Fitch Ratings has affirmed Wind’s Issuer Default Rating at ‘B+’ with a Stable Outlook. Fitch has also affirmed Wind’s instrument ratings. The affirmation reflects that Wind’s operating trends are improving and Fitch expects revenue to stabilize in 2016. Capex is likely to remain high over the medium term as the company invests to meet growing demand for data services, limiting the pace of debt reduction. Leverage is high and headroom at the current rating remains limited. A potential merger with Three Italy has not been factored into our rating and will be treated as event risk.
Fitch Ratings has affirmed Wind Telecomunicazioni S.p.A’s (Wind) Issuer Default Rating (IDR) at ‘B+’ with a Stable Outlook. Fitch has also affirmed Wind’s instrument ratings. A full list of rating actions is at the end of this commentary. The affirmation reflects that Wind’s operating trends are improving and Fitch expects revenue to stabilise in 2016. Capex is likely to remain high over the medium term as the company invests to meet growing demand for data services, limiting the pace of debt reduction. Leverage is high and headroom at the current rating remains limited. A potential merger with Three Italy has not been factored into our rating and will be treated as event risk. KEY RATING DRIVERS Stabilising Mobile Market The Italian mobile telecom market is continuing to shrink in revenue terms. However, the pace of decline has significantly abated and operators are braced for less pressure ahead. We believe more stability can be expected in 2016 driven by the end of a price war and rising mobile data consumption. Wind reported a -3.3% yoy service revenue reduction in 1Q15, which is a significant improvement compared with double-digits declines of -10.6% yoy in 1Q14 and -12.7% yoy in 1Q13. Wind outperformed its key competitors over 2012-2014, steadily increasing its subscriber and revenue market share. We view Wind’s competitive positions as strong, but any significant further gains are unlikely. The worst of the price war seems to be over, which promises more tariff stability in future. With average revenues per user (ARPU) already low in the range of EUR12-EUR13 per month, customers are likely to become relatively less price sensitive. Subscriber demand for higher mobile speed and larger amounts of mobile data remain strong, which will be the key growth driver. With the current tariff structure suggesting surcharges for larger data consumption, this may drive ARPUs up. However, we do not expect a significant rebound as the Italian economy remains weak and unemployment high at above 12%. Profitable Fixed-Line Business. Wind’s strategy to prioritise profitable direct fixed-line customers and focus on margins is likely to be sustainable, in our view, at least until new fibre infrastructure starts to have an impact. Against the backdrop of relatively modest capex requirements, this segment is likely to have achieved strong cash flow generation, supporting the company’s credit profile. However, given Wind’s reliance on Telecom Italia’s (TI) infrastructure, EBITDA margins are unlikely to rise from their current levels (which is slightly below 30%), while the subscriber base and revenue will remain on a modest decline. LTE, Fibre Networks Key For Future Wind has been able to achieve broad parity with peers in terms of network coverage and capacity, both in mobile and fixed line segments — for the latter through the reliance on TI’s ADSL-capable infrastructure. However, maintaining network parity with peers may become more challenging. The company may need to increase its network investments, which would put pressure on its leverage. Wind is currently lagging its peers in terms of LTE network coverage. As of end-1Q15 the company had 38% population coverage vs TI’s and Vodafone’s approximately 80%. This has not been a significant competitive disadvantage in view of low LTE take-up in Italy, which we estimate at below 10% of the country’s subscriber base at end-1Q15. The company’s plans suggest a steady catch up, on the assumption of continuing strong value proposition of its current 3G offerings. However, a quicker than expected LTE take-up may jeopardise this and require faster investment. A pivotal decision for the industry would be a fibre development plan. Wind will have to ensure its access to the new infrastructure that will be critical to maintain its positions in the fixed-line segment. Although the final terms are not yet clear and a significant in-kind infrastructure contribution by Wind is likely, the company may be required to make additional cash contributions to the new network development, which may be a challenge in view of its stretched leverage. The Italian government pledged EUR6bn in support to encourage new fibre network construction that will span 85% of the country’s households. However, incumbent TI is in disagreement with other industry players as to how to achieve this. Wind has signed a letter of intent to form a consortium with other players including Vodafone and MetroWeb to participate in a construction of a nationwide fibre network, in line with the government’s guidelines. Tight Cash Flow Generation We expect Wind’s free cash flow generation to remain tight, with the company unlikely to be able to generate more than EUR150 m per year on average in 2015-2017. A few rounds of refinancing in 2014 and 1Q15 resulted in substantial interest savings, but these would be largely diluted by moderate EBITDA pressures. The company has maintained strong cost discipline, which we view as a key factor supporting future EBITDA margins. High Leverage Wind’s leverage is high and its deleveraging capacity is low. We expect leverage to remain around the current levels in the medium term, sensitive to minor EBITDA or cash flow pressures. Wind’s leverage was at 5.8x net debt/EBITDA and 6.8x funds from operations (FFO) adjusted net leverage at end-2014 (Fitch definitions). The sale of a 90% stake in the company’s tower assets will only result in a marginal improvement in these metrics of around 0.2x-0.3x, but these would be diluted by continuing modest EBITDA pressures in 2015. Shareholder Support Positive but Limited Wind’s ratings benefit from potential support from its sole ultimate shareholder, Vimpelcom Ltd., whose credit profile remains significantly stronger than Wind’s. However, we believe that a further rise in Wind’s leverage may reduce Vimpelcom’s propensity to provide support. An increase in leverage to above 6x net debt/EBITDA will no longer likely be consistent with expectations of any parental support. Vimpelcom’s support has been modest so far. A EUR500m cash contribution in conjunction with PIK-notes refinancing in 1H14 was insufficient to materially reduce Wind’s leverage, given its limited size relative to Wind’s total debt of approximately EUR10bn. Vimpelcom has not committed itself to any additional support. No Short-Term Refinancing Risks Wind does not face any material refinancing risks before 2019 when approximately EUR850m of its debt comes due. KEY ASSUMPTIONS Fitch’s key assumptions within the rating case for Wind include the following: — Mobile revenue stabilisation from 2016 — Stable EBITDA margin of around 37% supported by disciplined cost control — Capex in the range of EUR800m per annum in the medium term — Substantial interest savings on the back of a few rounds of refinancing in 2014 and 1H15 — A rise in lease payments driven by the tower sale in 1H15 — No dividend payments RATING SENSITIVITIES Negative: Future developments that may individually or collectively lead to negative rating action include -A deterioration in leverage beyond 6x net debt /EBITDA and/or FFO adjusted net leverage sustainably above 6.5x -Continuing operating and financial pressures leading to negative FCF generation Positive: Future developments that may individually or collectively lead to positive rating action include -Tangible parental support such as equity contribution or debt refinancing via intercompany loans leading to a material reduction in Wind’s leverage. -Net debt/EBITDA sustainably below 5.5x and FFO adjusted net leverage sustainably below 6x -Stabilisation of operating and financial performance resulting in stronger and less volatile FCF generation FULL LIST OF RATING ACTIONS Wind Telecomunicazioni S.p.A. Long-term IDR: affirmed at ‘B+’; Stable Outlook Short-term IDR: affirmed at ‘B’ Senior credit facilities: affirmed at ‘BB-‘/’RR2’ Wind Acquisition Finance S.A. Senior secured fixed and floating 2020 notes: affirmed at ‘BB-‘/’RR2’ Senior unsecured 2021 notes: ‘B-‘/RR5 Contact: Principal Analyst Slava Bunkov Associate Director +7 495 956 9931 Supervisory Analyst Nikolai Lukashevich, CFA Senior Director +7 495 956 9968 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chair Damien Chew, CFA Senior Director +44 20 3530 1424 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: email@example.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary.