Fitch Affirms Russia's OAO MegaFon at 'BB+'; Outlook Stable

Mon Jul 28, 2014 1:04pm EDT

(The following statement was released by the rating agency) MOSCOW/LONDON, July 28 (Fitch) Fitch Ratings has affirmed Russia-based OAO MegaFon's (MegaFon) Long-term Issuer Default Rating (IDR) at 'BB+' with a Stable Outlook. A full list of rating actions is available at the end of this commentary. OAO MegaFon's business and financial profile corresponds to mid-'BBB' rating level on a standalone basis, given the company's established market positions, strong free cash flow generation and low leverage. This is notched down two levels for corporate governance risks generally in Russia and specific to MegaFon, in particular shareholder influence by Alisher Usmanov, the ultimate controlling owner. KEY RATING DRIVERS Strong Market Positions MegaFon is the second-largest mobile operator in Russia by subscriber and revenue. The company has been able to gradually increase its market share over the last five years. We believe further gains are likely, although at a slower pace. Historically, MegaFon has invested more than its peers, resulting in strong territorial coverage and quality network. Prior years' capex and its network advantage over peers should continue to help improving the company's market position. Russia's Largest LTE Portfolio MegaFon controls more spectrum than any other operator in Russia, which guarantees it a high data capacity for years to come. However, any strategic advantages of having more spectrum over peers may only be realised in the long-run. The currently available frequencies intended for LTE remain under-utilised in Russia due to low LTE device proliferation. Positive Growth Outlook We estimate that MegaFon's revenue growth will remain positive in the short term, likely in the low-to-mid single digit territory. A key growth driver will be data and bundled offers compensating for mild pressures on voice revenue. Competition is likely to intensify when a joint venture of Tele2 Russia and Rostelecom rolls out its operations into new territories, including, most importantly, in Moscow. However, we believe that significant pricing pressure is unlikely for quality network operators, including MegaFon. Moderate Leverage Sustainable In our view, organic development and the current dividend policy of paying the higher of 50% of net income and 70% of cash flow may be financed from the company's strong internally generated cash flow. Pre-dividend free cash flow margin is likely to remain in the low double-digit territory and leverage within a targeted range of between 1.2x and 1.5x net debt/EBITDA. Shareholding a Risk Fitch does not view corporate governance at Megafon as significantly above-average. This is reflected in Fitch's application of the standard two-notch discount for systemic governance weaknesses in Russia and in its legal environment under which issuer-specific governance standards operate. While MegaFon has put in place appropriate board practices and internal controls Fitch believes key risks relate mainly to the potential negative influence of MegaFon's majority shareholder, USM Holdings. The latter company is a non-transparent private holding company controlled by Alisher Usmanov. Sound Liquidity and Maturity Profile MegaFon's maturity profile is long-dated with over 40% of debt, as of end-1Q14, scheduled for redemption in five years and longer. The company's RUB63.2bn of cash on the balance sheet at end-1Q14 and undrawn credit facilities (reported at RUB85.6bn as of end-2013) comfortably covered its 2014 debt repayments and Scartel acquisition commitments. The company's exposure to foreign currency risks is low with 80% of debt denominated in RUB (including through FX hedges) at end-1Q14. We expect this ratio to have significantly improved after the company made an early USD payment for Scartel in June 2014. RATING SENSITIVITIES Negative: Future developments that may individually or collectively lead to negative rating action include - A sustained increase in leverage to above 3x funds from operations (FFO)-adjusted net leverage (FY13: 2.1x; we forecast it to remain stable in FY14). This, combined with liquidity and refinancing risks, may lead to a downgrade. - Competitive weaknesses and market share erosion, leading to significant deterioration in pre-dividend free cash flow (FCF) generation. MegaFon's pre-dividend FCF margin averaged 19% in 2011-2013, and we expect it to be in the low double-digit territory in the medium term. Positive: Future developments that may individually or collectively lead to positive rating action include - Stronger strategic positioning in the Russian market while maintaining robust financial performance and cash flow generation. This may be demonstrated by a pronounced mobile market leadership in spite of a fourth mobile operator entry and/or by a capability to offer a wider package of telecom services to most of its customer base including wire-line broadband services. However, we believe both are remote prospects over the medium-term; - A stronger ring-fence around MegaFon, protecting it from potential negative shareholder influence. FULL LIST OF RATING ACTIONS Long-Term Foreign Currency IDR: affirmed at 'BB+', Outlook Stable Long-Term Local Currency IDR: affirmed at 'BB+', Outlook Stable Short-Term Foreign Currency IDR: affirmed at 'B' National Long-Term Rating: affirmed at 'AA(rus)', Outlook Stable Senior unsecured: affirmed at 'BB+' and 'AA(rus) Bonds issued by MegaFon Finans LLC and guaranteed by MegaFon: affirmed at 'BB+' and 'AA(rus)'. Contact: Principal Analyst Slava Bunkov Associate 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 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com; 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 May 2014, are available at www.fitchratings.com. Applicable Criteria and Related Research: Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage 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. 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