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Fitch Downgrades Portugal Telecom on Associate Dividend Concerns

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Fitch Ratings has downgraded Portugal Telecom's logn term debt rating to 'BBB ' from 'BBB', and set a negative outlook.

­The downgrade takes into account a change in Fitch's expectations for associate dividends at PT, principally from Oi in Brazil, which is currently in the midst of a turn-around, as well as the extended time taken to repatriate dividends from Unitel, PT's 25%-owned mobile associate in Angola. While performance at the latter remains strong, approval from the central bank to repatriate dividends from 2010 and 2011, is in Fitch's view, proving increasingly difficult to gauge. It seems likely that receipts, which form a key part of Fitch's assessment of PT's leverage, will miss previous assumptions for 2013.

PT's own dividend cut (reducing the commitment for the next two years to EUR0.10 per share from EUR0.325), provides some offset, and signals management's deference to bondholder interests. However, in Fitch's view it will be insufficient to stop the company's leverage (measured as net debt to EBITDA (both excluding Brazil) plus associate dividends) trending above 3.0x; a level the agency has previously stated as a key downgrade sensitivity. PT continues to manage its domestic business effectively. However, Fitch expects domestic EBITDA to decline by mid-to-high single digits in 2013 given the correlated effects of the economy. Liquidity is strong, with the EUR1.0bn seven-year Eurobond issued in April proving good market access, and ensuring the company is pre-financed through 2016.

Associate Dividends Underperform

PT owns 25.3% of Brazilian integrated telecom operator Oi; a business that PT proportionately consolidates, while Fitch treats the business as an associate and includes the dividend stemming from PT's 15.5% direct interest in its leverage calculation. Oi has cut its BRL2.0bn commitment to BRL500m having breached its self-imposed 3.0x leverage target; Both Oi and Unitel receipts are important in the leverage denominator. The latter are exposed to central bank capital controls and the timing of payments increasingly difficult to judge (inclusion of these values in the leverage denominator has a disproportionate effect on the metric notwithstanding the cash flow benefits of PT's own dividend cut).

Domestic Business Pressures

Against the backdrop of a difficult domestic economy and ongoing sovereign pressures, PT's domestic business is regarded as well managed and performs well at the operating level. That said, its domestic revenues and EBITDA remain under pressure, with Fitch's current rating case assuming a high single digit EBITDA decline in 2013 and continued erosion into 2014. The combination of lowered expectations for associate dividends, the more volatile nature of these payments, and domestic market pressures underscore the Negative Outlook.

Medium-Term Investment Grade Fundamentals

An early and widespread investment in fibre has strongly positioned PT's fixed-line business. Uniquely among its peer group, PT is improving its residential fixed revenues and has overtaken the country's main cable operator to become the largest provider of triple-play services. H113 operating results suggest the company's quad-play offer is proving successful, as evidence by strong mobile subscriber additions, both at the retail and enterprise levels. Strong operating fundamentals underline Fitch's view that current sovereign and leverage pressures aside, PT maintains good qualitative characteristics and the potential to sustain an investment grade rating.

Sovereign Pressure, Sound Liquidity

Portugal's sovereign rating (BB+/Negative) implies a level of ongoing economic pressure and protracted austerity driven weakness. In this environment, Fitch considers that prospects for private consumption and highly correlated telecoms expenditure, are unlikely to improve materially over the next two years, although the pace of decline could slow. Sovereign driven corporate funding conditions are likewise likely to undergo sporadic instability, despite European policy-makers' actions to reduce this volatility over the past 12 months. However, PT has solid liquidity, including EUR2.6bn of domestic cash and a further EUR857m of undrawn committed facilities at H113. Debt markets remain accessible to the company with maturities, in Fitch's view, pre-financed through 2016.

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Tags: oi  fitch ratings  portugal telecom  unitel  Angola  Brazil  Portugal