December 22, 2017 / 10:36 AM / 3 months ago

Fitch Revises T2 RTK's Outlook To Stable; Affirms at 'B+'

(The following statement was released by the rating agency) MOSCOW, December 22 (Fitch) Fitch Ratings has revised LLC T2 RTK Holding's (T2R) Outlook to Stable from Negative, while affirming the telecoms company's Long-Term Issuer Default Rating (IDR) at 'B+'. A full list of rating actions is available at the end of this commentary. The change in the Outlook reflects significant improvement in T2R's financial performance following the company's entry into the Moscow regional market and resultant substantial deleveraging. We expect T2R's funds from operations (FFO)-adjusted net leverage to decline to below 4.5x in 2018 from slightly above this level end-2017. T2R is the fourth-largest facilities-based mobile-only operator in Russia with approximately a 15% subscriber market share at end-2016. The company benefits from close cooperation with Rostelecom PJSC (BBB-/Stable), its large strategic shareholder. Rostelecom provides T2R with access to its extensive country-wide backbone infrastructure and enables T2R to provide bundled services including fixed broadband and Pay-TV. KEY RATING DRIVERS Strategic Focus on Value: T2R's strategic shift in focus to become a value-for-money operator rather than a heavy discounter will likely lead to less market disruption and allow for faster margin improvement, albeit at the expense of slower subscriber additions. The company has achieved a low churn, which enhances the financial benefits of long customer relationships and adds credibility to its strategy of gradually growing average revenue per user (ARPU) and attracting higher-value customers. Foray into Moscow: T2R has made its foray into the Moscow market and this region will become less of a cash drag in the near future as start-up costs diminish. Although the company has not fully achieved its initial target to take approximately 10% subscribers in this region, market share gains are no longer a key target, with financial performance higher on the agenda. Data Drives Growth: T2R is likely to continue to gradually increase its subscriber market share and grow revenue ahead of the market. The company has significantly reduced its gap versus. peers in terms of 3G and 4G coverage, and can expect to grab a wider share of data-heavy subscribers. T2R has rolled out 4G service in 49 out of its 65 total regions of operations by end-2017. Continuing network investments should sustain improvements in network quality. MVNO Platform: T2R's willingness to open the company's network to mobile virtual network operators (MVNOs) is likely to be margin-accretive as it helps the company to better utilise its infrastructure. We believe the strategic risks are limited as MVNO regulation is almost non-existent in Russia while T2R retains a flexibility to re-negotiate terms every two to three years. The company has invited a number of MVNOs to join its infrastructure, and plans to add more MVNOs in the future. Strategic Relationship with Rostelecom: T2R benefits from its strategic partnership with Rostelecom, its 45% shareholder. T2R enjoys access to Rostelecom's wide back-bone infrastructure, leading to capex efficiency. The two companies can offer fixed-mobile bundled service, which may give them an edge over key peers that lack this option across most of Russia. T2R is also likely to spend less on the implementation of the Yarovaya law that requires all operators to store customer internet traffic as Rostelecom has already invested in significant new storage capacity. Rapid Deleveraging: We expect T2R's leverage to decline to within the range for 'B+' rating in 2018. Deleveraging will be supported by stronger EBITDA generation on the back of gradually improving financial performance in the not-so-long-ago-entered Moscow market. We estimate FFO-adjusted net leverage at 4.7x at end-2017 (end-2016: 7x) and 4.3x at end-2018. We believe T2R is past the Moscow-related EBITDA trough and capex peak in 2016. Recovering EBITDA generation and capex rationalisation were the key factors behind T2R's strong deleveraging in 2017. We believe deleveraging will become a lesser priority once the company reduces debt below its comfort level of 4x net debt/EBITDA (company definition) in 2018. Capex to Grow: We project significantly higher capex in 2018 after it was more than halved yoy in 2017. The company is expecting to enter two new regions in 2018 and will keep investing in network quality to reach closer parity with its larger peers. However, we do not expect capex to exceed 20% of revenue in 2018 and forecast it will likely start to slow over the medium term. Cash Flow Break-Even to Slightly Positive: We expect T2R's cash flow on average to breakeven or be slightly positive over 2018-2020. The company is likely to prioritise investments over shareholder distributions, applying free cash flow (FCF) to capex. Although the absolute quantum of debt is unlikely to materially decline, we expect cash flow to be helped by substantial interest savings due to improving leverage and a lower interest rate environment in Russia. Shareholder banks, the company's key creditors, will likely allow loan re-pricing on market terms. Shareholder Funding: We expect shareholder banks to remain the key funding source for T2R, which mitigates refinancing and liquidity risks. We believe T2R retains an option to diversify into a wider creditor base after its leverage and financial performance stabilise in 2017. DERIVATION SUMMARY T2R, the smallest of the four Russian facilities-based mobile operators, lacks scale versus its larger peers and has lower profitability, driven by its still low market share in the lucrative Moscow market. T2R is facing stronger growth prospects as it catches up with its peers in terms of network coverage and quality and enters new regions. The company is significantly more leveraged than its domestic peers, all of whom have FFO-adjusted net leverage of less than 3x. Although T2R lacks any fixed-line operations, this is addressed by its partnership with its strategic shareholder Rostelecom. KEY ASSUMPTIONS -Mid-single digit revenue growth in 2018-2020 on the back of entry into new regions, gradually increasing market share and higher data consumption. -EBITDA margin recovering to 27% in 2018 and further growing to low-thirties territory in the medium term. -Substantial yoy interest savings in 2017 and 2018. -Capex below 20% of revenue in 2018, slowly declining in the medium-term. -No dividends until leverage drops below 4x net debt/EBITDA under the company definition. -Operating lease payments at 5% of revenue, on a par with Russian peers and taking into account management information KEY RECOVERY RATING ASSUMPTIONS -The recovery analysis assumes that T2R would be considered a going-concern in bankruptcy and that the company would be reorganised rather than liquidated. -We assume a 10% fee for administrative claims. -The going-concern EBITDA estimate of RUB21 billion reflects Fitch's view of a sustainable, post-reorganisation EBITDA level upon which we base the valuation of the company. This going-concern EBITDA is 30% below our forecast of the company's 2017 EBITDA. -An EV/EBITDA multiple of 4.5x is used to calculate a post-reorganisation valuation, reflecting a conservative post-distressed valuation. -The recovery rating of the senior unsecured bond is capped at 'RR4' due to country considerations. RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action -Successful operating development and FFO-adjusted net leverage stabilising at below 4x. Developments That May, Individually or Collectively, Lead to Negative Rating Action -A protracted rise in FFO-adjusted net leverage to above 4.5x without a clear path for deleveraging. -Weak cash flow generation driven by operating under-performance and insufficient growth from the expansion programme in Moscow and 3G/4G rollout in region. LIQUIDITY Comfortable Liquidity: At end-3Q17 T2R had undrawn credit facilities with relationship banks that covered its debt maturities till end-2018. FULL LIST OF RATING ACTIONS LLC T2 RTK Holding -Long-Term IDR: affirmed at 'B+', Outlook revised to Stable from Negative OJSC Saint-Petersburg Telecom -Senior unsecured rating: affirmed at 'B+'/Recovery Rating 'RR4' Contact: Principal Analyst Alexander Cherepovitsyn, CFA Analyst +44 20 3530 1755 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 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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