Training on sovereign risk credit analysis, October 24

ACRA affirms AA(RU) to PJSC «MegaFon», outlook Stable, and AA(RU) to bonds issued by PJSC «MegaFon»

ACRA has conducted a monitoring of the credit rating of PJSC «MegaFon» (hereinafter, the Company or MegaFon) in connection with the ordinary shares and GDRs buyback program and the subsequent delisting of GDRs from the London Stock Exchange declared by MegaFon Investments (Cyprus) Limited (MICL), a 100% subsidiary of MegaFon. The Agency confirms the Company's credit rating due to the moderate influence of buyback of shares and GDRs on the Company's leverage, which is estimated by ACRA as average. In addition, MegaFon's credit rating is based on the Company's very large size and very high profitability, strong business profile, strong liquidity position, and very high corporate governance level and weak cash flow.

PJSC «MegaFon» is one of the largest telecommunications companies in Russia, it ranks second in terms of the number of subscribers and revenues among the mobile communications providers. The key shareholder of MegaFon is USM Holdings.

Key rating assessment factors

The leverage has remained at an average level. According to the announced offer, MICL will pay to holders of 128.95 million of its shares and GDRs USD 9.75 per a security, which is about RUB 78.5 billion in aggregate. The resulting amount will depend on the volume of shares and GDRs offered for redemption and the ruble exchange rate. In its calculations, ACRA assumed that the entire volume of shares and GDRs would be offered for redemption.

As of the end of 2017, the MegaFon's ratio of total debt to FFO before net interest was 2.2x, the ratio of debt adjusted for operating lease to FFO before fixed charges was 2.7x. MegaFon's refusal to pay dividends for 2017, together with the stable operating cash flow of the Company, will help finance the buyback and increase capital expenses without significant growth in the leverage. According to ACRA estimates, the Company is able to maintain the ratio of total debt to FFO before net interest within 2.5x and the ratio of adjusted debt to FFO before fixed charges within 3.0x by the end of 2018. The leverage of the Company's telecommunications segment (that is, excluding the financials of Group Limited, which are to be de-consolidated from the Company's financial statements starting from 2Q2018) is slightly higher, but it still remains within the average range.

Strong liquidity position and weak free cash flow. MegaFon's refusal to pay dividends for 2017 has been positive for the cash flow of the Company. On the other hand, the cash flow is under pressure of increasing capital expenses, which may reach 22–23% of revenue in the next three years (vs 17% in 2017). Therefore, according to ACRA estimates, by the end of 2018, the FCF margin may decrease by 2 p.p. to about 5% (without shares buyback) against the previous year. In view of the expected significant buyback payments, we have decreased the assessment of the Company's liquidity position from "very strong" to "strong". At the same time, in ACRA's opinion, MegaFon has a sufficient amount of undrawn credit lines, cash balances and cash flow to finance the buyback and to perform its debt obligations in a timely manner.

Key assumptions

  • Negative FCF caused by dividend payments and shares and GDRs buyback in 2018; FCF to become positive in 2019;
  • ARPU shrinking annually by not more than 3%;
  • Subscriber base to remain stable;
  • No one-off, substantial expenditures required to comply with new requirements to communications providers (amendments in the Federal Law “On Counteracting Terrorism” and in the Criminal Code of the Russian Federation).

Potential outlook or rating change factors

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

A positive rating action may be prompted by:

  • Declining debt adjusted for operating lease to FFO before fixed charges ratio below 2.0x and advancing FFO before fixed charges to fixed charges ratio above 5.0x.

A negative rating action may be prompted by:

  • Shares buyback (including de-listing from Moscow Exchange);
  • Increasing debt adjusted for operating lease to FFO before fixed charges above 3.5х;
  • Negative FCF caused by dividend payments and shares buyback in 2018–2019;
  • Annual decrease of ARPU by over 3% or subscriber base by over 5%.
  • Declining FFO margin before fixed charges and taxes below 40%;
  • Access to external liquidity sources worsening considerably;
  • Deteriorating corporate governance practices (including information transparency);
  • Need for substantial capital expenditures in order to comply with requirements to telecommunications providers as detailed in amendments to the Federal Law “On Counteracting Terrorism” and to the Criminal Code of the Russian Federation. 

Rating components

Standalone creditworthiness assessment (SCA): aa.

Adjustments: none.

Issue ratings

PJSC «MegaFon» (RU000A0ZYC98), maturity date: October 03, 2022, issue volume: RUB 15 bln, — AA(RU).

PJSC «MegaFon» (RU000A0ZYTM6), maturity date: February 15, 2021, issue volume: RUB 20 bln, — AA(RU).

Credit rating rationale. The issues represent senior unsecured debt of MegaFon. Due to the absence of either structural or contractual subordination of the issues, ACRA regards them as equal to other existing and future unsecured and unsubordinated debt obligations of the Company in terms of priority. According to the ACRA methodology, the credit rating of the issues is equivalent to that of MegaFon, i.e. AA(RU).

Regulatory disclosure

The credit ratings were assigned to PJSC «MegaFon» and bonds (RU000A0ZYC98, RU000A0ZYTM6) issued by PJSC «MegaFon» under the national scale for the Russian Federation based on the Methodology for Credit Ratings Assignment to Non-Financial Corporations under the National Scale for the Russian Federation and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities. To assign a credit rating to the above bond issues the Methodology for Assigning Credit Ratings to Individual Issues of Financial Instruments under the National Scale of the Russian Federation was also applied.

The credit ratings assigned to PJSC «MegaFon» and bonds (RU000A0ZYC98, RU000A0ZYTM6) issued by PJSC «MegaFon» were first published by ACRA on September 21, 2017, October 09, 2017 and February 19, 2018, respectively. The credit rating of PJSC «MegaFon» and its outlook and the credit ratings assigned to bonds (RU000A0ZYC98, RU000A0ZYTM6) issued by PJSC «MegaFon» are expected to be revised within one year following the rating action date (August 03, 2018).

The credit ratings were assigned based on the data provided by PJSC «MegaFon», information from publicly available sources, as well as ACRA’s own databases. The rating analysis was performed using IFRS consolidated statements and management reporting of PJSC «MegaFon». The credit ratings are solicited, and PJSC «MegaFon» participated in their assignment.

No material discrepancies between the provided data and the data officially disclosed by PJSC «MegaFon» in its financial statements have been discovered.

ACRA provided additional services to PJSC «MegaFon». No conflicts of interest were discovered in the course of credit rating assignment.

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