Portuguese Telecom Operator NOS Assigned 'BBB-' Rating; Outlook Stable

Transcription

1 Research Update: Portuguese Telecom Operator NOS Assigned 'BBB-' Rating; Outlook Stable Primary Credit Analyst: Thibaud Lagache, Paris ; thibaud.lagache@spglobal.com Secondary Contact: Xavier Buffon, Paris (33) ; xavier.buffon@spglobal.com Table Of Contents Overview Rating Action Rationale Outlook Ratings Score Snapshot Related Criteria Ratings List MARCH 14,

2 Research Update: Portuguese Telecom Operator NOS Assigned 'BBB-' Rating; Outlook Stable Overview NOS, SGPS, S.A. is Portugal's leader in pay-tv and the No. 2 player in fixed broadband and postpaid mobile services, thanks to well-invested networks and a strong brand, which have resulted in significant organic growth in recent years. That said, NOS faces direct competition from two other large players and operates solely in the small service area of Portugal. We consider that NOS has a solid balance sheet, a conservative financial policy, and sound free cash flow generation, despite significant sport-content costs and a lower EBITDA margin than several of its rated peers. We are assigning our 'BBB-' rating to NOS. The stable outlook reflects our expectation that NOS will deliver organic revenue growth and improve margins, sustain S&P Global Ratings' adjusted leverage comfortably below 2.5x, and strengthen its free operating cash flow to debt to significantly above 10%. Rating Action On March 14, 2018, S&P Global Ratings assigned its 'BBB-' long-term issuer credit rating to Portuguese telecommunications operator NOS, SGPS, S.A. The outlook is stable. Rationale The rating reflects NOS' leading position in Portugal's pay-tv market as well as its well-established presence as the No. 2 operator in mobile postpaid and fixed broadband, paired with our expectations that it will maintain S&P Global Ratings' adjusted leverage (debt to EBITDA) below 2.5x and generate sound and increasing free operating cash flows (FOCF). NOS was formed in 2013 from the merger between Portugal's No. 1 cable and audiovisuals company, Zon Multimedia, and the No. 3 mobile operator, Optimus, in response to Portugal Telecom's (PT's) launch of convergent offers (packages that include fixed and mobile services). NOS has since grown organically thanks to the successful integration of Zon and Optimus, and the launch of its convergent strategy, with market share gains across all services in both the consumer and business/wholesale markets translating into an improved customer mix MARCH 14,

3 (increasing penetration of higher-value convergent customers) and fixed average revenue per user (ARPU) growth. In coming years, we expect that NOS will continue to show organic single-digit revenue growth, supported by improving macroeconomic conditions and driven by a sustained pace of growth in more value-added convergent bundles and steady price increases despite tough competition. We expect this growth will also be supported by the increasing coverage of its 4G+ mobile network and the ongoing upgrade of its fixed network, following the reciprocal fixed-network sharing agreement it reached with Vodafone in 2017 to swap approximately 2.6 million households to fiber-to-the-home (FTTH) technology by We expect that by 2022 about 70% of NOS' footprint (3.1 million Portuguese households) will use FTTH technology. NOS' reported EBITDA margin (S&P Global Ratings' unadjusted) has improved in recent years, reaching 37% in 2017 up from 35.5% in 2015, thanks to its strong pay-tv position, which successfully supported the upselling of fixed and mobile services via attractive quad-play bundles. This resulted in a leading share of total net customer additions in mobile postpaid and broadband customers over the past four years (+1.6 million mobile postpaid and +411 thousand broadband customers) above PT and Vodafone, while maintaining its leading pay-tv market share and superior fixed ARPU. We expect that EBITDA margins will further improve toward 40% as convergence adoption increases. We note that 47.4% of fixed-access customers are currently convergent, from just about 3.8% at the beginning of 2014, and we expect it to reach 51% by Additionally, we believe NOS' margins will likely improve further from increasing operating leverage. That said, NOS' recent mobile network overhaul and planned fixed-network upgrade will continue to translate into heavy capital expenditures (capex), albeit somewhat lower than current level of 25%-26%. We expect capex will remain above 21% of revenues in order to address rising data/bandwidth demand through 4G+ technology and further increasing broadband speeds. We nevertheless expect that NOS will deliver solid and growing (reported) FOCF, reaching 160 million in 2019 compared with 57 million in 2016 ( 125 million in 2017), translating into improving adjusted metrics, such as FOCF to debt of 16% and leverage reducing toward 2.2x by Our assessment of NOS' business risk is supported by: The company's 4G mobile network, which covers 91% of the Portuguese population, combined with its well-invested next generation network, which covers about 90% of domestic households (4.1 million) through FTTH (20%) and Docsis3.1 cable (80%). The company's fixed network provides speeds of 100 megabytes per second (Mbps) or more to 73% of its fixed broadband customers, which supports higher consumer fixed ARPU ( 44.6 per month on average) than competitors (PT 37.7 per month on average). NOS' No. 1 position in pay-tv and its attractive brand, which successfully supported the upselling of fixed and mobile services with competitive convergent offerings. NOS has a strong track record of net customer gains, translating into subscriber market shares of above 38% in MARCH 14,

4 fixed broadband (PT 40%), above 43% in pay-tv (PT 38%), and about 2.6 million of total postpaid mobile customers, which is well above the No. 3 operator Vodafone's 1.9 million. NOS' leading convergent position in terms of multiplay subscribers' (share of about 40%, compared with Vodafone's 17%) and a solid No. 2 position in quad-play bundles (40.5% share compared with PT's 48.0%, and Vodafone's 9%). NOS' good customer service, which is illustrated by its relatively low churn, mitigating a more difficult network differentiation in a mature and highly penetrated market. Limited exposure to content cost inflation, as the rights for broadcasting major sporting events are equally shared among players through a joint venture and costs are frozen until , which is a unique model compared with the rest of Europe. Likely absent onerous regulatory risks, other than the recent roaming policy across Europe. Lower mobile termination rates (namely the fee one telecommunications operator charges another for terminating calls on its network) are largely offset by price increases. Our assessment of NOS' business risk is balanced by: NOS having to compete with two other large players that operate overlapping platforms and also offer converged services, within Portugal's relatively small service area (10.3 million inhabitants, about 5.5 million households). The company's relatively limited scale and operations compared with market incumbent PT, which has a slightly larger network footprint of 5.0 million households versus NOS' 4.1 million currently (we expect 4.4 million for NOS by 2018). PT has a larger business and wholesale segment than NOS, although NOS has gained market share in recent years from PT. NOS' EBITDA margin, which is lower than that of PT and other European cable players. The uncertain market impact of Media Capital's acquisition by Altice. Our view of NOS' financial risk profile is supported by its solid balance sheet, with relatively low leverage of 2.4x at end-2017, sound free cash flow generation, and a conservative financial policy targeting around 2.0x net reported leverage. Despite our forecast that NOS will distribute most of its FOCF to shareholders, we expect that S&P Global Ratings' adjusted leverage will slightly improve thanks to EBITDA growth and remain well below 2.5x over our forecast horizon through Our adjustments to debt primarily include the addition of operating lease liabilities of about 158 million stemming from NOS' telecom networks (towers and rooftops equipment), movie theatres, and stores, as well as securitization, among others. In our base case, we assume: Portuguese GDP per capita will reach above $23,000 by 2020, following GDP MARCH 14,

5 growth of about 2.7% in 2017 and about 1.8%-2.3% over , mainly driven by continued solid economic growth; and the unemployment rate will decline below 9.0% by 2018 and to 7.0% by The Portuguese telecom market will grow primarily from price increases and rising convergence adoption, rather than from subscriber or household growth (which we expect to increase in line with inflation). We expect this is due to the already high penetration of telecom services (about 170% mobile penetration per population, about 70% and 90% of broadband and pay-tv penetration per households, respectively). NOS' total revenues will increase by about 3.0% in 2017, 1.6% in 2018, 2.3% in 2019, and 1.6% in 2020 (+1.7% compound annual growth rate [CAGR] over our forecast period), mostly driven by service revenues growth (+2.2% CAGR). Consumer revenues will increase by 1.7% on average per year over (+4.2% in 2017), driven by: yearly price increases (slightly above inflation rate) in convergent packages; further adoption of quad-play packages, with convergent customers reaching about 51% of the pay-tv base by 2020; and NOS' network expansion. We expect this will in turn support continuous, although moderate, revenue-generating-unit (RGU) growth (1% in average per year) and fixed ARPU growth. Business and wholesale revenues will increase by a +3.3% CAGR, supported by additional contract wins RGU growth, and price increases. Flat growth in the audiovisual and cinema business. S&P Global Ratings' adjusted EBITDA margins will improve to about 38%-39% over , from about 37%-38% in 2017, stemming from revenue growth and an improved customer mix. Total reported capex will decline to about 21.0%-23.0% of revenues over , from 24%-25% in 2017, excluding spectrum costs for 5G. Capex reduction will be mainly driven by more moderate RGU growth and subsequently lower customer-related capex. However, we expect capex will remain above 21% of sales, given NOS' planned FTTH upgrade and mobile network overhaul that it initiated in late 2017 to optimize its spectrum utilization and improve capacity for 4G+ technology. Distribution of the bulk of FOCF in dividends of 103 million in 2017, 155 million in 2018, and increasing to about 180 million by Based on these assumptions, we arrive at the following credit measures: Adjusted debt to EBITDA declining to about 2.2x in 2020, from 2.4x in Funds from operations (FFO)-to-debt ratios improving to about 40% by 2020, from 37% in Gradually improving FOCF to debt of about 11%-16% over , versus 10%-11% in MARCH 14,

6 Liquidity We assess NOS' liquidity as adequate, based on our view that the company has a satisfactory standing in credit and equity markets, sound relationships with banks, and generally prudent risk management. We also expect that sources will cover uses by more than 1.2x over the 12 months from Dec. 31, We note that NOS has 118 million in debt maturing in 2018, and we expect that the company will extend its maturity profile before rolling into the six-month maturity window. We estimate that principal liquidity sources for the 12 months from Dec. 31, 2017, include: FFO of about 550 million. Availability under undrawn committed lines of 245 million. Cash on balance sheet of 3.0 million. For the same period, we estimate that principal liquidity uses include: Debt maturities of about 20 million within the next six months. Working capital outflows of about 30 million. Capex of about 390 million. Dividend distributions of about 155 million. Outlook The stable outlook reflects our expectation that NOS will continue to leverage its attractive brand and solid market position, deliver organic revenue growth, and gradually increase margins. We think this will position the company comfortably at our 'BBB-' rating level, with S&P Global Ratings' adjusted leverage comfortably below 2.5x and FOCF to debt above 10%, steadily rising on moderating investments and increasing absolute EBITDA. Downside scenario We could take a negative rating action if adjusted leverage increased for a prolonged period above 2.75x, or if FOCF to debt deteriorated significantly below 10%. In our view, this could occur from a more aggressive financial policy than we foresee, if NOS experienced declining revenues, or if margins started to deteriorate, for example as a result of a market-wide price decline, which seems unlikely at this stage. Upside scenario We could raise the rating if NOS' performance is stronger than our base-case expectation and translates into FOCF to debt significantly above 15% and adjusted leverage sustainably reducing toward 2.0x. MARCH 14,

7 Ratings Score Snapshot Issuer Credit Rating: BBB-/Stable/-- Business risk: Satisfactory Country risk: Intermediate Industry risk: Intermediate Competitive position: Satisfactory Financial risk: Intermediate Cash flow/leverage: Intermediate Anchor: bbb- Modifiers Diversification/Portfolio effect: Neutral (no impact) Capital structure: Neutral (no impact) Liquidity: Adequate (no impact) Financial policy: Neutral (no impact) Management and governance: Satisfactory (no impact) Comparable ratings analysis: Neutral (no impact) Related Criteria Criteria - Corporates - General: Reflecting Subordination Risk In Corporate Issue Ratings, Sept. 21, 2017 General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017 Criteria - Corporates - General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 Criteria - Corporates - Industrials: Key Credit Factors For The Telecommunications And Cable Industry, June 22, 2014 General Criteria: Group Rating Methodology, Nov. 19, 2013 Criteria - Corporates - General: Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013 Criteria - Corporates - General: Corporate Methodology, Nov. 19, 2013 General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013 General Criteria: Methodology: Industry Risk, Nov. 19, 2013 General Criteria: Methodology: Management And Governance Credit Factors MARCH 14,

8 For Corporate Entities And Insurers, Nov. 13, 2012 General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009 Ratings List New Rating NOS, SGPS, S.A. Corporate Credit Rating BBB-/Stable/-- Additional Contact: Industrial Ratings Europe; Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at for further information. Complete ratings information is available to subscribers of RatingsDirect at All ratings affected by this rating action can be found on the S&P Global Ratings' public website at Use the Ratings search box located in the left column. Alternatively, call one of the following S&P Global Ratings numbers: Client Support Europe (44) ; London Press Office (44) ; Paris (33) ; Frankfurt (49) ; Stockholm (46) ; or Moscow 7 (495) MARCH 14,

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