TEXT-S&P summary: Mobile TeleSystems (OJSC)
Aug 27 -
Summary analysis -- Mobile TeleSystems (OJSC) --------------------- 27-Aug-2012
CREDIT RATING: BB/Stable/-- Country: Russia
Primary SIC: Radiotelephone
Mult. CUSIP6: 607409
Credit Rating History:
Local currency Foreign currency
28-Aug-2008 BB/-- BB/--
28-Apr-2004 BB-/-- BB-/--
The rating on Russia's largest telecoms operator, Mobile TeleSystems (OJSE) (MTS), is constrained by the credit profile of Sistema (JSFC) (BB/Stable/--), its majority shareholder (53%). Standard & Poor's Ratings Services considers the credit quality of both companies to be closely linked, reflecting Sistema's track record of control over MTS' corporate governance and financial policies.
According to our stand-alone assessment, MTS' main credit risks are associated with the company's organic and external growth plans, intensifying competition, and the risks associated with operating in Russia.
The company's strong business and financial characteristics, based on solid positions in the Russian and Ukrainian mobile telephony markets, mitigate these risks, in our opinion. These characteristics include improving economies of scale, sound operating profitability, strong cash flows, and adequate liquidity.
S&P base-case operating scenario
We expect MTS' operating performance to remain resilient in the second half of 2012 and in 2013. In our base-case scenario we assume revenue growth to slow to a rate of 2%-5% in Russia because of saturation of the Russian telecommunications market and mid-single digit percentage growth in Ukraine and other markets in the Commonwealth of Independent States (CIS). In our view, an expected increase in data usage should create modest revenue growth, which could, however, be hindered by decreasing consumer spending in Russia and elsewhere in the CIS.
It is also our expectation that MTS will particularly focus on maintaining its profitability margins, which improved to 41.8% in the first quarter of 2012 from below 40% in the second quarter of 2011. It is our expectation that MTS will maintain its consolidated EBITDA margin at 40%-41% in 2012-2013 due to its focus on cost control and the effects of scale in value-added services.
MTS has recently resumed operations in Turkmenistan after a forced suspension. At the same time, the company is now facing a similar issue in Uzbekistan, including a large tax claim against a subsidiary. We understand that MTS' license has been suspended and that the company might have to deconsolidate its operation in Uzbekistan, which accounts for about 4% of consolidated revenue and EBITDA.
We also expect that volatility in exchange rates could significantly affect the company's financial statements, which the company reports in U.S. dollars. This should not translate into foreign exchange losses, however, because the company has significantly increased the proportion of Russian ruble-denominated debt to about 80% over the past two years.
S&P base-case cash flow and capital structure scenario
We expect that MTS' solid credit metrics will continue to support the rating. In our base-case scenario we assume that MTS will maintain its capital expenditures at 20%-22% of revenues in 2012-2013, which should still allow for meaningful positive free operating cash flow. That said, we assume that MTS will continue to distribute most of that as dividends.
We also assume that the company will maintain adjusted debt to EBITDA in the range of 1.5x-2x, maintaining some headroom against our rating target of 2.5x. We believe that MTS could be considering acquisitions in Russia, however we expect them to be relatively small in scale, thereby keeping leverage within the indicated expectations.
In our view, MTS' liquidity is adequate, reflecting significant cash balances, a manageable maturity profile, and robust free operating cash flows. This translates into a ratio of liquidity sources to uses of more than 1.2x for 2012 and 2013. As of March 30, 2012, the company's short-term maturities of about $0.9 billion were fully covered by cash and equivalents of $1.6 billion. MTS has other undrawn committed credit facilities, including $1 billion in untapped financing from export credit agency EKN, which can be used to finance capital spending.
The issue ratings on MTS' Russian ruble-denominated unsecured notes are 'BB', in line with the 'BB' corporate credit rating. The recovery rating on the notes is '3', indicating our expectation of meaningful (50%-70%) recovery in an event of payment default.
The ratings on $750 million 8.625% loan participation notes due June 2020 issued by special-purpose vehicle MTS International Funding Ltd. (unrated) are 'BB'. We have not assigned a recovery rating to these notes.
The rating on a $750 million 8.625% loan facility provided to MTS by MTS International Funding Ltd., with proceeds from the $750 million loan participation notes, is 'BB', in line with the corporate credit rating on MTS. The recovery rating on this loan is '3', indicating our expectation of meaningful (50%-70%) recovery in an event of payment default.
To determine recoveries, we simulate a default scenario. In this scenario, excessive leverage as a result of lengthy operating underperformance would most likely lead to default in 2017. We have valued the company on a going-concern basis, given MTS' leading market positions in Russia and other parts of the CIS, established network assets, and valuable customer base.
At the hypothetical point of default, we value the company at about $5.4 billion. We assume that the company's debt structure would remain similar to that of today on its path to default. After deducting about $400 million of enforcement costs, the residual enterprise value available for unsecured creditors is about $5.0 billion. This is sufficient for meaningful (50%-70%) recovery on MTS' unsecured debt facilities.
The stable outlook reflects our view that MTS will perform in line with our base-case scenario, which includes low-single-digit percentage revenue growth in 2012 and 2013, a consolidated EBITDA margin of above 40%, and positive discretionary cash flow. It also reflects our expectation that an as yet unpaid arbitral award against an MTS subsidiary will have no impact on the company's financial profile. The rating will likely remain capped by Sistema's financial profile and corporate governance.
The rating has limited upside in the next 12 months, as improvement of corporate governance practices will take time, in our view.
We could consider a negative rating action in the event of large debt-financed acquisitions or dividends that would increase leverage closer to 2.5x. In addition, we could lower the rating in the event of negative developments in the company's corporate governance.
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