OREANDA-NEWS. Fitch Ratings has downgraded Oi S.A.'s (Oi) long-term foreign and local currency Issuer Default Ratings (IDR) to 'BB' from 'BB+'. Fitch has also downgraded Oi's National long-term rating and National long-term debentures to 'AA-(bra)' from 'AA(bra)'. The Rating Outlook on these ratings has been revised to Negative from Stable. Fitch has also downgraded Oi's senior unsecured and secured debt, and the senior unsecured notes issued by Oi Brasil Holdings Cooperatief U.A (Oi Netherlands) to 'BB' from 'BB+'.

KEY RATING DRIVERS

The downgrades mainly reflect a negative operating environment in Brazil and Oi's weak market position, and its persistent negative free cash flow (FCF) generation, which Fitch does not expect to be curbed in the short- to medium-term. Oi's financial profile has continued to deteriorate and is no longer considered strong within the 'BB' rating category. Also, low visibility on the potential industry consolidation in Brazil is a negative. Without this, Fitch does not foresee any material improvement in Oi's operating fundamentals over the medium term.

Oi's ratings reflect its fully integrated fixed and mobile service lineup, which enables convergent service offerings, its extensive network coverage and its incumbent fixed-telephony service provider position 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 and high leverage. The operating environment is unfavorable as the competitive pressures in Brazil are among the highest in the region.

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 Brazilian revenue and routine 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 billion-BRL7.4 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 unfavorable 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, the net book value of which 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 another shareholder. Excluding this, any deleveraging in the short term would remain difficult.

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 improved moderately as Fitch estimates that the financial leverage of PT Portugal assets sold to Altice which excludes African assets was estimated to be above 5.0x in 2014. Based on Oi's pro forma routine EBITDA during the last 12 months (LTM) ended March 2015, Fitch estimates the company's adjusted net leverage following the asset sale including the hedge derivatives and tax instalments to be about 4.3x.

On June 2, 2015, Oi completed the sale of PT Portugal and received the net cash proceeds of EUR4.9 billion, after the prepayment of EUR869million of PT Portugal debt. 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.

Industry Consolidation:

The delay in industry consolidation is negative for Oi. Despite Oi's intent to pursue options for industry consolidation, 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 4.0x unlikely in the absence of material improvement in the key operating metrics.

RATING SENSITIVITIES

Oi's ratings are under negative pressure, given its high leverage and weak cash flow generation amid 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 revise the Outlook to Stable should the company's net leverage improve to below 4.0x 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. This compares to BRL15.5 billion of debt maturities in between 2Q15 and 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. Positively, the company held the net value of BRL4.3 billion for its hedge derivatives. 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.