S&P base-case operating scenario
In our base-case operating scenario we assume that VimpelCom will report mid-single-digit percentage consolidated revenue growth in 2013 and 2014. This will be primarily driven, in our view, by residual growth in its largest cash-generating subsidiaries in Russia, where VimpelCom has managed to stabilize its operating performance, and Ukraine. We expect that performance in the Italian market will continue to be under pressure due to the weakening economy and negative regulatory changes. We do not assume, however, any weakening in Wind's operating performance, which remains in line with or better than the overall Italian market. We also expect sound growth across VimpelCom's emerging market portfolio, which might nevertheless be offset by currency swings.
VimpelCom's consolidated profitability has improved markedly, with reported EBITDA margin widening to 44% in the third quarter of 2012. We believe that in the next two years the EBITDA margin could stabilize around 40%-42%, as the impact from increasing economies of scale could be offset by increasing competition and regulation.
There continue to be significant uncertainties related to VimpelCom's subsidiary in Algeria, which accounts for a sizeable percentage of its emerging market operations. We understand that the negotiations with the Algerian authorities are continuing; however, whether VimpelCom will be able to retain its operations in the country remains uncertain. We continue to think that positive resolution of the conflict in Algeria, including the sale of the operation at a fair price, could positively impact our assessment of VimpelCom's business risk profile.
S&P base-case cash flow and capital-structure scenario
VimpelCom's consolidated leverage continues to be at the upper end of our expectations for the current rating, leaving limited leeway for major cash outlays or significant underperformance. In our base-case scenario we assume that VimpelCom's leverage will decline gradually from the current level of 2.8x in Sept. 30, 2012 to about 2.5x in about 12-18 months, absent significant acquisitions.
We also assume that free cash flow generation could improve in 2013 on the back of moderating capital spending and become an important source for deleveraging, along with growth in consolidated EBITDA. That said, we think that VimpelCom will continue paying significant dividends, which limits the pace of deleveraging. The company has not yet paid its dividends for 2011 due to a restriction imposed by the Russian court. However, we understand the issue was recently resolved, which paves the way for resumption of the company's dividend payments, subject to the court withdrawing its court order.
In our assessment we assume that Wind will continue to operate on an isolated basis, as it remains self-sufficient in financing its operations. Still, we think that in the case of financial difficulties at Wind, VimpelCom might need to provide intragroup financing to its subsidiary. We currently do not factor in the potential refinancing of debt at Wind level in our analysis, but we note that this might potentially further improve cash flow generation for the group, as a result of interest and tax savings, in our view.
We view VimpelCom's liquidity as adequate. Our view is primarily supported by the company's significant free cash flow generation capacity, notably at its Russian and Ukrainian subsidiaries, which should be sufficient to finance organic growth and dividends. We calculate that the company's ratio of liquidity sources to liquidity uses exceeded 1.2x at the end of September 2012 and should remain at this level throughout 2013, reflecting the absence of large debt maturities in the next several quarters.
VimpelCom's largest short-term maturities are concentrated at its Russian subsidiary. Even so, in our view, the consolidated debt maturity profile is not challenging, with total maturities of $2.0 billion in 2013 and $1.6 billion in 2014. Importantly, the weaker cash generating subsidiaries, namely Wind Telecomunicazioni SpA (B+/Stable/--) and Orascom Telecom Holdings (not rated), do not have any meaningful repayments in the next four years, which could allow VimpelCom to maintain adequate liquidity over the longer term.
Additional liquidity sources for the company stem from availability of committed credit facilities at operating companies in Russia and Italy, and two untapped facilities totaling $0.5 billion at parent company level.
To determine recoveries, we simulate a default scenario. We assume a default in 2015, at which time, we envisage EBITDA to be $1.75 billion and the stressed enterprise valuation of the company at $8.7 billion. After deducting enforcement costs and prior-ranking claims totaling $1 billion, we assume $13.3 billion of senior unsecured debt outstanding at default. This would leave sufficient value for meaningful recovery in the 50%-70% range, consistent with a recovery rating of '3' and an issue rating of 'BB'.
The recovery rating on the notes issued by VimpelCom Holdings B.V. is '4', reflecting our expectation of average recovery (30%-50%) in the event of a payment default. The lower recovery rating on these notes reflects our view that structural complexities and a relatively unfavorable jurisdiction (Russia) for creditors could lead to lower recovery prospects for the holders of VimpelCom Holdings' notes.
For more information please see "Vimpel-Communications JSC Recovery Rating Profile," published Dec. 22, 2011, on RatingsDirect on the Global Credit Portal and "Global Telecoms Group VimpelCom Unsecured Debt Assigned 'BB' Issue Rating, '3' Recovery Rating," published April 4, 2012.
The stable outlook reflects our expectation that VimpelCom will continue its strong operating performance across its various markets and use its free operating cash flow to reduce debt.
At the current rating level, we anticipate consolidated debt to EBITDA to be in the range of 2.5x-3.0x. We believe VimpelCom has the potential to strengthen its financial profile because it can generate meaningful positive free cash flows. However, this could be partly offset by volatile credit ratios, depending on the resolution of the situation with the Algerian subsidiary and fluctuations in currency exchange rates.
We could lower the ratings if VimpelCom's consolidated adjusted debt leverage exceeded 3x for a prolonged period. A downgrade could also be triggered by more aggressive investment decisions, including further expansion into countries with higher-than-average country risk, or increased dividend payments. At this point, we do not anticipate negative rating implications from the disputes concerning VimpelCom's Algerian subsidiary, mainly because we believe that these disputes are unlikely to result in significantly higher financial leverage. However, if the company were to lose control over its Algerian subsidiary without adequate compensation, it could hamper VimpelCom's credit profile.
We could consider raising the ratings if VimpelCom were to reduce its debt to EBITDA to consistently lower than 2.5x and show its commitment to its own long-term financial policy targets. An upgrade would also depend on the positive resolution of the dispute involving the Algerian subsidiary.
Related Criteria And Research
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008