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These factors are partly offset by the group's position as the leading fixed-line and mobile telecommunications operator in Greece, as well by our expectations that OTE's cost-cutting activities are likely to support operating margins despite further revenue declines.
The group's financial risk profile is primarily constrained by our assessment of OTE's liquidity, which we view as "less than adequate" under our criteria. This is only partly mitigated by the group's only moderately leveraged balance sheet and our expectation of solid free operating cash flow (FOCF) generation in 2012 and 2013.
The 'B-' rating on OTE is one notch higher than our assessment of OTE's stand-alone credit quality, primarily because we factor in moderate support from OTE's 40% shareholder, Deutsche Telekom AG (DT; BBB+/Stable/A-2), which fully consolidates OTE in its financial results in line with its shareholder agreement with the Greek government. While we continue to think that DT might shore up OTE's liquidity to prevent a default on a debt payment, we consider it difficult to assess at this time whether DT would step in to offset conversion of OTE's debt into the drachma in the event that Greece exits the eurozone. Under our criteria, such a conversion would likely ultimately result in a default.
S&P base-case operating scenario
In our base-case assessment, we forecast OTE's revenues will decline by about 8% in 2012 and roughly 7% in 2013 on a like-for-like basis, mainly as a result of the continued very weak economic environment in Greece. We currently project that Greece's GDP will contract by 10%-11% cumulatively in 2012-2013, following a drop of about 7% in 2011. In addition, we think the continued fierce competition and steep cuts in mobile termination rates in Greece and Bulgaria will burden group revenues from its fixed-line and mobile operations.
Nevertheless, we also assume that the EBITDA margin, as adjusted by OTE, will remain relatively stable between about 35% and 36% in 2012 and 2013 (versus 35.6% in the first nine months of 2012), primarily because we expect that the likely decline in revenues will be mostly offset by OTE's continued cost-cutting activities.
S&P base-case cash flow and capital-structure scenario
We have revised up our expectation for OTE's generation of FOCF in 2012 to about EUR0.7 billion (compared with EUR520 million in 2011) in our base case. This follows the group's better-than-expected FOCF generation of EUR503 million in the first nine months of 2012. In addition, we expect OTE to generate about EUR0.4 billion in FOCF in 2013. The likely decline in 2013 is primarily due to our anticipation of lower EBITDA and sizable cash outflows to acquire spectrum licenses. Nevertheless, our forecast could change markedly if we revised our assumptions related to OTE's cash tax payments, spectrum payments, working capital requirements, or cash outflows from the voluntary departure program for employees .
In our base case, OTE's debt-to-EBITDA ratio in 2012, as adjusted by Standard & Poor's, will likely decline to about 1.9x by year-end 2013, from 2.6x as of Sept. 30, 2012. This is primarily because we assume that OTE will use its entire free cash flow for debt reduction, which would more than offset the expected decline in EBITDA. We have not considered the intended disposals of the Bulgarian mobile operation and the subsidiary Hellas SAT in our leverage or FOCF calculations.
The short-term rating is 'B'. We assess OTE's liquidity as "less-than-adequate" under our criteria. This is primarily because OTE's liquidity sources as of Sept. 30, 2012, are likely to exceed its funding needs by only 1.0x in the next 12 months. We nevertheless see OTE's so far resilient free cash flow generation as a source of support for its refinancing plans. In addition, in November, the group was able to extend EUR500 million of its EUR900 million loan facility, due February 2013, by one-year to February 2014.
Nevertheless, if OTE is unable to further improve its liquidity position through significant asset disposals or further refinancing activities, we could lower our assessment of OTE's liquidity to "weak" in the first quarter of 2013 in light of its EUR1.0 billion debt maturity in August 2013 and EUR0.5 billion in February 2014.
As of Sept. 30, 2012, we estimate OTE's liquidity sources in the following 12 months at about EUR2.0 billion. These include:
-- Cash balances and short-term investments of EUR1.1 billion, of which we currently consider EUR0.8 billion to be surplus cash, reflecting that a large portion of OTE's liquidity is needed for working-capital purposes.
-- Sizable funds from operations of about EUR1.1 billion to EUR1.2 billion.
We estimate OTE's liquidity needs to be about EUR2.0 billion in the same period, including:
-- Capital expenditures including spectrum license payments of about EUR0.6 billion to EUR0.7 billion;
-- Debt maturities of EUR400 million in February 2013 and EUR1.0 billion in August 2013.
In our base case, we estimate that OTE will maintain headroom of at least 15% under the maintenance covenants of its EUR900 million loan facility in 2013. The facility includes two financial covenants, namely that group net debt should not exceed 3x group EBITDA at all times, and that group EBITDA should exceed 5x OTE's net interest payable at all times.
Most of OTE's debt was incurred by OTE PLC, a wholly owned and unconditionally guaranteed financing vehicle of OTE, and lent on via intercompany loans to OTE or its subsidiary Cosmote. For this reason, we believe OTE's debt is not affected by structural subordination. We therefore rate this debt at 'B-', the same level as the corporate credit rating on OTE.
The negative outlook reflects the possibility of a downgrade in the first quarter of 2013 if our assessment of OTE's liquidity profile weakens. This could primarily result if OTE is unable to further refinance its upcoming debt maturities or if it doesn't bolster liquidity through asset disposals to address its debt maturity in August 2013. In addition, we could lower the rating if we considered that DT's commitment to OTE had weakened or if the likelihood of Greece's exit from the eurozone (European Economic and Monetary Union) would increase.
We could revise the outlook to stable if OTE managed to proactively cover its debt maturities of EUR1.4 billion in 2013 and EUR1.0 billion in 2014. In addition, we would expect OTE to maintain adequate covenant headroom. We could also revise the outlook to stable if we saw that the likelihood of Greece's exit from the eurozone is negligible and that any negative impact from another possible Greek sovereign default would not materially affect our base-case assumptions.
Although likely to be limited in the coming quarters, ratings upside could arise if OTE were able to generate meaningful disposal proceeds or raise significant capital to comfortably address its large debt maturities in 2013 and 2014, and if at the same time, its exposure to country risk in Greece were to meaningfully decline. In addition, we could raise the rating if our view of DT's commitment to OTE strengthened, for example thanks to a pronounced increase in its shareholding in OTE or other explicit forms of financial support.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008