Our view of Wind’s financial risk profile is constrained by the company’s highly leveraged capital structure and low deleveraging prospects on a stand-alone basis and weak free cash flow generation. These factors are only partially mitigated by our view of the parent, VimpelCom Ltd. (BB/Stable/--), as better capitalized and more financially flexible than Wind, which will enable it to support Wind if required.
Wind’s business risk profile is supported by its stable market position as Italy’s third-largest mobile operator and continued growth in its mobile market share; its position as Italy’s second-largest fixed-line operator; and its solid profitability compared with peers, assisted by low subscriber acquisition costs and its focus on cost control. These factors are partly mitigated, however, by the weak economic conditions in Italy, which compound competitive pressures, particularly in the mobile telephony segment. In addition, the rating remains constrained by potential regulatory pressures. We view Wind’s management and governance as “fair,” reflecting no exposure to meaningful management or governance deficiencies.
S&P base-case operating scenario
Our base-case credit scenario assumptions result in our forecast of a mid-single-digit EBITDA decline in 2013 despite a slightly growing EBITDA margin (unadjusted). We anticipate that Wind will continue to outperform the Italian mobile market by increasing its mobile subscriber base and its mobile market share in 2013, albeit at a somewhat slower pace than in previous years. We currently assume about a 2% increase in mobile subscribers, compared with about 3% under our base-case scenario for 2012. We also assume, however, that the additional regulatory reduction of mobile termination rates (MTRs) and increased competition in mobile voice will lead to meaningful average revenue per user (ARPU) decline and an overall decline of 2%-5% in Wind’s mobile revenues in 2013. We also anticipate that Wind’s current focus on local loop unbundling (LLU) subscribers and the continued decline in fixed-line voice ARPU will lead to about 5% decline in fixed-line revenues but that fixed line EBITDA will experience positive growth as a result of growing LLU subscriber base and efficiency measures implemented by the company.
We note, however, that increasingly difficult economic conditions in Italy could hamper the company’s ability to deliver the expected performance outlined in our base-case scenario.
During the first nine months of 2012, Wind’s total revenues and EBITDA declined by 2.1% and 2.4%, respectively, compared with the previous year. This was mainly a result of the MTR cuts in July 2011 and July 2012.
S&P base-case cash flow and capital-structure scenario
We anticipate that Wind’s Standard & Poor‘s-adjusted debt will slightly decline to about EUR11 billion at year-end 2012 (from about EUR11.4 on Dec. 31, 2011), after the company repaid the bridge loan and made debt prepayments on its senior secured loans. We forecast that adjusted debt will remain at a relatively similar level at year-end 2013, due to very limited debt maturities and the impact of accruing interest of the PIK loan at parent company, Wind Acquisition Holding Finance SpA (WAHF), which we include in our adjusted debt figure. Along with our forecast for a mid-single-digit EBITDA decline in 2013, we expect this to lead to an increase in adjusted debt to EBITDA to about 5.4x in 2013, up from our forecast of 5.2x in 2012, with some potential for deleveraging only from 2014.
We anticipate that Wind’s unadjusted free operating cash flow (FOCF) will amount to about EUR150 million in 2012, after annuity payments. We forecast an additional decline in FOCF in 2013 to less than EUR100 million, mainly due to cash tax payments. Although we anticipate an improvement in free cash flow generation from 2014 onward, we still view Wind’s free cash flow generation as relatively weak and we see FOCF to adjusted debt remaining at 2%-3%.
We view Wind’s liquidity as “adequate” under our criteria, despite our projection that headroom under Wind’s amended maintenance covenants for its senior secured facilities will fall to lower than 15%, which we consider to be “less than adequate” under our criteria.
Our assessment of Wind’s liquidity as “adequate” partly relies on our expectation of some sort of support from its parent company, VimpelCom, in the case of a liquidity gap.
We expect the ratio of liquidity sources to uses to exceed 1.2x in 2013, mainly due to limited debt amortization. Given that we expect cash balances to be low and FOCF generation to be limited, liquidity will depend heavily on the availability of credit under Wind’s revolving credit facility (RFC) or the company’s ability to refinance debt over the next couple of years.
We project the following sources of liquidity for Dec. 31, 2012:
-- Minimal cash balances at year end after repaying the remainder EUR250 million on its bridge loan and EUR81 million to the Italian government.
-- Undrawn revolving credit facility of EUR315 million, maturing in 2016.
-- Funds from operations of EUR900 million-EUR950 million in 2013.
We project the following uses of liquidity for Dec. 31, 2012:
-- Minimal working capital requirements.
-- Capital expenditures (capex) of about EUR900 million.
-- Annual debt maturities of EUR81 million.
We forecast that covenant headroom under Wind’s new total leverage ratio could fall below 15% in 2013.
The issue ratings of ‘BB-’ on Wind’s EUR3.33 billion senior secured credit facilities (of which EUR400 million is an RCF) and EUR3.2 billion-equivalent senior secured notes are one notch higher than the corporate credit rating on Wind. The recovery rating on the senior secured bank facilities and the notes is ‘2’, indicating our expectation of substantial (70%-90%) recovery for senior secured lenders in an event of a payment default.
The issue rating on Wind Acquisition Finance S.A. (WAF)’s high-yield notes, guaranteed by Wind, is ‘B+', equal to the corporate credit rating on Wind. The recovery rating on this debt is ‘4’, indicating our expectation of average (30%-50%) recovery for noteholders in an event of a payment default.
The issue rating on Wind Acquisition Holding Finance S.A.’s EUR750 million-equivalent PIK debt, guaranteed by Wind Acquisition Holding Finance SpA (WAHF), is ‘B-', two notches below the corporate credit rating on Wind. The recovery rating on the PIK debt is ‘6’, indicating our expectation of negligible (0%-10%) recovery for noteholders in an event of a payment default.
Recovery prospects are supported by our view that Wind would be reorganized as a going concern in the event of a payment default. Furthermore, our recovery expectations are supported by a fairly comprehensive security package. The insolvency regime of Italy, which we consider to be relatively unfavorable for creditors, is a constraint on the recovery rating on the senior secured debt.
To determine recoveries, we simulate a default scenario. Under this scenario, we assume operational underperformance and significant leverage leading to an inability to refinance maturities in 2016. We estimate EBITDA at our hypothetical point of default to be about EUR1.58 billion.
We value the business as a going concern, given what we consider to be Wind’s good market position in Italy, established network assets, and valuable customer base. In determining our default scenario and stressed enterprise value, we assume that Wind’s parent, VimpelCom, would not provide additional support to Wind on the path to default. At the hypothetical point of default, we value the company at about EUR7.9 billion, using a 5.0x stressed valuation multiple. We have slightly revised the multiple downward, to reflect the macroeconomic environment in Italy.
After deducting enforcement costs of about EUR550 million, this leaves around EUR7.4 billion of value available for secured creditors. Recovery prospects for Wind’s senior secured bank debt and WAF’s senior secured notes reflect our view of the estimated value available and accessible to their respective creditors. They also reflect the likelihood of insolvency proceedings being impeded because Wind’s main center of operations is in Italy. In addition, the recovery ratings take into account our view of the fairly comprehensive security package, guarantees from the main holding and operating companies, and share pledges from material group operating companies. The recovery ratings on the existing senior and PIK debt also factor in our view of their structural subordination.
Coverage for the high-yield notes is highly sensitive to changes in valuation and priority debt assumptions, in our opinion. Given the limited documentary protection and significant amount of prior-ranking debt, recovery expectations might be vulnerable to potential downside.
The stable outlook reflects our base-case assumptions that Wind will maintain its market position in the Italian telecoms market. We also assume that revenue will continue to grow steadily, excluding the impact of regulatory actions, and that EBITDA margins will be solid at least at a high 30%. These factors will support the maintenance of Wind’s “satisfactory” business risk profile.
We could raise the rating if Wind reduces its debt much more quickly than we anticipate in our base-case scenario. In particular, we would look to see adjusted debt to EBITDA dropping to comfortably less than 5.0x, and FOCF to debt sustainably increasing to about 5%. This could happen if Wind’s shareholders refinanced a meaningful part of the group’s high-interest-bearing debt.
We currently see a downgrade as unlikely, but could lower the rating if our assessment of Wind’s liquidity deteriorates, if leverage rises to more than 6x with no immediate deleveraging prospects; or if our assessment of Wind’s business risk profile changes to “fair” following significant deterioration in Wind’s operating performance, including a drop in profitability to about 30%.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal.
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Criteria Guidelines For Recovery Ratings On Global Industrial Issuers’ Speculative-Grade Debt, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008