(The following statement was released by the rating agency)
Dec 11 -
Summary analysis -- OJSC Rostelecom ------------------------------- 11-Dec-2012
CREDIT RATING: BB+/Stable/-- Country: Russia
Primary SIC: Communications
Mult. CUSIP6: 77852T
Credit Rating History:
Local currency Foreign currency
13-May-2011 BB+/-- BB+/--
16-Dec-2008 BB/-- BB/--
The rating on Russian telecommunications operator OJSC Rostelecom is based on the company’s stand-alone credit profile, which Standard & Poor’s Ratings Services assesses at ‘bb’, and Standard & Poor’s view that there is a “moderate” likelihood that the government of the Russian Federation would provide timely and sufficient extraordinary support if the company were to encounter periods of financial distress.
We view Rostelecom’s business risk profile as “fair” and financial risk profile as “significant”, as our criteria define these terms.
The business risk profile assessment is constrained by Rostelecom’s weak position in mobile telephony, where it currently operates as a distant No. 4 or 5 in the saturated, competitive Russian market. These risks are only partly offset by Rostelecom’s exclusive ownership of nationwide fixed-line telecom infrastructure and resulting strong position in fixed-line telephony and broadband.
The financial risk profile assessment is primarily limited by the limited predictability of Rostelecom’s strategy and financial policy, including, in our view, an increasing risk of mergers and acquisitions and a meaningful increase in capital spending. It is also constrained by our assessment that Rostelecom has “less-than-adequate”, as the company still has significant exposure to refinancing risk. Somewhat offsetting these risks are Rostelecom’s currently moderate debt leverage, robust cash generation of core fixed-line business, and ongoing support from state banks.
In accordance with our criteria for government-related entities (GREs), our view of a “moderate” likelihood of extraordinary government support is based on our assessment of Rostelecom‘s:
-- “Strong” link with the state, reflecting the state’s majority ownership and an absence of immediate plans to decrease its stake in the medium term; and
-- “Limited” importance for the government because we view the Russian telecom market as quite mature and competitive, and Rostelecom could be replaced by other service providers.
S&P base-case operating scenario
In our base-case assessment, we assume that Rostelecom’s annual percentage revenue growth in 2013 will slow to low single digits, due to saturation of the Russian broadband market and intensifying competitive pressures in this segment. However, residual growth in the number of broadband customers and increasing numbers of pay-TV subscribers should compensate for the decline in revenues from traditional regulated fixed-line services, in particular, long-distance and intrazonal telephony.
Generally, we do not expect Rostelecom’s gross margins to decline because of competition. However, we believe that the company’s investments in its own unified brand and a single billing system will put pressure on operating profitability. Consequently, we see a risk that its reported EBITDA margin could decline to 35% over the next two-three years from the current 39%.
We assume that Rostelecom will seek to develop its mobile operations. Rostelecom was one of the four operators that was awarded a nationwide 4G license. Also, based on the press reports, the company is mulling over creation of a joint venture with Tele2 (not rated) for this purpose. Although our forecast projects an increase in capital spending associated with the network buildout, we do not expect that it could meaningfully improve our assessment of the company’s business profile over the next 12 months.
S&P base-case cash flow and capital-structure scenario
In our base-case assessment, we assume that Rostelecom’s free cash flow generation in 2013 will be constrained by significant capital expenditures, which will likely exceed 20% of revenues. We also assume that Rostelecom will continue to make acquisitions in both the mobile and broadband segments that will constrain cash generation.
We assume that Rostelecom’s debt will increase in 2013 as a result of such acquisitions, capital spending, and dividends, but will stay below 2x its EBITDA. We also assume that Rostelecom will gradually refinance its significant short-term debt, which it inherited from the regional operators with which it merged in 2011.
We consider Rostelecom’s liquidity to be “less than adequate”, as defined in our criteria. This reflects our assessment that its liquidity sources do not fully cover liquidity uses for the next 12 months. The reason for this is the company’s sizable short-term maturities of about Russian ruble (RUB) 74 billion (about $2.3 billion), which it acquired as part of the mergers in 2011. The company is gradually refinancing its short-term maturities but they remain significant, compared with the available sources of liquidity. However, Rostelecom claims to have a meaningful amount of committed and uncommitted credit lines, which should cover the debt repayments for at least six months. We expect that Rostelecom will gradually refinance its short-term debt with medium-term debt instruments, which should improve its liquidity sources-to-uses ratio.
In our liquidity assessment for Rostelecom we take into account the company’s very strong relationship with the largest state-owned banks, including Sberbank (not rated) and VTB Bank JSC (BBB/Stable/A-3; Russia national scale ‘ruAAA’), which suggests continued access to the domestic credit markets. As long as Rostelecom’s leverage is moderate and it generates robust cash flows, we believe there is a high likelihood that state-owned banks will roll over its maturing credit facilities.
The stable outlook reflects our expectation that Rostelecom’s fixed-line business will generate sufficient cash flows to finance its growth in other segments of the market, such as broadband Internet. We also assume that Rostelecom’s investments in restructuring its operations, developing a nationwide brand, and unifying its billing system will be prudently managed and will not lead to significant operating disruptions or increases in debt leverage. At this rating level, we anticipate a ratio of debt to EBITDA of not meaningfully more than 2x. In our base-case scenario, we assume that Rostelecom will continue to enjoy strong access to funding from state-owned banks and improve its capital structure over the longer term.
A downgrade could result if Rostelecom were to implement a more aggressive financial policy, for example fueled by mergers and acquisitions, that would lead to an increase of the adjusted debt-to-EBITDA ratio, as calculated by Standard & Poor‘s, to more than 2.5x. We could also lower the rating if Rostelecom were to maintain its current capital structure, characterized by significant exposure to short-term debt, by not extending the average duration of its debt maturities. A significant reduction in the state’s shareholding in Rostelecom, for example as a result of the ongoing reorganization of telecom holding Svyazinvest, could lead to a one-notch downgrade.
In our view, an upgrade is unlikely over the next 12 months and would require a significant improvement in Rostelecom’s business risk profile, such as a meaningfully stronger market position in mobile telephony and better operating efficiency.
Related Criteria And Research
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008