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Fitch Rates Turkcell 'BBB-'; Outlook Stable

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Fitch Ratings has assigned Turkcell a Long term Issuer Default Rating (IDR) and a senior unsecured rating of 'BBB '. The Outlook on the IDR is Stable.

­The ratings incorporate Turkcell's strong domestic business profile, leading market position and high-quality mobile business, well-positioned and growing fixed line operations and sound financial performance. Limited diversification, ambitions to expand internationally and its targeted leverage, which in turn will lead to a growing currency mismatch, somewhat constrain the ratings despite low financial leverage at present.

Strong Domestic Position

Turkcell is positioned strongly as the leading mobile operator in a three player market. With 34 million customers and 47% market share at 2Q15, its overall subscriber market share is 18 percentage points ahead of second placed Vodafone. A high postpaid mix gives it 48% share of this segment - a twenty percentage point lead over its closest rival. The Turkish market is maturing - with penetration estimated by Fitch at 94%. An urban population that is expected to continue to grow though offers ongoing growth potential revenue growth for Turkcell is more likely to come from the ongoing shift in the postpaid mix, increasing smartphone penetration and improving data revenues.

Fitch estimates Turkcell's Superonline has 14% of the broadband market (at 1Q15), with roughly 1.3 million broadband customers, and a base that is growing at 35% year on year. With 818,000 fibre to the home (FTTH) customers at 2Q15 and a business that is growing in the mid-20s in percentage terms it has 53% of the country's FTTH market. A nascent IPTV business (140k customers at end-2Q15) is important as triple play becomes more important in the market and convergence is expected to be of increasing importance in Turkcell's offer.

Competitive Pressures

Turkcell's market is competitive, with an effective fixed-line incumbent and a competitive dimensioned three- player mobile market. In mobile Turkcell continues to suffer modest net subscriber losses to Turk Telecom's (TT) Avea and Vodafone. Fixed line and broadband services are facing competition from the incumbent, alternative operators including Vodafone, and cable, while a well-developed pay-TV market is dominated by satellite operators, Digiturk and D-Smart.

Triple play and convergence are expected to become increasingly important. Turk Telecom (TT) leads the IPTV market and is offering a satellite service in areas not accessed by fibre, a strategy Fitch believes Turkcell may also consider. Both Turkcell and TT have committed fibre builds, while recent spectrum auctions saw Turkcell acquire a leading share of available frequencies, although at roughly EUR1.6bn, it has agreed to pay significantly more in absolute terms than its competitors.

Investment levels are therefore expected to remain high over the next three years, while the temptation to bid for football rights or other premium content - Super lig rights come up for renewal in 2016/17 - has the potential to increase commercial investment and pressure margins.

International Ambitions

Management has stated it intends to adopt a more leveraged financial policy and identified international expansion as an area for investment. Fitch recognises the business can sustain some leverage while international diversification can help offset regional or domestic volatility in a business. Turkcell's domestic operations account for roughly 90% of revenues and a higher share in earnings and cash flow. Regional expansion is likely to be focused on markets which are geographically and culturally close to Turkey - potentially Eurasia, the Middle East or Balkans; markets that offer profitable growth potential but that are also likely to add emerging market risk. Any potential deal is considered event risk - although Fitch notes the company has some headroom within its existing leverage metrics.

Corporate Governance Clearer

Ownership and governance issues have improved. A shareholder impasse that had blocked dividends for the past five years has been resolved - a USD1.5bn payment covering 2010-2014 was made in May 2015. A seven member board of independent directors is appointed by the Capital Markets Authority, with each of the principle shareholders - TeliaSonera (TLSN), Alfa Group and Cukurova, given the opportunity to nominate. Fitch understands from Turkcell that only TLSN alone has taken advantage of this opportunity. Transparency of reporting and management autonomy including public statements around financial policy and strategy suggest a pragmatic and normalised governance approach is being adopted.

Financial Policy; Leverage Target

Management has said it will pursue a more efficiently capitalised balance sheet and stated publicly that net debt-to-EBITDA could be tolerated up to 2.0x. Fitch expects a normalised range is more likely to evolve in the region of 1.0x-1.5x. With a delta to Fitch's guidance metric of funds from operation (FFO) net lease adjusted leverage of around 0.7x, unadjusted leverage that is managed below 1.5x would be below Fitch's downgrade guideline of 2.25x.

Fitch acknowledges Turkcell's business and operational profile can support higher debt than at present. Areas of investment deemed likely to increase leverage include spectrum payments, M&A and ongoing fibre investment. Fitch's current base case forecasts FFO net leverage settling at around 1.6x by 2019. The normalised metric takes account of a period of heightened capex given scheduled spectrum costs payments that will impact cash flow through to 2018.

FX Mismatch and Volatility

Although with its currently unlevered balance sheet a mismatch between hard currency- denominated debt and a mainly lira-based cash flow do not impact its financial profile - this will become a risk factor as the capital structure evolves and leverage increases. The recapitalisation of both its Ukraine and Belarusian subsidiaries has removed a significant debt currency mismatch. Fitch nonetheless expects future holdco debt to be raised largely in hard currency, which will leave the company exposed to leverage shocks in the event of accelerated lira depreciation.

Our base case assumes an ongoing and gradual depreciation of the Turkish lira. A progressive depreciation sensitivity which assumes a further 20% decline in 2016 (after what has been a fall by around 38% this year), is forecast to push FFO adjusted net leverage to a peak of around 2.2x in 2017, before falling thereafter. Although metrics at this level would remain below our downgrade guidance of 2.25x this outcome would remove rating headroom. A combination of events that include significant M&A or heightened content investment, combined with such an FX outcome, would put pressure on the downgrade metric and potentially undermine the company's investment grade rating.

Ratings Effectively Capped

At 'BBB-' Turkcell's IDR is in line with the Turkish sovereign and in line with incumbent telecom, TT. Given its current business profile the company is primarily a domestic business with ambitions to diversify internationally. Turkcell exhibits similar operational strengths to the incumbent and a lower financial risk profile - the latter will change as management implement stated leverage targets and execute expansion plans.

Fitch considers a degree of execution risk exists, which along with other risk factors - FX risk, M&A event risk, a period of heightened investment and risk of TV content cost inflation - constrain the ratings at the current level. These factors add the potential for rating volatility, depending on how disciplined management prove in adhering to its stated financial policy.

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