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Fitch: Liquidity a Credit Constraint for Russian Fixed-Line Incumbents

February 18, 2008 | Cbonds

Fitch Ratings – London/Moscow – 18 February 2008: Fitch Ratings has said today that weak liquidity management and a high reliance on short-term financing are a key credit constraint for Russian fixed-line telecom incumbents.

Fitch views this heavy reliance on short-term debt as a negative rating factor as it exposes Russian telecoms incumbents to significant refinancing risks, and in the current tight debt market environment liquidity issues are a major concern. “Although many of the incumbents achieved significant operational improvements and face reasonably strong growth prospects on the back of rapid broadband roll-out, suggesting a potential upward rating momentum, material short-term refinancing risks are not consistent with a higher rating level,” says Nikolay Lukashevich, Senior Director in Fitch’s TMT team. Liquidity concerns are exacerbated by the industry’s negative free cash flow generation as a result of unsustainably high infrastructure capex, which account for about 30% of revenues.

Fitch notes, however, that telecom capex is highly scalable. Exceptionally heavy investments in 2004-2007 mean operators have the flexibility to make significant capex cuts if needed, without materially affecting their competitiveness, market shares and service quality. Although high capex is partially driven by the regulatory requirement to fully digitise local exchange infrastructure by end-2009, Fitch understands that this deadline is flexible and that penalties for breaching it are highly unlikely. The agency estimates that capex cuts may be sufficient to return free cash flow generation to positive territory and provide a modest liquidity cushion.

As Russian telecoms incumbents are ultimately controlled by the government, they benefit from strong relationships with state-controlled banks, such as Sberbank (‘BBB+’/Stable) and VTB (‘BBB+’/ Stable), their dominant providers of bank debt financing. Fitch expects these banks will continue to be key lenders to the industry. However, direct financial support from the incumbents’ parent holding, Svyazinvest, is unlikely. Fitch also does not expect Svyazinvest will be willing, or able, to tap the cash flows of strongly performing subsidiaries to support their vulnerable counterparts.

In Fitch’s view, incumbent operators’ operating cash flows are stable and visible while their leverage is moderate for their ratings, making them quality domestic corporate borrowers. Fitch believes underlying operating strengths make these companies attractive bank clients. However, domestic longer-term borrowing has become increasingly scarce, shortening these operators’ debt maturity profiles. Fitch’s ratings will increasingly factor in the ability of regional incumbents to maintain sufficient back-up bank credit lines on a rolling basis.

Individual liquidity and refinancing risks differ significantly across the industry. North-West Telecom (‘BB-’ (BB minus)/Stable) benefits from considerable cash inflow after it sold its 15% stake in Telecominvest for USD410m in October 2007, while Volgatelecom’s (‘BB-’ (BB minus/Stable) debt maturities are well-spread, with only 18% of its debt being short-term (less than one year) at end-H107 and a modest 1.5x net debt/EBITDA at end-2006. Refinancing risks are much higher for Uralsvyazinform (‘B+’/Stable) and Sibirtelecom (‘B+’/Stable) with short-term debt accounting for 42% and 49%, respectively, of total at end-H107. The share of short-term debt at Centertelecom (‘B’/Positive) was at an acceptable 16% at end-H107 although this is compromised by its lower flexibility to cut capex given relative under-investment in 2005-2006. At end-September 2007, 27% of Dalsvyaz’s (‘B+’/Stable) debt was short-term while its leverage was moderate at 1.8x at end-2006, mitigating refinancing concerns.

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