December 21, 2017 / 1:40 PM / a year ago

Fitch Affirms Kazakhtelecom at 'BB+'; Outlook Stable

(The following statement was released by the rating agency) MOSCOW, December 21 (Fitch) Fitch Ratings has affirmed Kazakhtelecom JSC's (Kaztel) Long-Term Issuer Default Rating (IDR) at 'BB+'. The Outlook on the IDR is Stable. A full list of rating actions is available at the end of this commentary. Fitch raised the downgrade threshold to 2.5x funds from operations (FFO) adjusted net leverage, from 2x, after Kazakhtelecom repaid the US dollar-linked debt instrument in 4Q17, removing a currency mismatch between revenue and debt. All the outstanding debt is now in Kazakh tenge. Kaztel is a strong fixed-line incumbent with dominant market shares in traditional telephony and fixed-line broadband services, operating in a benign regulatory environment. The company created a mobile joint venture with Tele2 that had an about 26% subscriber market share by end-1H17 and is on track to improve its profitability due to larger scale and post-integration synergies. Kaztel's funds from operations (FFO) adjusted net leverage is low, and unlikely to spike above 2x on the expected acquisition of Tele2's stake in the mobile joint venture in 2019. KEY RATING DRIVERS Strong Incumbent Positions: Fitch expects Kaztel to maintain its leading position in the fixed-line segment, helped by benign regulation and a shortage of alternative networks. Kaztel estimated its fixed-line telephony market share by revenue at a dominant 93% at end-2016. The company consistently retains above 70% market share in fixed-line broadband (75% by subscribers at end-2016), where it generates almost half of its total revenue. It also has a strong position in the pay TV market with a 36% revenue share, although this is smaller than in other fixed-line segments. Nevertheless, this segment has the highest growth rates, supporting overall revenue growth. Broadband Market: Kazakhstan's broadband market was fully restored in revenue terms in 2016 after a sharp decline by 11% yoy in 2014. The market is approaching saturation and revenue growth rates are likely to slow to low single digits yoy from 2017 from mid-single digits in 2014-2016. Fixed-line broadband penetration remains low at 9.2% of households at end-2016, which leaves upside for growth. Competition is concentrated in large cities where there are several facilities-based operators. It remains rational, as indicated by companies' ability to selectively increase prices without a material impact on their market shares. Strong Performance in Mobile: Kaztel's mobile JV with Tele2 had strong performance in 9M17, with its subscriber market share reaching 26% in 2Q17, up from 25% at end-2016. Competition in the Kazakhstan mobile market has intensified in recent years and has been affected by the disruptive behaviour of Beeline and Tele2/Altel JV, driven by their attempts to increase market shares. However, the market has largely stabilised in 2017, as shown by the removal of promotional unlimited offerings and selective increases in prices that support ARPUs. Altel and Tele2 continue to operate as separate brands, with the former targeting premium and home mobile-broadband niches and the latter remaining a discounter. The JV benefits from its leadership in 4G coverage and vast distribution network. We expect the JV's operating and financial performance to improve further as the company starts benefiting from larger scale and integration synergies. Reduced Forex Exposure: Kaztel repaid KZT27 billion of US dollar-linked notes in 4Q17, fully removing debt exposure to currency risks. The removal of forex mismatch between debt and EBITDA drives our decision to relax our downgrade threshold to 2.5x FFO adjusted net leverage from 2.0x. Low Leverage, Strong Cash Flow: Fitch expects Kaztel's leverage to be 0.4x FFO adjusted net leverage by end-2017 (2016: 0.9x) and decline further in 2018.The company is likely to continue accumulating cash on its balance sheet in order to have money for the acquisition of full control in the mobile joint venture in 2019, when we expect Tele2 to execute its put option. The company's deleveraging is supported by strong free cash flow (FCF) generation combined with moderate dividends. The company decreased the amount of guarantees it provides to its mobile JV to KZT17 billion from KZT24 billion in 2017, which also has a positive impact on Fitch-defined total debt. Some Restricted Cash: We treat a portion of company's cash as restricted. We believe that the access to cash held at low-rated domestic banks remains uncertain and therefore we only treat cash placed with banks rated 'BB-' and above as available for debt service, with all other cash treated as restricted and excluded from net leverage metric calculations. Nevertheless, the company has been able to use some of its significant cash holdings with the low-rated banks. Further progress with accessing this cash would be treated as positive event risk. Weak Parent-Subsidiary Links: Kaztel's ratings reflect the company's standalone credit profile. Kaztel is of only limited strategic importance for Kazakhstan, while operating and legal ties with its controlling shareholder, the government-controlled Samruk-Kazyna, are weak. Indirect government control is a positive credit factor, but it does not justify a rating uplift, in our view. Kaztel appeared in the government's shortlist for the privatisation and may be sold to a strategic investor. The change in the controlling shareholder may have an impact on Kaztel's ratings subject to the outcome of parent-subsidiary linkage analysis. DERIVATION SUMMARY Kaztel's ratings are driven by the company's strong market positions in key fixed-line segments, robust FCF generation, low leverage and a benign regulatory environment. Its peer group includes Russian fixed-line incumbent Rostelecom PJSC (BBB-/Stable), mobile operators PJSC Mobile TeleSystems (BB+/Rating Watch Negative) and PJSC Megafon (BB+/Stable), and PJSC Tattelecom (BB/Stable), a regional incumbent in the Republic of Tatarstan. Other close EMEA peers are Turk Telekomunikasyon A.S. (BBB-/Negative) and Turkcell Iletisim Hizmetleri A.S. (BBB-/Negative). Kaztel is rated lower than other CIS and EMEA incumbents due to its smaller scale and a weak domestic financial market resulting in a lack of liquidity diversification. Kaztel is also rated higher than the largest Kazakhstan mobile operator Kcell JSC (BB/Stable). KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Kaztel include the following: - largely flat revenues in fixed-line in 2017-2020; - EBITDA margin at 35%-36% in 2017-2018 declining to 32%-33% in 2019-2020 due to consolidation of less profitable mobile joint venture; - capex intensity ratio at 15%-16% in 2017-2020; - KZT17 billion of guarantees to mobile JV treated as Kazakhtelecom's debt; - moderate dividend payments at KZT4 billion-7 billion a year in 2017-2020; - purchase of the remaining stake in the mobile JV in 2019. RATING SENSITIVITIES Future Developments that May, Individually or Collectively, Lead to Positive Rating Action - Successful integration with the mobile segment. This is unlikely before 2019, when Fitch expects Kaztel to take full control over its mobile joint venture with Tele2 - Maintaining sufficient liquidity diversified between external and internal sources - Consistently strong FCF generation with pre-dividend FCF margin in mid to high single digits Future Developments that May, Individually or Collectively, Lead to Negative Rating Action - A protracted rise in FFO-adjusted net leverage to above 2.5x (end-2016: 0.9x) - A material increase in refinancing risks driven by insufficient liquidity - Operating underperformance and significant market share erosion including in the mobile segment LIQUIDITY Strong Liquidity: Kaztel's liquidity is supported by a large amount of cash holdings and deposits in banks (KZT99 billion at end-3Q17). Fitch believes the availability of these funds may be constrained by the quality of some banks and therefore treats cash held in banks with ratings at or below 'B+' and unrated banks as restricted. We expect Kaztel to generate robust FCF, which is likely to accumulate on the company's balance sheet ahead of the potential execution of a put option related to the mobile joint venture. The company does not face any substantial debt maturities in 2018. Therefore we consider overall liquidity as strong. FULL LIST OF RATING ACTIONS Kazakhtelecom JSC Long-Term Foreign and Local IDRs: affirmed at 'BB+', Outlook Stable Short-Term Foreign Currency IDR: affirmed at 'B' National Long-Term Rating: affirmed at 'AA-(kaz), Outlook Stable Senior unsecured debt: affirmed at 'BB+' Senior unsecured debt in local currency: affirmed at 'AA-(kaz)' Contact: Principal Analyst Irina Andrievskaya Associate Director +44 20 3530 1715 Supervisory Analyst Slava Bunkov Director +7 495 956 9931 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chairperson Damien Chew, CFA Senior Director +44 20 3530 1424 Summary of Financial Statement Adjustments Balance-sheet cash and deposits held in banks rated 'B+' and below are treated as restricted. Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email:; Adrian Simpson, London, Tel: +44 203 530 1010, Email: Additional information is available on For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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