Fitch Maintains Russia's MTS on Ratings Watch Negative

Fitch Ratings says that it is maintaining Russia's MTS on Rating Watch Negative (RWN) following news that it is to buy a controlling stake in landline operator, Comstar from its parent company, Sistema.

"The acquisition of Comstar will trigger only a modest increase in MTS's leverage, which will still be consistent with its current ratings. At the same time, the combined entity will be a strongly free cash flow-generative company, providing a flexibility to repay debt and de-leverage," says Nikolay Lukashevich, Senior Director with Fitch's TMT team.

MTS announced that it is going to make an offer to Sistema to purchase its 50.91% stake in Comstar for US$1.3 billion in cash. The purchase agreement is conditional on MTS obtaining the required funding for this transaction . Fitch understands this is likely to be at least a medium-term facility.

Comstar is an integrated alternative provider of primarily fixed-line telecoms services (including broadband) in Russia. It also holds a controlling majority stake in MGTS, a fixed-line incumbent in the City of Moscow. Although the immediate synergies from the transaction are not obvious and are unlikely to be large, in the long-run the tie-up would create convergence and cross-selling opportunities and allow for certain cost efficiencies. As the ultimate owner Sistema does not change as a result of this transaction under Russian law there is no obligation to make a buy-out offer to minority shareholders of Comstar, and hence no more cash is likely to be expensed by MTS.

As both Comstar and MTS are free cash flow-generative companies, the combined entity is expected to be strongly FCF-positive. MTS and Comstar's revenues and earnings are likely to be fairly resilient in rouble terms in the current downturn, although in USD terms there has been a significant decline in net earnings due to depreciation in the rouble and other CIS currencies. While MTS's dividend policy remains unchanged (i.e. to pay out at least 50% of net income under US GAAP), lower net earnings are likely to lead to dividend reduction in USD terms. Fitch notes that after the acquisition MTS would have limited flexibility to maintain shareholder remuneration in absolute USD terms without putting its ratings under pressure.

While MTS's ratings continue to be capped by the ratings of its controlling shareholder Sistema, Fitch notes that Sistema's liquidity should significantly improve after this transaction. This may reduce Sistema's strong dependence on MTS's dividends as a key source of cash, if only temporarily. Under Fitch's parent-subsidiaries methodology the ratings of MTS and Sistema are linked and MTS's ratings may be affirmed with the assignment of a Stable Outlook once Fitch has received enough evidence that the risk of Sistema up-streaming excessive cash out of MTS has been reduced on a sustainable basis.

The acquisition of Comstar is unlikely to significantly increase refinancing risks for MTS. The company's liquidity has improved recently, following the USD2.5bn raised from banks and on capital markets since end-2008. Fitch views this as largely sufficient to meet MTS's 2009 and 2010 debt maturities estimated at USD1.2bn and USD1.6bn respectively at end-2008.

The ratings affected are MTS' Long-term Issuer Default rating (IDR) of 'BB+' and National Long-term rating of 'AA(rus)'. The RWN on MTS reflects that on parent Sistema. The Short-term IDR is affirmed at 'B'.

Posted to the site on 6th August 2009