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Fitch Maintains MTS on Rating Watch Negative
October 30, 2017 / 4:21 PM / 21 days ago

Fitch Maintains MTS on Rating Watch Negative

(The following statement was released by the rating agency) MOSCOW, October 30 (Fitch) Fitch Ratings has maintained PJSC Mobile Telesystems' (MTS) ratings, including the Long-Term Issuer Default Rating (IDR) of 'BB+', on Rating Watch Negative (RWN) on uncertainty over the litigation against controlling shareholder Sistema Public Joint Stock Financial Corporation (Sistema, BB-/RWN) in relation to claims filed by Rosneft. A full list of rating actions is at the end of this commentary. MTS is a leading Russian and CIS mobile operator with moderate leverage and sustainable positive pre-dividend free cash flow (FCF) generation. It is the largest operator in Russia and the second-largest in Ukraine by subscriber and revenue. KEY RATING DRIVERS Litigation Impact: Fitch placed MTS's ratings on RWN in June 2017 following a Russian court injunction to freeze significant Sistema assets including its 31.76% stake in MTS in relation to claims filed by Rosneft against Sistema. In August the court ruled that Sistema should pay RUB136 billion of damages to Rosneft for alleged abuse of Sistema's shareholding rights in PJSOC Bashneft (Bashneft) (BBB-/Stable). Sistema strongly believes that Rosneft's claims are without merit and filed the appeal against the ruling. The watch is likely to be resolved when Fitch receives more clarity on the financial consequences of the litigation, and their implications for both Sistema and MTS. Mobile Market Stabilised: The competitive intensity on the Russian mobile market eased in 4Q16-2Q17 after the challenger operator LLC T2 RTK Holding (B+/Negative) completed the active stage of expansion into Moscow market and other regions. Mobile operators have demonstrated low single-digit revenue growth yoy in the last three quarters and we expect the positive trend to persist in the near term. However, the Russian market is mature and saturated, making revenue growth in the medium term a challenge. Stabilisation of Retail: Mobile operators have realised that the existing number of retail stores is excessive and announced optimisation/cuts of their distribution networks in 4Q16. This trend should be supportive of all operators due to reduction of rental costs, improvement of retail margins due to removal of heavy discounts on handsets and a potential reduction of churn in the long run. The active development of retail network, accompanied with handset price war, was a defensive move by MTS in 1H15 when the company needed to replace distribution channels following a conflict with independent retailers. Robust Pre-Dividend FCF Generation: We project that MTS's pre-dividend FCF margin will be maintained in the low double-digit territory, supported by strong EBITDA generation and stable capex at below 20% of revenue over the next four years. EBITDA margin is likely to be at around 40% in 2017 and slightly decline in 2018-2020, mostly on the back of inflationary pressures and limited ability of telecom companies to increase prices. FCF to Fund Shareholder Distribution: Fitch expects that MTS will continue to spend its FCF on shareholders remuneration in the form of dividends and share buybacks. The company announced a new round of share buybacks in September 2017 targeting RUB20 billion worth of own shares for repurchase by April 2019, after having spent RUB10 billion for that purpose in 4Q16-1Q17. The repurchase plan implies a mechanism of a proportionate buyback of shares from Sistema and other shareholders so that the share of Sistema remains unchanged upon the completion of the buyback. Our projections on dividend payments remain unchanged at RUB52 billion per year in 2017-2020. Turkmenistan Negotiations Ongoing: MTS was forced to suspend its services in Turkmenistan in September 2017 after the state-owned telecom company Turkmentelekom cut it from its network as local regulators have not extended certain agreements necessary for providing services. MTS is continuing to negotiate with the regulatory authorities. The cessation of operation in Turkmenistan would have a marginal impact on MTS's credit profile as the subsidiary contributed only 1% to 2016 group's EBITDA. Fundamentals Weighed Down by Shareholding: On a standalone basis MTS's credit profile is commensurate with a low investment-grade rating. Its ratings are notched down for the potential risks of negative influence of Sistema. Under Fitch's methodology, a subsidiary can generally be rated a maximum of two notches higher than the consolidated profile of its parent in the presence of weak parent/subsidiary links. DERIVATION SUMMARY MTS is well-positioned in its rating category as the leading mobile operator in Russia both by revenue and subscriber. On a standalone basis MTS corresponds to mid-'BBB' category and its profile is close to leading western European operators with a strong focus on their domestic markets, such as Telefonica Deutschland Holding AG (BBB/Positive) and Royal KPN N.V. (BBB/Stable). Fitch applies a two-notch discount for corporate governance and Russia-related risk, in line with the majority of other Russian corporates. MTS is rated at the same level as its Russian peers PJSC MegaFon and VEON Ltd (both BB+/Stable). The operator's ratings are supported by low leverage, stable market positions and operating performance and strong pre-dividend FCF generation. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for include: - Low single-digit revenue growth per year in Russia in 2017-2020; - A sharp decline in revenue in CIS markets in 2017 before gradually stabilising in 2018-2019; - Group's EBITDA margin under modest pressure in 2017-2020 at around 38%-40%; - Capital intensity at 18% of revenue in 2017-2020; - RUB52 billion of dividend payments per year; and - Around RUB20 billion spending on share buybacks in 2018-2019. RATING SENSITIVITIES Positive: Future developments that may individually or collectively lead to positive rating action -An upgrade of Sistema's rating provided that MTS continues to adhere to high corporate governance standards. Negative: Future developments that may individually or collectively lead to negative rating action -Weaker corporate governance but also excessive shareholder remuneration and other developments that lead to a sustained rise in funds from operations adjusted net leverage to above 3.0x (2016: 2.0x). -Competitive weaknesses and market share erosion, leading to significant deterioration in pre-dividend FCF generation. -A downgrade of Sistema if it remains the dominant shareholder. LIQUIDITY Strong Liquidity: The company's debt maturity profile is evenly spread, with annual principal payments of below RUB75 billion per year. Cash, liquid investments and bank deposits as of end-2Q17 cover upcoming debt maturities until end-2018. In addition, the company has RUB38 billion of unused credit facilities from various banks. Its strong liquidity profile is supported by expected robust cash flow generation in 2017-2020. FULL LIST OF RATING ACTIONS PJSC Mobile Telesystems' (MTS) Long-Term Foreign and Local Currency IDRs: 'BB+'; maintained on RWN Short-Term Foreign and Local Currency IDRs: 'B'; maintained on RWN Senior unsecured debt: 'BB+'; maintained on RWN MTS International Funding Ltd Loan participation notes guaranteed by MTS: 'BB+'; maintained on RWN Contact: Principal Analyst Irina Andrievskaya Associate Director +44 20 3530 1715 Supervisory Analyst Slava Bunkov Director +7 495 956 9931 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chairperson Tajesh Tailor Senior Director +44 20 3530 1726 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com; Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Additional information is available on www.fitchratings.com. 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