PPF Arena 1 B.V., Parent Of O2 Czech Republic, CETIN, And Telenor CEE, Assigned 'BB+' Rating; Outlook Stable

  • PPF Arena 1 B.V.--holding company of O2 Czech, CETIN, and Telenor CEE--is a well-established and diversified mobile telecommunications network operator in Central and Eastern Europe (CEE), with relatively stable markets, and sound mobile networks, and spectrum holdings.
  • The company is a mobile-only player in five of the six countries in which it operates, with the exception of the Czech Republic where it is also the incumbent fixed operator and investing in a fiber network.
  • We are assigning our 'BB+' long-term issuer credit rating to PPF Arena 1.
  • The stable outlook reflects our anticipation of 1%-2% pro rata revenue growth and an adjusted EBITDA margin of more than 40% in 2019-2020, combined with adjusted debt to EBITDA of below 3.5x, and free operating cash flow (FOCF) to debt of close to 15%, excluding spectrum payments.
PARIS (S&P Global Ratings) March 14, 2019—S&P Global Ratings said today that 
it took the rating actions listed above. 

The rating reflects PPF Arena 1's leading positions in most of the mobile 
markets in which it operates, where the competitive environment has been 
relatively stable. It also factors in the company's position as a midsize 
European telecom operator, with presence in several CEE countries and an 
above-industry average adjusted EBITDA margin. We consider PPF Arena 1's sound 
mobile networks and capacity, as well as the ongoing upgrade of wholesale 
infrastructure provider CETIN's fixed network in the Czech Republic, a 
positive. In particular, we believe the company's investments in fiber 
technology will benefit CETIN's wholesale activities, and O2's subscriber mix, 
and retail fixed broadband market shares. The absence of fixed broadband 
activities in Slovakia and Telenor CEE's markets, as well as our view of a 
weaker fixed broadband position in the Czech Republic compared with other 
European incumbents, mitigate these strengths. Our ratings also factor in our 
expectation that PPF Arena 1's adjusted debt to EBITDA will be about 3.4x over 
the next two years. Growing capital expenditure (capex) for spectrum and a 
fixed network upgrade, combined with dividend payments, will hamper any 
material deleveraging prospects. In addition, we forecast the company's 
reported net leverage at about 3x, which is within management's financial 
policy guidelines.  

Our assessment of PPF Arena 1's business risk is supported by its strong 
position in the mobile markets of most of its countries of operation. We also 
see the company's geographic diversification in six CEE countries, strong 
adjusted EBITDA margin exceeding 40%, sound mobile network and capacity, and 
the ongoing upgrade of its fixed broadband network in the Czech Republic as 
business strengths. 

PPF Arena 1 became a midsize European mobile player following its acquisition 
of Telefonica O2 Czech--later split into O2 Czech and CETIN--in 2013 and 
Telenor CEE in 2018. Pro forma consolidated revenue reached €3.2 billion in 
2018 and the group now operates in six countries. The Czech Republic accounts 
for about 50% of total EBITDA, followed by Hungary (14%), Bulgaria (13%), 
Serbia (12%), Slovakia (8%), and Montenegro (2%). PPF Arena 1 is the No. 1 
mobile operator in three of these markets: Bulgaria, Serbia and Montenegro, 
with revenue market share of 37%-41% in 2018. The group is also co-leader with 
T-Mobile in the Czech Republic, at 37%-38% revenue market share each in 2018, 
as well as No. 3 in Slovakia (24%) and No. 2 in Hungary (28%). We believe PPF 
Arena 1's mobile markets are moderately competitive, based on the presence of 
three mobile network operators (MNO) in each country. So far, these markets 
have been characterized by relatively low churn rates, with monthly postpaid 
churn in the Czech Republic below 1%, and broadly stable or slightly improving 
average revenue per user (ARPU). This has limited market share declines in 
Serbia, Montenegro, and Hungary and improved PPF Arena 1's positioning in the 
Czech Republic, Slovakia, and Bulgaria. 

We view positively CETIN's ongoing upgrade of its fixed network, which is set 
to provide next generation access (NGA) speeds for the majority of households 
passed by 2021, from less than half in 2017. We believe having access to 
CETIN's upgraded fixed network is positive from a wholesale perspective, 
because rivals Vodafone and T-Mobile recently focused on cross-selling their 
mobile subscriber base, and from a retail perspective as O2 managed to improve 
its subscriber mix toward higher-speed and higher-value packages. We believe 
the voluntary separation of CETIN (wholesale infrastructure provider) and O2 
(retail and services) in 2015 streamlined both businesses, allowing CETIN to 
focus on improving and maximizing the utilization of its networks. Meanwhile, 
O2 was freed up from regulation linked to infrastructure ownership.
Our assessment also factors in PPF Arena 1's sound profitability, with an 
adjusted EBITDA margin above 40%. This is supported by CETIN's high 
infrastructure margin of about 65% on a reported basis, when excluding 
low-margin international transit business, and the sound profitability at 
Telenor CEE, which we expect to benefit from modest synergies in procurement.  

Balancing the strengths listed above are O2 Czech's lower market share in 
fixed broadband compared with other European incumbents. The operator's Czech 
revenue market share was about 31% in 2018, significantly less than Telekom 
Austria's 56% fixed broadband market shares in Austria. PPF Arena 1 also lacks 
convergence in five of its six countries of operations. 

The late and slow rollout of asymmetric digital subscriber line (ADSL) 
technology in the Czech Republic has favored the emergence of multiple local 
Wi-Fi and fiber providers, resulting in a relatively fragmented fixed 
broadband market. This has been at the expense of O2, which registered 
subscriber net losses until third-quarter 2018. Similarly, CETIN's total DSL 
lines declined until third-quarter 2018, with subscriber market share 
contracting to about 28% in 2017 from about 37% in 2012, according to the 
Czech Telecommunications Office. However, CETIN's total DSL lines grew 0.9% in 
fourth-quarter 2018 compared with the same period in 2017 and O2's fixed 
broadband net additions stabilized, following ongoing fixed network 
modernization and the gaining of a better mix of higher-speed and higher-value 
fixed subscribers. Therefore, we believe that CETIN's capacity to monetize its 
fixed network upgrade and O2 Czech's capacity to ramp-up its fixed broadband 
and pay-TV market share, if realized, could strengthen the group's business 
risk profile in the medium term. Although this in turn could be offset should 
the pending combination of Vodafone and UPC lead to fiercer competition. 
However, we believe fiercer competition from the merger may partly be 
mitigated by the opportunity for PPF Arena 1 to access UPC's network should 
the regulator require it to be made available to other market participants. 

In Slovakia and Telenor CEE's geographies, PPF Arena 1 is a mobile-only player 
with no fixed broadband operations, also constraining our assessment of the 
group's business risk profile. We believe that a push toward convergence from 
existing fixed-mobile local competitors in these countries would be 
detrimental to PPF Arena 1, although we have not seen it to date because churn 
rates are relatively low in markets with three MNOs. 

Our view of PPF Arena 1's financial risk profile is supported by our 
expectation that pro rata adjusted debt to EBITDA will remain slightly below 
3.5x and FOCF to debt will approach 15% in 2019 and 2020 excluding spectrum 
payments, and 10%-15% including payments. The company's investments to upgrade 
the fixed network and acquire spectrum bands will limit FOCF at €445 
million-€465 million in 2019-2020, compared with about €580 million in 2018. 
This, combined with dividend returns to shareholders, will hamper 
discretionary cash flow and limit deleveraging prospects over the next 12-24 
months. In our base case, we assume shareholder returns at the higher end of 
the expected range. Although we understand the group's dividend policy is 
flexible, we forecast that reported leverage will be in the middle of its net 
consolidated leverage target of 2.8x-3.2x, with our adjustments adding about 
0.4x. It remains to be seen if, and when, management would want to utilize 
dividend flexibility to drive reported leverage toward the lower end of its 
policy range. We haven't factored such an assumption into our base case at 
this stage. 

We deconsolidate from reported figures, including debt, revenue, and EBITDA, 
32.31% of O2's and 10.27% of CETIN's corresponding figures, to reflect the 
existence of meaningful minority shareholders. 

Our adjustments to debt also include the addition of operating leases of €380 
million, and asset-retirement obligations of about €25 million. We also 
exclude 85%-90% of consolidated cash. We do not net €1.5 million of restricted 
cash at CETIN and about €40 million of cash reserves maintained at Telenor CEE 
for operating purposes because this may not be immediately accessible to PPF 
Arena 1 to repay debt. Our adjustments to EBITDA primarily include the 
addition of €80 million-€90 million corresponding to rent costs.     

The stable outlook reflects our expectation that PPF Arena 1 will successfully 
integrate Telenor CEE, expand its organic pro rata revenue by 1%-2% per year 
in 2019-2020, and maintain an adjusted EBITDA margin slightly above 40% over 
the same period. We expect the company to monetize its network upgrade and 
TV-content investments, while maintaining its current mobile market shares and 
ARPU in all countries of operations. We also forecast adjusted pro rata 
leverage will remain below 3.75x and FOCF to debt will approach 15% when 
excluding spectrum payments.

We could raise the rating over the medium term if PPF Arena 1 builds a 
favorable track record of fixed broadband and pay-TV market share gains, 
maintains or further improves its mobile positioning, and sustains an adjusted 
EBITDA margin of more than 40%. We could also upgrade PPF Arena 1 if 
management aimed to maintain reported leverage at the very low end of its 
financial guideline, translating into adjusted debt to EBITDA sustained at 
less than 3.25x, with FOCF to debt at more than 15%, excluding spectrum.

Rating downside is currently remote given PPF Arena 1's financial policy, but 
we could lower the rating if adjusted debt to EBITDA sustainably increases 
above 3.75x, together with FOCF to debt declining to less than 10%. This could 
result from a more competitive Czech mobile market following the potential 
entry of a fourth mobile player, or a push toward convergence in markets where 
PPF Arena 1 is a mobile-only operator.  

We work across the world

From London to San Francisco, to our home base in (Saint Helier) Jersey, we’re looking for extraordinary and creative scientists to help us drive the field forward.

Disclaimers: AC Investment Inc. currently does not act as an equities executing broker or route orders containing equities securities. All data and information is provided “as is” for personal informational purposes only, and is not intended for trading purposes or advice. Please consult your broker or financial representative to verify pricing before executing any trade.

77 Massachusetts Avenue Cambridge, MA 02139 617-253-1000 pr@ademcetinkaya.com