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Fitch Assigns 'BB' IDR to Kcell; Outlook Stable
November 1, 2017 / 11:43 AM / 20 days ago

Fitch Assigns 'BB' IDR to Kcell; Outlook Stable

(The following statement was released by the rating agency) MOSCOW/LONDON, November 01 (Fitch) Fitch Ratings has assigned a Long-Term Issuer Default Rating (IDR) of 'BB' and a Kazakhstan National Long-Term Rating of 'A(kaz)' to Kcell JSC. The Outlooks are Stable. Kcell is the market-leading mobile-only operator in Kazakhstan. The company does not have a proprietary backbone network and lacks any broadband bundling options, which is a strategic weakness. Leverage is likely to remain moderate but higher than the company's public target of up to 0.9x net debt/EBITDA, driven by continuing 4G and backbone investments in the medium term. Kcell is majority controlled by Telia Company AB (A-/Stable); we expect this to change soon, in line with Telia's intention to divest its emerging-market assets in the near future. KEY RATING DRIVERS Leading Market Positions: Kcell is the leader in Kazakhstan's three-operator mobile market, with a subscriber market share of 39% at end-2016, within its targeted range. A rapid 4G roll-out after receiving 4G spectrum in 2016 and significant network investments will help protect its positions. The impact of mobile number portability is unlikely to be significantly negative. The company has only shed about 50,000 subscribers on a net basis, less than 1% of the total, since its introduction in January 2016. Intense But More Rational Competition: Competition in the Kazakh mobile market is likely to remain intense but more rational than in 2015-2016, after Kazakhtelecom's mobile subsidiary Altel and Tele2 merged their mobile assets into a joint venture at end-2015 operating under the Tele2 brand. The merger was between the two most disruptive companies in the market. The new enlarged operator is likely to be less aggressive. Tele2 is targeting further market share growth, but it already has about a quarter of the market by subscribers, and financial performance has become a greater priority. Less Pressure Ahead: We expect Kcell's revenues to be flat to modestly negative yoy due to more rational competition and improvements in macroeconomic sentiment. Kcell's competitors removed most aggressive all-inclusive unlimited pricing offers in early 2017, paving the way for less pricing disruption. Relatively low current tariffs do not leave much headroom for further undercutting as operators risk turning consistently free cash flow negative and never recouping their investments. Kcell's revenues and EBITDA were under severe stress in 2015-2016, with 2016 revenues lower by 22% compared with 2014 and adjusted EBITDA shedding 45% over this two-year period. The EBITDA margin fell to 39% in 2016 from 56% in 2014. Lack of Backbone: We view Kcell's lack of a proprietary backbone network and its over-reliance on other operators for domestic transit traffic as a strategic weakness in the absence of long-term contractual relationships. Short-term network leases are exposed to substantial repricing risk, particularly on the about 15% of Kazakhstan territory where alternative network providers are not present. Kcell's management is exploring a number of options to address this issue, but we believe higher lease payments and additional investments into back-bone infrastructure are likely in the short to medium term. Cost-Cutting Benefits Delayed: We do not expect the company's EBITDA margins to improve from the high 30s in the short to medium term, in spite of substantial cost-cutting efforts. Faced with severe declines in revenue and EBITDA in 2015-2016, Kcell launched strategic initiatives aimed at significant operating improvements and cost savings in the long run. However, these are being run largely in parallel, entail a degree of execution risk and may require additional expenses in the short to medium term, in our view. Kcell has announced that it will change its equipment vendor and plans to insource network maintenance, as it considers the current external maintenance provider non-optimal. The company is also replacing its billing and some IT systems, and is reviewing its distribution practices, in addition to some marketing initiatives. Moderate Leverage Overall: We estimate that Kcell's leverage may keep modestly rising due to negative free cash flow resulting from high capex. We expect FFO adjusted net leverage of 2.1x-2.6x in the medium term (2.1x at end-2016). The company's organic capex spend has been in the low teens on average over 2012-2016, but we believe it may rise to the mid-to-high teens, pushed by continuing 4G investments and new backbone construction. The company may also need to keep capex parity with its peers in absolute terms, with Tele2 having invested over KZT20 billion in 2016. The company's public target is to have leverage between 0.5x and 0.9x net debt/EBITDA (company definition) and pay out at least 70% of net income. Pending Shareholding Change: Fitch treats a pending shareholder change as an event risk. Kcell is majority controlled by Telia but this is scheduled to change as Telia announced plans to 'responsibly' dispose of its emerging market assets, with an exit expected by the shareholder before end-2017. A number of scenarios are possible, but shareholding changes may not necessarily put pressure on the ratings unless accompanied by a prolonged rise in leverage or resulting in a new controlling shareholder with a significantly lower credit profile than Kcell and unfettered power to take cash out of the company. DERIVATION SUMMARY Kcell's operating and leverage profile is similar to that of its Russian mobile peers PJSC Mobile TeleSystems (BB+/Rating Watch Negative) and PJSC Megafon (BB+/Stable) but these benefit from more presence in the fixed-line/broadband segment, largely proprietary backbone infrastructure and a near completion of 4G roll-out. Unlike incumbent Kazakhtelecom JSC (BB+/Stable), Kcell lacks fixed broadband/pay-TV bundling opportunities, although it benefits from stronger mobile-only market positions. Italian Wind Tre SpA (B+/Positive) is rated lower due to higher leverage. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Kcell include: - modest and improving low-single-digit service revenue declines in the medium term; - EBITDA margin in the high-30s, with margin pressure from higher backbone leases not exceeding 1%; - continuing negative working capital movements driven by handset sales; - capex in the mid-to-high teens in 2017-2020; - dividends on par with the company's guidance of 70% of net income. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Lower dependence on external providers for domestic traffic transit, better broadband bundling opportunities - Stronger free cash flow generation while maintaining market leadership and network quality parity with peers, and comfortable liquidity Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Leverage sustainably above 3x FFO-adjusted net leverage without a clear path for deleveraging - Continuing market share losses and financial underperformance leading to persistent and strongly negative FCF - Persistently weak liquidity situation - Negative changes in corporate governance after Telia's exit LIQUIDITY Limited Liquidity: Cash on balance sheet totalled KZT13.8 billion at end-1H17, only sufficient to cover KZT8 billion of scheduled maturities within the following 11 months, without any available committed lines. The consistent lack of adequate liquidity to cover short-term obligations on a rolling basis would be a credit concern, and may lead to a negative rating action. Kcell's liquidity is supported by good relationships with large domestic banks that are typically prepared to renegotiate and extend the maturity of their facilities ahead of their scheduled due dates. FULL LIST OF RATING ACTIONS Kcell JSC -- Long-Term IDR: assigned at 'BB', Outlook Stable -- Kazakhstan National Long-Term Rating: assigned at 'A(kaz)', Outlook Stable Contact: Principal Analyst Irina Andrievskaia Associate Director +44 20 3530 1715 Supervisory Analyst Nikolai Lukashevich, CFA Senior Director +7 495 956 9968 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chairperson Damien Chew, CFA Senior Director +44 20 3530 1424 Click here to enter text. 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