S&P summary: Kazakhtelecom (JSC)
June 13. Reuters
Kazakhtelecom’s SACP is constrained by weak macroeconomic conditions in Kazakhstan, where growth is limited in the consumer-oriented segments, and by its own relatively weak operating performance and declining profitability. In addition, it reflects the company’s exposure to foreign-exchange and interest-rate risk.
The key supporting factor for the rating is Kazakhtelecom’s dominant market position in its most important revenue segments, which include local and long-distance telephony, data transmission, internet, and other value-added services. Kazakhtelecom’s improved, expanded network and vertically integrated business model support its market leadership, which will be hard for any potential competitors to challenge over the next three years.
In accordance with our criteria for government-related entities, our view of a “moderately high” likelihood of extraordinary government support is based on our assessment of Kazakhtelecom’s:
– “Strong” link with the state, primarily because the government defines Kazakhtelecom’s strategy and financial policy and is unlikely, in our view, to reduce its majority ownership stake in the medium term; and
– “Important” role as Kazakhstan’s sole provider of essential telephony services in many regions of the country. The company exclusively owns and continuously invests in telecom infrastructure. Moreover, Kazakhtelecom is one of the largest employers in Kazakhstan, underlining the importance of the company for the country.
S&P base-case operating scenario
We expect Kazakhtelecom’s revenue growth to slow in 2012 to about 5% from 13% in 2011, as the increase in broadband subscribers likely peaked in 2011. We also assume that revenues from traditional fixed-line voice services will decline gradually, limiting the consolidated revenue growth potential.
In the first quarter of 2012, Kazakhtelecom sold its stake in Kazakhstan’s largest mobile operator GSM Kazakhstan (not rated), which had historically paid significant dividends. This will significantly hamper Kazakhtelecom’s adjusted EBITDA, which included the dividends. In our base-case scenario, we assume that the adjusted EBITDA margin will decline to about 40% in 2012 from 55% at the end of 2011. However, we assume that the profitability of Kazakhtelecom’s core operations will remain robust, supporting by the company’s various cost-cutting initiatives.
S&P base-case cash flow and capital-structure scenario
We expect Kazakhtelecom’s free operating cash flow (FOCF) to weaken significantly in 2012, reflecting the loss of incoming dividends. Moreover, we believe that in 2013 FOCF can turn negative if the company were to pursue an aggressive strategy in the mobile telephony segment.
With the completion of the asset sale early this year, Kazakhtelecom strengthened its net cash position. In our base-case scenario, we assume that Kazakhtelecom will use its cash to construct its own mobile telephony network and other capital spending. We anticipate that Kazakhtelecom will not require a meaningful increase in debt and that its leverage ratios will remain well below our threshold for the rating, namely debt to EBITDA of 2x.
Kazakhtelecom has recently announced a large on-off dividend payment of KZT210 billion, which will not affect the rating because of the company’s financial flexibility. We assume that Kazakhtelecom will continue paying dividends. However, another one-time dividend payment of this size is not factored into our base case.
We view Kazakhtelecom’s liquidity as “adequate,” as defined in our criteria. The company’s cash and equivalents of Kazakhstani tenge (KZT) 319.3 billion (about $2.15 billion) as of March 31, 2012, not only fully cover all of its debt, but also provide a cushion for potential negative FOCF for the next several years. The company has announced plans to pay dividends of KZT210 billion. However, we believe this will not have any meaningful impact on its liquidity. Accordingly, we calculate that the company’s ratio of liquidity sources to uses will exceed 1.2x in each of the next two years. The company’s debt maturity profile poses no challenges, in our view, since it mainly features amortizing payments of about KZT10 billion per year.
The issue rating on Kazakhtelecom’s local currency unsecured debt issue is ‘BB’, the same as the corporate credit rating. The recovery rating on these notes is ‘3’, indicating our expectation of meaningful (50%-70%) recovery in the event of a payment default. This incorporates the unsecured nature of the debt and a jurisdiction-related recovery-rating cap.
We have valued the business as a going concern because we believe that Kazakhtelecom’s business model would remain viable after a default, thanks to its significant market position, valuable nationwide infrastructure, and customer base. We believe that a hypothetical default would most likely stem from deterioration in general economic conditions in Kazakhstan, which would in turn result in operational underperformance and negative cash flow generation.
The issue and recovery ratings on the unsecured debt take into account the nature of Kazakhtelecom’s assets, the probability of a restructuring or going-concern sale, and the likelihood of insolvency proceedings being adversely influenced by Kazakhtelecom’s domicile in Kazakhstan.
For full details, please see “Kazakhtelecom (JSC)’s Recovery Rating Profile,” to be published shortly.
The stable outlook reflects our assessment that Kazakhtelecom’s core business will likely continue to generate stable and predictable cash flows, based on its dominant position in a market with very limited competition. We anticipate that given its increased financial flexibility, Kazakhtelecom might consider significantly increasing its capital spending. The company’s financial profile will likely nevertheless remain commensurate for the rating, as long as leverage stays moderate, with some headroom relative to our rating benchmark of debt to EBITDA of less than 2x.
We could downgrade the company if it made sizable cash outlays, such as for acquisitions or dividend distribution, that increased leverage to more than 2x. A significant reduction in the state’s shareholding in Kazakhtelecom, and a consequent reappraisal of our assessment of the company’s link with and role for the Kazakh government, could lead to a one-notch downgrade.
The possibility of an upgrade is limited over the next 12 months, as it is constrained by the fundamental characteristics of the company’s business. In the longer term, it would require Kazakhtelecom to show a strong position in mobile telephony and revenue diversification in value-added segments of the market.
Related Criteria And Research
– Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
– 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
– 2008 Corporate Criteria: Analytical Methodology, April 15, 2008