OREANDA-NEWS. June 17, 2015. Fitch Ratings has assigned a 'BB+(EXP)' rating to Oi Brasil Holdings Cooperatief U.A.'s (Oi Netherlands) proposed up to EUR750 million senior unsecured notes due 2021. Oi Netherlands is a wholly-owned subsidiary of Oi S.A. (Oi, 'BB+'/Outlook Stable) and the notes will be fully guaranteed by Oi and will rank pari passu with Oi's other senior unsecured debt obligation.

The proceeds from the notes will be used for Oi's liability management. Holders of Oi's certain existing notes, as listed below, will be eligible for an option to switch into the proposed notes, or sell their position for cash, which will be funded by the notes proceeds. The remaining portion of the proceeds, if any, will be used to prepay or refinance Oi's other debt obligations. This transaction would help bolster Oi's solid liquidity profile.

Oi's existing notes to be tendered are:

--EUR600 million 5.625% notes due 2016;
--EUR500 million 4.375% notes due 2017;
--EUR250 million 5.242% notes due 2017;
--EUR 750 million 5.125% notes due 2017.

KEY RATING DRIVERS

Oi's ratings reflect its fully integrated service lineup of fixed and mobile, which enables convergent service offerings, its extensive network coverage and its position as the largest fixed-telephony service provider in Brazil. The company's liquidity is sound following its recent sale of PT Portugal, SGPS, S.A. (PT Portugal)

The ratings are tempered by Oi's weak market positon in the mobile segment and negative free cash flow (FCF) generation, which have led to high leverage despite the company's intention to delever in recent years. Operating environment is unfavourable as the competitive pressures in Brazil are among the highest in the region.

Sale of PT Portugal:

Oi's recent sale of PT Portugal to Altice Portugal S.A. (Altice) is positive as it provided ample liquidity and financial flexibility for the company to pursue any strategic investment options, if needed. Following the transaction, the company's net debt was significantly reduced to BRL33 billion from BRL52 billion at March 31,2015, including its guarantees for PT Portugal debt. Leverage has also moderately improved as Fitch estimates that the financial leverage of PT Portugal assets sold to Altice which excludes African assets was estimated to be well above 5.0x in 2014. Based on Oi's pro forma EBITDA during the last 12 months (LTM) ended March 2015, Fitch estimates the company's adjusted net leverage following the asset sale to be 4.5x.

On June 2, 2015, Oi completed the sale of PT Portugal and received the net cash proceeds of EUR4.9 billion. As part of the transaction, Portugal Telecom International Finance B.V. (PTIF) became Oi's wholly owned subsidiary and PTIF's outstanding debt, which amounts to about EUR4.9 billion, is now included in Oi's consolidated debt. Oi plans to use the proceeds only for its debt repayment unless there is an industry consolidation opportunity in Brazil.

Tough Operating Environment:

Brazil remains one of the most competitive markets in Latin America, while its mobile market has increasingly become saturated. Oi has the lowest mobile market share among the four major players, with about 18% subscriber shares. Mobile data and fixed services, including broadband and pay-TV, have become the key growth drivers for the industry, but Oi's rivals have made more aggressive investments in those services than the company so far. Under this environment, Oi's Brazil revenue and EBITDA contracted by 3% and 8%, respectively, in 2014.

Positively, Oi managed to successfully execute various cost saving measures which led to EBITDA turnaround during the first quarter of 2015 (1Q15). Despite high inflationary pressures, the company's operating expenses from the main Brazil operation declined by 5% compared to a year ago, resulting in EBITDA improving by 13% to BRL1.9 billion from BRL1.7 billion during the same period. Backed by these measures, Fitch believes that Oi's 2015 Brazil EBITDA target of BRL7.0-7.4 billion is achievable.

Weak Cash Flow Generation; High Leverage

Oi's negative FCF generation is unlikely to be curbed in the short to medium term given unfavourable operating environment. Despite projected modest EBITDA improvement, the company's high interest expenses, capex, and judicial deposits will continue to weigh on its cash flow generation and negatively affect leverage. Oi's leverage is considered high for the rating category. The company intends to sell its 75% equity stake in Africatel Holdings BV, of which the net book value was BRL5.8 billion including the dividends receivable of BRL1.5 billion as of March 2015, but the likelihood remains uncertain due to the legal dispute with the minority shareholder. Excluding this, any material deleveraging would remain difficult.

Industry consolidation:

Delayed industry consolidation is negative for Oi. Despite Oi's efforts to pursue an acquisition or merger with TIM Brasil, as disclosed in August 2014, the details on the structure, or timing of the deal remains largely uncertain at the moment. Without the industry restructuring, Fitch does not foresee any meaningful recovery in Oi's credit profile.

In Fitch's view, the transformation to a three-player market led by Oi in a crowded Brazil telecom industry should benefit the company, as it would ease the competitive intensity, mainly price-based competition, and help protect industrywide profitability. Cash flow generation could also improve, given more efficient use of capital investments, as well as network infrastructures and distribution channels.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Oi include:

--Muted to low single digits revenue growth over the medium term;
--Brazil EBITDA margin to recover to about 26% in 2015 from 24% in 2014 backed by ongoing cost saving measures;
--Continued negative FCF generation at least for the short term despite tempered capex budget of around BRL4.5 billion;
--Net leverage recovering to below 4.5x unlikely without successful pending asset sales and potential industry consolidation.

RATING SENSITIVITIES

Oi's ratings are under negative pressure, given its high leverage and unfavorable operating trends. The company's credit profile could substantially change depending on how its additional asset disposal and consolidation plans pan out in the short term. A negative rating action could be considered if its net leverage ratio is forecast to remain well above 4.0x over the medium to long term without any meaningful improvement in its key operating metrics.

Conversely, any positive rating action is unlikely at this time. Fitch would consider a positive rating action should the company's net leverage improve to below 3.5x along with material improvements in its operational fundamentals on a sustained basis.

LIQUIDITY AND DEBT STRUCTURE

Oi's liquidity profile is sound backed by its large cash position of about BRL22.3 billion following the completed sale of PT Portugal, which compares to BRL15.5 billion of debt maturities by the end of 2016. The company also held BRL10.8 billion of credit facilities as of March 2015. During the same period, the company's total debt was BRL38.9 billion, mainly comprised of senior notes, public debentures, and bank loans. In addition, PTIF's outstanding debt of EUR4.9 billion, which Oi used to provide a full guarantee, became Oi's consolidated debt as PTIF became Oi's wholly owned subsidiary.