Brazil's Oi Gets Debt Downgrade
Moody's has downgraded the debt ratings of Brazilian telecoms network operator, Oi. Concurrently, Moody's has downgraded the ratings of Telemar Participacoes, Oi's holding company and owner of 56% of its common shares.
The ratings downgrades were triggered by Oi's elevated leverage and the fact that the company will take longer to reduce its debt than Moody's expected. The outlook on the ratings is negative.
"Today's ratings downgrades were based on Oi's elevated leverage," says Nymia Almeida, a Moody's Vice President - Senior Analyst and lead analyst for Oi. "During the last twelve months ended June 30, 2012, Oi's adjusted gross debt leverage was at 4.1x, which negatively compares with other telecommunications companies in the same rating category," explains Ms. Almeida. "In addition, Oi's ability to deleverage significantly in the near term will be limited given the competitive environment in the Brazilian telecoms industry and strong regulatory pressure on the country's telecoms companies to undertake high capital expenditure, as well as by the company's rigid dividend commitments."
Moody's believes that Oi's business model is solid and supportive of the company's operating margins given the strong pent-up demand for data and pay-TV services in Brazil and the absence of a price war among the country's telecom operators. However, the highly competitive nature of the telecoms industry in Brazil (at least three strong operators per type of service) forces telcos to immediately pass on operating savings to consumers, limiting the ability of these companies to materially grow revenue and improve margins. In addition, the strong regulatory pressure on Brazilian telcos, including Oi, to undertake high levels of capital expenditure, in order to ensure continuing service improvements and coverage expansion, exerts negative pressure on their free cash flow. Moreover, Oi has high dividend payout commitments vis-a-vis its net profit generation. For these reasons, Moody's believes that Oi will be able to deleverage only gradually.
Oi's ratings reflect (1) the leading market position of its incumbent wireline operations; (2) a sound EBITDA margin, albeit declining; (3) the company's prudent financial policies, which contribute to its overall strong debt protection metrics; and (4) its good level of corporate governance standards when compared with other Brazilian companies. The ratings also reflect Moody's expectation that Oi will be able to sustain its current margins by continuing to bundle services and increasing the proportion of its total service revenues that comprises data services, thereby reducing churn of fixed and mobile subscribers and improving its revenue mix. This way, the company would manage to reduce operating costs in a business environment characterized by declining prices. At the same time, the ratings are principally constrained by Oi's current high leverage and the challenges the company faces to address the decline in its higher-margin fixed-line telephony revenues, as well as the fierce competition in the Brazilian telecoms industry.
Oi's liquidity position is good. As of June 30, 2012, the company's cash on hand plus projected cash flow for the following 18 months were sufficient to cover interest payments, debt maturities, taxes, working capital, capex and dividends. As of that date, Oi also had sizeable committed and undrawn credit facilities amounting to around BRL11 billion (USD5.5 billion). Oi's revolving credit facilities not only support the company's liquidity position but also highlight its conservative financial policies.
Moody's standard adjustments to Oi's debt and EBITDA include those related to operating leases; pension funds; foreign exchange derivatives; refinanced taxes; and Anatel credit lines.
The ratings of Telemar Participacoes are based on the structural subordination of its debt to the debt at Oi. Moody's estimates that, as of June 2012, Telemar Participacoes' total debt represented 10% of the aggregate debt of the group.
The negative ratings outlook is based on Moody's view that Oi may find it more difficult to deleverage its balance sheet than the rating agency initially anticipated, as a result of which the company's credit metrics may remain weak for the Baa3 rating category for an extended period of time.