Fitch Maintains Tele2 Russia on Rating Watch Evolving on Shareholding Uncertainty
Published on: 23rd Dec 2013
By: Ian Mansfield
Fitch Ratings has maintained Tele2 Russia Holdings's ratings including its Long Term Issuer Default Rating of 'BB ' on Rating Watch Evolving (RWE) on uncertainty over its longer term capital structure and strategic shareholding situation.
The proposed terms of cooperation with Rostelecom suggest that this company will only acquire a minority 45% stake in a joint business with Tele2 Russia which will likely lead to a downgrade, however, other options remain available. The RWE is likely to be resolved once there is more clarity on these issues.
Tele2 Russia is a successful regional mobile-only operator in Russia with a lean and efficient business model. It is uniquely positioned as a mild price discounter. Tele2 Russia's ratings were placed on RWE following its acquisition by Russian Bank VTB from Tele2.
Rating Watch Evolving
Fitch understands that the company and its shareholders are likely to address their strategic options in the near future. Rostelecom's board approved the terms of its potential cooperation with Tele2 Russia and the announced intention is to create a joint venture between Rostelecom and Tele2 Russia. The two companies are expected to contribute their mobile assets to a joint business with Rostelecom intending to ultimately control a 45% stake in the joint venture.
Although the terms of the deal are not yet final, Fitch understands that Rostelecom has not made a commitment to become a majority shareholder in the new joint venture. In the event of a lack of a strong parent-subsidiary linkage between Rostelecom and the new company, Tele2 Russia is likely to be downgraded by at least one notch reflecting corporate governance concerns that private investors with a relatively weak credit profile may end up as effective controlling shareholders in the company. An aggressive capital structure and material asset divestments by Tele2 Russia may be credit concerns.
However, the deal has not been officially signed and negotiations continue. Tele2 Russia's ratings may be upgraded if linkage with Rostelecom is viewed as strong which will likely require shareholding of above 50% and an evidence of legal, operating and strategic ties.
VTB announced that it was a financial investor and already divested of a 50% stake to a consortium of private investors. Fitch believes that it is likely to divest or at least significantly further reduce its exposure to this asset in future as it would be unusual for a bank to hold on to an equity investment in a non-financial corporate.
Fitch understands that the plan is to make sure that public debt currently recourse to Tele2 Russia will become recourse to the new joint venture. A failure to do so would be viewed as a rating conern.
Successful 2G Operator
Tele2 Russia's ratings reflect the company's successful position of a value-for-money operator. It is the fourth-largest Russian mobile operator with around a 10% market share and 23.7 million subscribers at end-3Q13. The company has been able to grow its subscriber base slightly ahead of the market maintaining a strong customer perception of price leadership coupled with acceptable service quality.
Limited Geographic Franchise
Tele2 Russia's 2G licenses only cover less than half of the country's 143m population. It is unlikely that the company can organically acquire mobile licenses to operate in new regions, including in Moscow. The company will be challenged to increase its low market share of corporate customers unless it becomes a truly nationwide operator.
New Regulation is Positive
The introduction of mobile number portability in Dec 2013 should benefit the company and help it to eat into the market share of its larger peers. This new piece of regulation allows Tele2 Russia to more fully exploit the benefits of its market positioning as a mild price discounter.
Strong Cash Generation
Tele2R's business model has been efficient with a tight control over operating costs and capex leading to strong free cash flow generation. Fitch believes it would be a challenge to preserve the company's lean business model after the company has been severed from business processes of its former shareholder Tele2.