Fitch Places Portugal Telecom on Rating Watch Negative

Wed Feb 26, 2014 11:30am EST

(The following statement was released by the rating agency) LONDON, February 26 (Fitch) Fitch Ratings has placed Portugal Telecom SGPS's (PT) 'BBB-' Long-term Issuer Default Rating (IDR) on Rating Watch Negative (RWN). At the same time, the agency has placed the senior unsecured rating of the bonds issued by Portugal Telecom International Finance BV on RWN. The RWN reflects Fitch's view that following the proposed merger between PT and Oi (BBB-/RWN) the financial profile of the post-merger entity is less likely to support a 'BBB-' rating. The RWN will be resolved following the closing of the transaction. PT continues to be rated on a standalone basis. Fitch expects the proposed merger between Oi and PT will proceed, with the enlarged group benefiting from increased scale and geographic diversification, merger synergies, and a simpler group structure. PT will have to recapitalise the intermediate holdings prior to the transaction and therefore increase its leverage. As such the deleveraging benefits from the BRL8.0bn capital increase are likely to be modest, with pro-forma opening leverage of the merged group likely to be inconsistent with current ratings. Financial pressures were evident in 2013 results from both companies, while Oi's Brazilian operations are in the midst of a turn-around, which is taking longer to deliver and requiring heightened levels of investment. PT's domestic EBITDA declined by 9.1% in 2013, while Oi's underlying EBITDA was down 7.6% and leverage (net debt to EBITDA) was 4.0x at year end. Pro-forma leverage of the post- merger group, estimated by Fitch at around 3.8x, with the absence of any material free cash flow, in Fitch's view, is unlikely to allow the company to deleverage for some time. Assuming outstanding regulatory approvals and other conditions to the merger are met, significant pressure is likely to remain on the merged entity's financial performance over the medium term, increasing the likelihood that ratings for the combined entity may be lower than the current 'BBB-' rating. Pro-forma 2013 revenues and EBITDA of the combined entity were BRL37.8bn and BRL11.3bn, of which approximately 67% of EBITDA originates from Brazil. KEY RATING DRIVERS (for PT on a standalone basis) Missed Associate Dividends and Leverage Although PT's domestic performance is under pressure, it nonetheless performed in line with Fitch's rating case in FY13. However, the absence of dividend receipts from Angolan associate, Unitel, was unexpected and pushed PT's leverage (net debt to EBITDA plus dividends) to 3.6x at YE13. While cash repatriation from Angola remains a concern, Fitch continues to factor some cash receipts into its forecasts, which along with some easing in the pace of decline in its domestic EBITDA, would be expected to allow the metric to return to around 3.5x on a standalone basis in 2014. This would remain commensurate with a 'BBB-' rating, albeit weak. PT Consent Solicitation PT has launched a liabilities management exercise, the successful completion of which is a condition to the merger going ahead. The consent process offers existing PT bondholders an unconditional guarantee from the enlarged Oi once the merger completes. Subject to an IDR being assigned to the post-merger group, Fitch would expect to assign a senior unsecured rating to bonds benefiting from the terms of the consent solicitation, at the same level as the IDR of the enlarged group. Portuguese Operational Performance In Fitch's view, PT's domestic business is well managed and performs well at the operating level. However, its domestic revenues and EBITDA remain under pressure, with the company reporting Portuguese EBITDA down by 9.1% in 2013. The company's residential fixed line operations perform more strongly than most European incumbent businesses, benefiting from an early investment in fibre, and TV and bundled services that have proven attractive and popular with consumers. Its mobile business continues to add subscribers and sustains a strong market share. The Portuguese market is nonetheless a low mobile ARPU market, while the company's largest domestic revenue segment - enterprise - remains under significant pressure (2013 revenues down 11.8%). Consolidated revenues and EBITDA are likely to remain under pressure, although further declines should be at a more moderate pace. RATING SENSITIVITIES Fitch's existing guidelines will apply until the merger as proposed is effective. Guidelines for the combined group will be developed once the transaction closes. The current guidelines are as follows: Negative: Future developments that could lead to negative rating action include: Fitch adjusted leverage (net debt to EBITDA (both excluding Brazil) plus associate dividends consistently above 3.5x). Sovereign Linkage Fitch has guided PT should be rated no more than two notches above the sovereign. A downgrade of the sovereign to 'BB-' would lead to an immediate downgrade of PT. Positive: Future developments that could lead to positive rating actions include: Fitch adjusted leverage (net debt to EBITDA (both excluding Brazil) plus associate dividends trending consistently below 2.8x. Contact: Principal Analyst Giovanni Reichenbach Associate Director +44 20 3530 1255 Supervisory Analyst Stuart Reid Senior Director +44 20 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Damien Chew Senior Director +44 20 3530 1424 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. 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. Applicable criteria, 'Corporate Rating Methodology', dated 5 August 2013; 'Rating Telecom Companies', dated 9 August 2012, are available on www.fitchratings.com. In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action that is different than the original rating committee outcome. Applicable Criteria and Related Research: Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage here Rating Telecom Companies here 2014 Outlook: Telecom and Cable (Data Growth a Key Positive, but Concerns Exist) here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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