June 20, 2017 / 11:56 AM / 2 months ago

Fitch Affirms Transtelecom at 'B+'; Outlook Stable

(The following statement was released by the rating agency) MOSCOW, June 20 (Fitch) Fitch Ratings has affirmed JSC Transtelecom Company's (TTK) Foreign- and Local-Currency Long-Term Issuer Default Ratings (IDRs) at 'B+'. The Outlook on both is Stable. TTK's senior unsecured debt has been affirmed at 'B+'/ 'RR4'. The Short-Term IDR is affirmed at 'B'. TTK runs a large-capacity fibre backbone network laid along Russian railways. It operates under an asset-light business model and leases its core fibre network from its 100% shareholder Russian Railways (RZD) (BBB-/Stable). TTK holds established positions in the inter-operator segment, and has developed a sufficiently large end-user broadband franchise, holding approximately 5% of the all-Russia subscriber market share. The company is likely to manage its leverage at slightly below 3x net debt/EBITDA, corresponding to below 4x FFO adjusted net leverage, in line with the leverage policy of its controlling shareholder RZD. KEY RATING DRIVERS Large and Underutilised Network; The company benefits from running a large backbone network laid along the railways throughout Russia. Control over this extensive infrastructure positions TTK as a strong wholesale operator, but also allows it to offer a competitive broadband service in its covered territories. The network remains underutilised which allows it to keep capex at a relatively low level, at below 15% of revenues, but also to seek new monetisation opportunities. Focus on Monetisation: The company's strategy is focused on a more efficient use of its existing asset base and a search for new growth areas. We understand that TTK is likely to refrain from committing itself to large-scale investment projects without clear payback. The entry into new markets entails substantial execution risks, but the chosen strategy, in our view, protects against overinvestment and spikes in leverage. It may also help mitigate the impact of shrinking revenues in the over-competitive wholesale segment and rapidly slowing retail broadband segment. The management is keen to explore entry into new segments such as the internet of things, MVNO operations, captive projects with shareholder RZD, and new end-to-end wholesale services for smaller operators on the existing telecoms infrastructure. We believe that opening TTK's infrastructure to other telecom players may be value-accretive, and that it will not be cannibalistic in view of the company's relatively small retail franchise. However, with the likely exception of synergistic projects with RZD, business models in the new segments remain unproven while the visibility on their financial performance is low. Traditional Wholesale Under Pressure: TTK's traditional wholesale segment will remain the core cash-generating unit for the company, supported by sizeable indefeasible rights of use (IRU) contributions. However, the segment is in long-term decline, as a result of falling voice traffic and the continuing build-out of own infrastructure by large telecoms operators. The company's long network with connections to Russia's European and Asian neighbouring countries provides opportunities for recurring IRU proceeds from international operators, at least in the short to medium term. Stagnating Broadband: We believe TTK's growth in its retail broadband segment is likely to stagnate, due to significant average revenue per user (ARPU) and revenue pressures on the back of promotions in 2016. The subscriber take-up of broadband service in its covered territories remains lower than for peers, in the low 20% territory, suggesting modest opportunities for further subscriber and revenue growth, but also margin improvement in the medium term. Growth will be supported by the launch of pay-TV in March 2017. Stable Leverage: We believe TTK is likely to manage its leverage at slightly below 3x net debt/EBITDA and 4x FFO adjusted net leverage. This is in line with the targeted leverage of its shareholder RZD, which is comfortable with leverage of 2.5x net debt/EBITDA under Russian Accounting Standards (RAS) both at the group level, but also for key operating subsidiaries. Differences under RAS and IFRS reporting (including due to early recognition of IRU revenues under RAS) result in leverage under IFRS being approximately 0.4x higher than under RAS. We expect TTK to remain FCF positive on a pre-dividend basis, with free cash either spent on new projects as capex or returned to the shareholder, instead of further significant debt reduction. Relationship With Shareholder: Fitch rates TTK on a standalone basis. Legal ties are weak between TTK and its parent RZD as the latter does not guarantee TTK's debt. Owning a telecoms company is not strategic for a railway operator. However, operating ties are strong and RZD is likely to retain control over TTK in the medium term at least. We therefore assume that TTK should be able to continue leasing dark fibre from its shareholder on non-discriminatory terms. DERIVATION SUMMARY The company ratings' benefit from the established positions in the inter-operator segment and an improved position in the broadband segment as the fifth-largest operator in Russia with an approximately 5% subscriber market share. Compared to Russian mobile operators and Rostelecom, the company has smaller scale and a weaker competitive position in the residential segment. Its wholesale segment is intrinsically more volatile than retail revenues. TTK operates under an asset-light model business model which is a constraining factor for the ratings. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - low single-digit revenue decline in 2017 and largely flat revenue in 2018-2020; - EBITDA margin at above 21% in 2017 and gradually improving in 2018-2020; - capex at below 12% of revenue in 2017 growing to 14% in 2018-2020; - progressively increasing dividends in 2018-2020; - around RUB0.4 billion of recurring cash proceeds from IRUs per year included in FFO in 2017-2020; - buyout of some minority interests in 2017; -given our understanding of the business and its peers, our recovery analysis assumes a post-restructuring EBITDA of RUB4.45 billion and a distressed EV/EBITDA multiple of 4.0x. Recovery prospects for the RUB16.2 billion senior unsecured debt are good, but the Recovery Rating of 'RR4' is limited by a soft cap due to country considerations. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Stable broadband performance and less volatility in the interoperator segment coupled with sustainably positive FCF generation and leverage at below 3x FFO adjusted net leverage (broadly corresponding to 2x net Debt/EBITDA) may lead to an upgrade. - A pre-requisite for a positive rating action is a comfortable liquidity position with a short-term liquidity score of at least above 1x. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Pressures in the interoperator segment, but also broadband underperformance and weak financial results of new projects leading to a sustained rise in leverage to above 4.0x FFO adjusted net leverage (broadly corresponding to above 3x net debt/EBITDA) without a clear path for deleveraging will likely lead to a downgrade. - Liquidity and refinancing pressures may also be negative. LIQUIDITY Adequate Liquidity: TTK's liquidity is comfortable with RUB9 billion of credit lines with Russian banks covering RUB6.3 billion of short-term debt maturities at end-2016. Contact: Principal Analyst Slava Bunkov 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. 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