Kazakhtelecom 'BB+' And 'kzAA' Ratings Affirmed Following K-Cell Acquisition; Outlook Stable

  • On Dec. 12, 2018, Kazakhtelecom JSC signed an agreement to acquire 75% of telecom operator K-Cell for US$445 million in December 2018. And we expect Kazakhtelecom will acquire an additional 49% stake in its mobile joint venture (JV) from Tele2 in 2019.
  • The enlarged group will benefit from a mobile market share of about 64%, larger scale, stronger adjusted margins, and growth opportunities. In our view, this will offset the temporary peak of adjusted debt to EBITDA at about 2.1x in 2019, before it declines to about 1.8x in 2020 (against 1.4x in 2019 and 1.2x 2020 in our previous base case excluding K-Cell).
  • As a result, we are affirming our 'BB+' issuer credit and 'kzAA' Kazakhstan national scale ratings on Kazakhtelecom.
  • The stable outlook reflects our expectation that adjusted debt to EBITDA will rapidly decline to below 2x after a temporary peak of about 2.1x in 2019 and that free operating cash flow (FOCF) to debt will remain above 10%.

MOSCOW (S&P Global Ratings) Dec. 20, 2018--S&P Global Ratings today took the 
rating actions listed above. The affirmation reflects our view that the 
benefits from the acquisition of K-Cell will offset leverage temporarily just 
above our threshold for the rating. The enlarged group has a stronger market 
position, stemming from an increase in the mobile market share in Kazakhstan 
to about 64% from 28% (via the JV with Tele2); larger scale with added 
revenues on top of our previous 2019 estimate for Kazakhtelecom, which already 
included the revenue increase from the Tele2 JV. In addition, we expect the 
adjusted EBITDA margin to improve gradually, partly because K-Cell reports 
higher margins but also because we expect Kazakhtelecom to achieve cost 
synergies over time, and organic revenues growth. 

In our view, these positive factors balance the increase in leverage stemming 
from the transaction. In 2019, we expect that leverage will be slightly above 
2.0x and FOCF to debt slightly above 10% in 2019, before improving in 2020 to 
1.8x and 17%-18%, respectively. These ratios are weaker than in our previous 
base case excluding K-Cell (1.4x and 21% in 2019) but commensurate with the 
'BB+' rating, because we have revised our credit measure targets that we deem 
adequate for the rating; target debt to EBITDA is now 2x compared with "below 
1.5x" previously to reflect the benefits from K-Cell.

Kazakhtelecom funded the transaction, a 51% stake in K-Cell from Fintur 
Holdings B.V. and 24% share in K-Cell from Telia (the remaining 25% are free 
float), with Kazakhstani tenge (KZT) 100 billion bonds and about KZT65 billion 
in cash on the balance sheet.

Our rating on Kazakhtelecom remains constrained by the group's exposure to 
country risk, which we assess as high for Kazakhstan, where all of the group's 
revenues and assets are located. In our view, Kazakhtelecom's credit quality 
is also affected by its public policy role, which sometimes requires it to 
invest in projects with long payback periods. A recent example of such a 
project is the four-year KZT48.5 billion project Kazakhtelecom started in 2018 
to provide high-speed internet access to rural areas. This will spur a hike in 
the company's capital expenditures (capex)-to-sales ratio to 18% in 2019 from 
10% in 2016-2017. We believe that its FOCF will weaken only temporarily as the 
bulk of capex related to this project will occur in 2019. We project the 
capex-to-sales ratio will fall to 16% in 2020. Our rating also takes into 
account our view that Kazakhtelecom's immediate 51% owner, Kazakhstan's 100% 
state-owned investment fund Samruk-Kazyna, has weaker credit quality than 
Kazakhtelecom, with a 'b' stand-alone credit profile. Additionally, we also 
factor in potential integration risks from the consolidation of both the JV 
and K-Cell.

The stable outlook reflects our expectation of the successful integration of 
K-Cell. This should result in continued organic revenue growth and margin 
improvements with adjusted debt to EBITDA rapidly declining below 2x after a 
temporary peak at about 2.1x in 2019 and FOCF to debt remaining above 10%. 

We could lower the rating if Kazakhtelecom's leverage remained above 2.0x for 
a longer period or if FOCF to debt declined below 10%, for example stemming 
from higher-than-expected integration costs from the K-Cell acquisition or 
higher-than-expected capex stemming from Kazakhtelecom's public policy role. 

Rating upside is remote in the next 12 months. However, we could take a 
positive rating action if Kazakhtelecom's adjusted leverage declined 
sustainably to 1.5x or below, coupled with FOCF to debt at or above 20%.
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