December 22, 2017 / 10:13 AM / a year ago

Fitch Rates Kcell's Proposed Domestic Bond 'BB(EXP)'

(The following statement was released by the rating agency) MOSCOW/LONDON, December 22 (Fitch) Fitch Ratings has assigned 'BB'/'A(kaz)' ratings to JSC Kcell's (BB/Stable) senior unsecured debt and 'BB(EXP)'/'A(kaz)(EXP)' ratings to its proposed domestic bond issue for up to KZT30 billion. Kcell is the market-leading mobile-only operator in Kazakhstan. The company does not have a proprietary backbone network and lacks any broadband bundling options, which is a strategic weakness. Leverage is likely to remain moderate but higher than the company's public target of up to 0.9x net debt/EBITDA, driven by continuing 4G and backbone investments in the medium term. Kcell is majority controlled by Telia Company AB (A-/Stable). We expect this to change soon, in line with Telia's intention to divest its emerging-market assets in the near future. KEY RATING DRIVERS Senior Unsecured Bond: The proposed bond is structured as senior unsecured obligations of Kcell. The bond's terms and conditions contain certain limitations on asset sales, cross-default provisions with Kcell's other debt, and a financial covenant of 2.5x net debt/EBITDA (company definition). However, these creditor-protective features are subject to significant carve-outs and weak implementation remedies. The bond has a maturity of three years and is callable at any time at the issuer's discretion. Leading Market Positions: Kcell is the leader in Kazakhstan's three-operator mobile market, with a subscriber market share of 39% at end-2016, within its targeted range. A rapid 4G roll-out after receiving 4G spectrum in 2016 and significant network investments will help protect its positions. The impact of mobile number portability is unlikely to be significantly negative. The company has only shed about 50,000 subscribers on a net basis, less than 1% of the total, since its introduction in January 2016. Intense but More Rational Competition: Competition in the Kazakh mobile market is likely to remain intense but more rational than in 2015-2016, after Kazakhtelecom's mobile subsidiary Altel and Tele2 merged their mobile assets into a joint venture at end-2015 operating under the Tele2 brand. The merger was between the two most disruptive companies in the market. The new enlarged operator is likely to be less aggressive. Tele2 is targeting further market share growth, but it already has about a quarter of the market by subscribers, and financial performance has become a greater priority. Lack of Backbone: We view Kcell's lack of a proprietary backbone network and its over-reliance on other operators for domestic transit traffic as a strategic weakness in the absence of long-term contractual relationships. Short-term network leases are exposed to substantial repricing risk, particularly on the about 15% of Kazakhstan territory where alternative network providers are not present. Kcell's management is exploring a number of options to address this issue, but we believe higher lease payments and additional investments into back-bone infrastructure are likely in the short to medium term. Cost-Cutting Benefits Delayed: We do not expect the company's EBITDA margins to improve from the high 30s in the short to medium term, in spite of substantial cost-cutting efforts. Faced with severe declines in revenue and EBITDA in 2015-2016, Kcell launched strategic initiatives aimed at significant operating improvements and cost savings in the long run. However, these are being run largely in parallel, entail a degree of execution risk and may require additional expenses in the short to medium term, in our view. Moderate Leverage Overall: We estimate that Kcell's leverage may keep rising modestly due to negative free cash flow resulting from high capex. We expect FFO adjusted net leverage of 2.1x-2.6x in the medium term (2.1x at end-2016). Pending Shareholding Change: Fitch treats a pending shareholder change as an event risk. Kcell is majority controlled by Telia but this is scheduled to change as Telia announced plans to "responsibly" dispose of its emerging-market assets, with an exit expected by the shareholder before end-2017. A number of scenarios are possible, but shareholding changes may not necessarily put pressure on the ratings unless accompanied by a prolonged rise in leverage, or if they result in a new controlling shareholder with a significantly lower credit profile than Kcell and with unfettered power to take cash out of the company. DERIVATION SUMMARY Kcell's operating and leverage profile is similar to that of its Russian mobile peers PJSC Mobile TeleSystems (BB+/Rating Watch Negative) and PJSC Megafon (BB+/Stable), but these benefit from a greater presence in the fixed-line/broadband segment, largely proprietary backbone infrastructure and a near completion of 4G roll-out. Unlike incumbent Kazakhtelecom JSC (BB+/Stable), Kcell lacks fixed broadband/pay-TV bundling opportunities, although it benefits from stronger mobile-only market positions. Italian Wind Tre SpA (B+/Positive) is rated lower due to higher leverage. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Kcell include: - modest and improving low single-digit service revenue declines in the medium term; - EBITDA margin in the high 30s, with margin pressure from higher backbone leases not exceeding 1%; - continuing negative working-capital movements driven by handset sales; - capex in the mid-to-high teens in 2017-2020; - dividends in line with the company's guidance of 70% of net income. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Lower dependence on external providers for domestic traffic transit, better broadband bundling opportunities - Stronger free cash flow generation while maintaining market leadership and network quality parity with peers, and comfortable liquidity Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Leverage above 3x FFO-adjusted net leverage on a sustained basis without a clear path for deleveraging - Continuing market share losses and financial underperformance leading to persistent and strongly negative FCF - Persistently weak liquidity situation - Negative changes in corporate governance after Telia's exit LIQUIDITY Limited Liquidity to Improve: Cash on balance sheet totalled KZT14 billion at end-3Q17, without any available committed lines. A successful bond placement would improve Kcell's liquidity. Contact: Principal Analyst Irina Andrievskaia Associate Director +44 20 3530 1715 Supervisory Analyst Nikolai Lukashevich, CFA Senior Director +7 495 956 9968 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chairperson Damien Chew, CFA Senior Director +44 20 3530 1424 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email:; Adrian Simpson, London, Tel: +44 203 530 1010, Email: Additional information is available on 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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