regions and ARPU is notably higher in Moscow compared with the rest of Russia.
T2R's entry into Moscow will be challenging due to strong competition, customers' high expectations for quality services and fairly low brand recognition. The company has only 3G and 4G networks in Moscow, which means that 2G-only handsets will not supported. This will likely constrain subscriber acquisition as 2G voice-only customers who are usually more sensitive to pricing and thus more likely to switch to discounter operator will not be able to use T2R.
The substantial investments will put pressure on free cash flows and leverage in 2015-2017. We expect leverage to peak in 2015 and gradually reduce in the following years driven by EBITDA growth and falling capex. Reported net debt/EBITDA and funds from operations (FFO) adjusted net leverage ratios are likely to be higher than 3.5x and 4.5x, respectively, during the peak capex years of 2015 and 2016.
EBITDA and FFO will be under pressure from substantial roll-out development costs that cannot be capitalised under IFRS accounting conventions. Fitch recognises that analytically these may be viewed as one-off exceptional expenses. New regions' development will be synergetic for the existing operations, which Fitch views as sustainable and generating stable cash flow. Temporary spikes in leverage above the downgrade rating guidelines caused by rapid development may be accommodated within the current ratings provided that they are accompanied by positive operating trends, substantial network coverage improvements and a return to normal leverage levels within 24 months.
Forex Risk Addressed
T2R's exposure to foreign currency risks is mostly attributed to capex. The company hedges forex-denominated capex on a regular basis, limiting its exposure to increase in equipment prices related to rouble devaluation. The purchases of equipment in large amounts for the ongoing rollout of 3G/4G networks allow the company to attain discounts from equipment vendors which partially mitigates the impact of price increase for forex-denominated network equipment.
MVNO with Rostelecom
Rostelecom plans to create a mobile virtual network operator (MVNO) using T2R's mobile networks. Fitch believes that T2R will benefit from this form of cooperation with the shareholder operator as it will receive additional revenue from networks' rent while the threat of intensifying competition is limited. Rostelecom intends to offer mobile services only as part of its bundled offerings, which include fixed telephony, internet and pay TV.
T2R's development programme is financed predominantly by its shareholding banks VTB and Bank Rossiya. Fitch understands from the company that the shareholders fully support the company's development ambitions and are ready to provide funding when needed. More than 60% of company's debt consisted of loans from VTB and Bank Rossiya as of end-2Q15.
- Revenue growth in high-single/low-double digits in 2016-2018, driven by increasing mobile data usage and entry into the Moscow market
- Underlying EBITDA margin (excluding development spend) at 32% in 2015 and 2016, increasing to 34% in 2017
- Gradual increase of subscriber market share in Moscow to 10% in 2019 from an estimated 2.5% in 2016
- Capital expenditure in line with the company's guidance of 44% of revenues in 2015 and falling to 26%-28% in 2016-2018
- No material M&A
- No dividends paid
Negative: Future developments that may result in negative rating action:
- Failure to reduce FFO-adjusted net leverage, on a sustained basis, to 4.5x by end-2017 (2014: 4.8x) which roughly corresponds to net debt/EBITDA of 3.5x (2014: 2.9x).
- Significant weakness in cash flow generation driven by operating underperformance and insufficient growth from the expansion programme in Moscow and 3G/4G rollout in regions.
- An evidence of weakening funding support from shareholding banks.
Positive: Future developments that may result in positive rating action:
-Successful operating development and leverage stabilising at below 4x FFO adjusted net leverage and 3x net debt/EBITDA on a sustained basis.
T2R's share of short-term debt, including capital leases, in total debt was around RUB51bn at end-2Q15. The major part of this debt consists of loans from shareholding banks, which will likely be refinanced by the same banks or extended. The refinancing of RUB19bn bonds with put option in the next 12 months with loans from VTB and Bank Rossiya is also likely.
FULL LIST OF RATING ACTIONS
LLC T2 RTK Holding
Long-term IDR: affirmed at 'B+', Outlook Stable
National Long-term Rating: affirmed at 'A(rus)', Outlook Stable
Bonds issued by OJSC Saint-Petersburg Telecom and recourse to T2R through an irrevocable undertaking: affirmed at 'B+'/A(rus)'/Recovery Rating 'RR4'