August 31, 2017 / 12:35 PM / in a year

Fitch Affirms Wind Tre at 'B+'/Stable Outlook, Upgrades Junior Debt

(The following statement was released by the rating agency) LONDON, August 31 (Fitch) Fitch Ratings has affirmed Wind Tre S.p.A.'s Issuer Default Rating (IDR) at 'B+' with a Stable Outlook (Wind Tre, the company resulted from the merger of previously rated Wind Telecomunicazioni S.p.A and H3G S.p.A.). Fitch has simultaneously affirmed Wind Tre's senior secured debt at 'BB'/'RR2'. The company's junior debt was upgraded to 'B+'/'RR4' on stronger expected post-merger recoveries. The company has an improved market position after the merger, but Iliad's entry creates some uncertainty while expected spectrum payments over the next two years could limit deleveraging efforts. A full list of rating actions is at the end of this commentary. KEY RATING DRIVERS Market Stabilisation: The Italian mobile market has stabilised in the last twelve months which has had a positive impact on all players, including Wind Tre. Market mobile service revenue grew by 1% yoy on average in each quarter during this period. Price competition is abating, with some operators starting to slightly increase tariffs, though often doing so with increased data allowances. The company's predecessors Wind and H3G were the most aggressive operators. We anticipate Wind Tre is likely to focus on their integration rather than further price-disruptive behaviour. Iliad Entry Creates Uncertainty: However, this stability may be challenged by the forthcoming arrival of Illiad - this newcomer is expected to launch operations at end-2017/early 2018. Illiad's entry is unlikely to be overly disruptive as the company faces a number of hindrances, but some impact is inevitable. We believe Wind Tre may lose approximately 15% of its mobile service revenues over the next three years under a reasonably conservative scenario. This loss is likely to be partially compensated by wholesale roaming revenue from Iliad. Iliad is targeting taking up to 10% of the Italian mobile market. We believe low-ARPU customers of Wind Tre are at most risk, as Iliad is likely to focus on the price-sensitive customer segment. Italian mobile tariffs are already among the lowest in Europe, and therefore room for further price declines is limited, in our view. Iliad is also lacking a wide retail distribution platform which may impede its growth plans. These factors mitigate the risk of a disruptive impact of Iliad's market entry, but do not completely rule it out. Spectrum Weighs on Cash Flow: Spectrum payments will be a drag on the company's cash flow in the short to medium term, mitigating deleveraging efforts. The Italian government was reported to be looking to raise EUR1.8 billion from the 900 MHz and 1800MHz spectrum renewal (the current license expires on 30 June 2018). Wind Tre is expected to pay an approximately EUR440 million renewal fee, which is likely to increase its leverage by 0.2x, by our estimates. On top of this, 5G spectrum investment is likely in the short to medium term, with an EU-wide deadline for 700MHz spectrum allocation set for mid-2020. Synergies Impact Delayed: Wind Tre's EBITDA growth over the next two years will be helped by significant post-merger synergies. The company is targeting EUR700 million of run-rate synergies, of which 90% is planned to be achieved by 2019. However, the positive impact on cash flows will be dampened by substantial restructuring expenses, which the management estimated at at least EUR600 million over 2017-2018. We therefore project that the company's cash flow may only show a notable improvement in 2019. Leverage: We expect Wind Tre's leverage to remain high at slightly above 5x FFO adjusted net leverage in 2017-2018 (it was 5.1x at end-2016). Deleveraging should primarily be driven by modest EBITDA growth on the back of post-merger synergies, the positive contribution from the roaming agreement with Illiad, and the receipt of EUR450 million from the spectrum sale that was agreed in 2016, but for which proceeds are expected to be received over 2017-2019. These positives will probably be offset by substantial restructuring costs, spectrum investments and continuing high capex as the company is seeking to improve its network quality. We believe the largest threat to deleveraging comes from renewed market pressures after Iliad's entry and higher-than-expected 5G spectrum costs. Debt Structure After Merger: We understand Wind Tre, as a successor company to Wind Telecomunicazioni S.p.A (Wind), became the guarantor of debt issued by finco Wind Acquisition Finance S.A. and previously guaranteed by Wind. The existing bond documentation states that the successor company assumes all the obligations of Wind in terms of the guarantee, priority agreement and security. Following the merger of all operating companies into Wind Tre, secured bondholders benefit from a wider collateral base enhanced by contributions from Hutchison's H3G. Junior debt holders benefit from stronger expected recoveries in view of larger post-merger EBITDA. DERIVATION SUMMARY Wind Tre, as a single-country operator, benefits from relatively large scale and well-established operating positions in Italy. It has larger revenue and subscriber market shares than Swiss-based Sunrise Communications Holding S.A. (BB+/Stable) or Polish P4 Sp. z.o.o. (BB-/Stable). However, Wind Tre is significantly more leveraged than its peers which justifies a multi-notch difference in ratings, while high interest payments on a large amount of debt consume more than a quarter of EBITDA, putting pressure on FCF generation. Roughly equally sized and mobile-only Telefonica Deutschland Holding AG is rated 'BBB'/Positive' in view of its exceptionally low leverage, strong pre-dividend free cash flow and the lack of significant market pressure. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Wind Tre include the following: -Iliad's market entry in early 2018 resulting in mobile revenue pressures of up to mid-single-digit percentages yoy in 2018-2020; - flat to low-single-digit percentage positive fixed-line revenue dynamics; - Post-merger EBITDA synergies growing to EUR375 million by 2019; - EUR600 million of integration costs spread over 2017-2019; - spectrum renewal payment in 2017; - 5G spectrum investment in 2018 assuming that Wind Tre takes approximately one-third of auctioned frequencies, with the total auction proceeds expected in the range of EUR2.5 billion; - capex in line with the management guidance of EUR7 billion spread over six years. KEY RECOVERY RATING ASSUMPTIONS - The recovery analysis assumes that Wind would be considered a going concern in bankruptcy and that the company would be reorganised rather than liquidated. - We have assumed a 10% administrative claim - The going-concern EBITDA estimate of EUR2.15 billion reflects Fitch's view of a sustainable, post-reorganisation EBITDA level upon which we base the valuation of the company - The going-concern EBITDA is 15% below expected 2017 EBITDA, assuming likely operating challenges at the time of distress - An EV multiple of 5x is used to calculate a post-reorganisation valuation and reflects a mid-cycle multiple. RATING SENSITIVITIES Future developments that may individually or collectively lead to positive rating action include: - FFO adjusted net leverage sustainably below 4.8x driven by successful integration of Wind and H3G. 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. LIQUIDITY Adequate Liquidity: Wind Tre does not face any significant refinancing exposure before 2019 when EUR850 million 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 EUR400 million RCF with a maturity in November 2019. 5G spectrum investments will probably require additional financing, by our estimates. FULL LIST OF RATING ACTIONS Wind Tre S.p.A. Long-Term IDR: affirmed at 'B+'; Stable Outlook Short-Term IDR: affirmed at 'B' Senior credit facilities: affirmed at 'BB'/'RR2' Wind Acquisition Finance S.A. Senior secured fixed and floating-rate notes: affirmed at 'BB'/'RR2' Senior notes: upgraded to 'B+'/'RR4' from 'B'/'RR5' Contact: Principal Analyst Slava Bunkov Director +7 495 956 9931 Supervisory Analyst Nikolai Lukashevich, CFA Senior Director +7 495 956 9968 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chair Damien Chew, CFA Senior Director +44 20 3530 1424 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor must be disclosed (in bullet points). Analysts should refer to the relevant section of the Data Control Form and discuss and agree the proposed disclosure at the rating committee. This disclosure should appear after the analyst contact information. 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