OREANDA-NEWS. August 10, 2015.  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 proposed merger of WIND and 3 Italia should result in an enlarged entity with a stronger operating profile and lower leverage. Greater scale from a higher mobile market share should boost the company's ability to compete. WIND's standalone rating should improve by one notch to 'B+' if the merger is approved, but the loss of the current one-notch uplift from parental support would leave the IDR unchanged at 'B+' when the transaction is closed. Fitch does not expect to change its rating approach until the merger is completed. A rating of 'BB-' for the merged entity is possible over the medium term as the integration process is completed and leverage falls.

KEY RATING DRIVERS
Better Competitive Position
CK Hutchison Holdings Ltd. (A-/Stable), parent company of Italian mobile operator 3 Italia, and VimpelCom Ltd., parent company of WIND, have entered into an agreement to form a 50/50 joint venture of their telecommunication businesses in Italy. The combined entity will have a one-third market share of the Italian mobile service revenue, similar to its two main competitors, Telecom Italia (BBB-/Negative) and Vodafone (BBB+/Stable). It will also retain WIND's current position as second-largest fixed broadband operator by subscribers. If approved, we believe the merged entity's competitive position and operating profile will be better than WIND on a standalone basis.

Significant Synergies
The combination of WIND and 3 Italia, subject to anti-trust authority approval and any potential regulatory remedies, should result in significant synergies. Management is targeting EUR700m of opex and capex savings per year (before tax and integration costs), 90% of which should be realised by the third year after the deal closing. These synergies should help the merged entity to reduce leverage in the two to three years after the transaction is closed. We expect the deal could close in about 12 months from now, due to the anticipated anti-trust approval process.

Loss of Parental Support
On a standalone basis, WIND's current rating corresponds to 'B'; this is uplifted by one notch for potential parental support. We expect to remove this rating benefit once the deal is closed as the merged entity will not have the undiluted support of a single significant majority shareholder.

Improved Leverage
WIND had net debt of EUR10.1bn at end-June 2015. 3 Italia is debt free. Compared with WIND's standalone net debt/EBITDA of 5.8x at the end of 2014, management expects proforma leverage to be currently 4.9x, with rapid deleveraging in the following three years post-closing as synergies are realised. Management has a long-term net debt/EBITDA target of 3.0x for the enlarged entity. Taking into account significant operating leases at both WIND and 3 Italia, we estimate that the new entity would have proforma funds from operations (FFO) adjusted net leverage of around 6x before reducing as net debt/EBITDA falls. With the anticipated operating profile improvement once the proposed merger is completed, the leverage profile of the merged entity is commensurate with a standalone rating of 'B+'. FFO adjusted net leverage sustainable below 4.75x could support a 'BB-' rating.

Debt Structure After Closing
We do not expect that the proposed merger will trigger any change of control clauses of WIND's debt, nor will bond holders' consent be required for WIND's debt to be transferred to the merged entity. However, under the terms of the proposed merger, WIND's existing debt will not benefit from any guarantees from the combined entity. Any improvement in the instrument ratings of WIND's debt (based on the standalone IDR of 'B', which could move to 'B+' post-merger) will depend on the financial integration of the two companies once the deal has closed. In particular, we will examine how the company's legal structure is adjusted so that existing debt holders benefit from the entire cash flow of the enlarged entity, as well as the terms of the subordinated shareholder loans from the JV holding company to the operating subsidiaries.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Wind (pre-merger) 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 year 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
For Wind as a standalone entity (pre-merger)

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 free cash flow (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'