Fitch Rates Turkcell 'BBB-'; Outlook Stable
The ratings incorporate TCELL's strong domestic business profile, leading market position and high-quality mobile business, well-positioned and growing fixed line operations and sound financial performance. Limited diversification, ambitions to expand internationally and its targeted leverage, which in turn will lead to a growing currency mismatch, somewhat constrain the ratings despite low financial leverage at present.
KEY RATING DRIVERS
Strong Domestic Position
TCELL is positioned strongly as the leading mobile operator in a three player market. With 34 million customers and 47% market share at 2Q15, its overall subscriber market share is 18 percentage points ahead of second placed Vodafone. A high postpaid mix gives it 48% share of this segment - a twenty percentage point lead over its closest rival. The Turkish market is maturing - with penetration estimated by Fitch at 94%. An urban population that is expected to continue to grow though offers ongoing growth potential revenue growth for TCELL is more likely to come from the ongoing shift in the postpaid mix, increasing smartphone penetration and improving data revenues.
Fitch estimates TCELL's Superonline has 14% of the broadband market (at 1Q15), with roughly 1.3 million broadband customers, and a base that is growing at 35% year on year. With 818,000 fibre to the home (FTTH) customers at 2Q15 and a business that is growing in the mid-20s in percentage terms it has 53% of the country's FTTH market. A nascent IPTV business (140k customers at end-2Q15) is important as triple play becomes more important in the market and convergence is expected to be of increasing importance in TCELL's offer.
Competitive Pressures
TCELL's market is competitive, with an effective fixed-line incumbent and a competitive dimensioned three- player mobile market. In mobile TCELL continues to suffer modest net subscriber losses to Turk Telecom's (TT) Avea and Vodafone. Fixed line and broadband services are facing competition from the incumbent, alternative operators including Vodafone, and cable, while a well-developed pay-TV market is dominated by satellite operators, Digiturk and D-Smart.
Triple play and convergence are expected to become increasingly important. Turk Telecom (TT) leads the IPTV market and is offering a satellite service in areas not accessed by fibre, a strategy Fitch believes TCELL may also consider. Both TCELL and TT have committed fibre builds, while recent spectrum auctions saw TCELL acquire a leading share of available frequencies, although at roughly EUR1.6bn, it has agreed to pay significantly more in absolute terms than its competitors.
Investment levels are therefore expected to remain high over the next three years, while the temptation to bid for football rights or other premium content - Super lig rights come up for renewal in 2016/17 - has the potential to increase commercial investment and pressure margins.
International Ambitions
Management has stated it intends to adopt a more leveraged financial policy and identified international expansion as an area for investment. Fitch recognises the business can sustain some leverage while international diversification can help offset regional or domestic volatility in a business. TCELL's domestic operations account for roughly 90% of revenues and a higher share in earnings and cash flow. Regional expansion is likely to be focused on markets which are geographically and culturally close to Turkey - potentially Eurasia, the Middle East or Balkans; markets that offer profitable growth potential but that are also likely to add emerging market risk. Any potential deal is considered event risk - although Fitch notes the company has some headroom within its existing leverage metrics.
Corporate Governance Clearer
Ownership and governance issues have improved. A shareholder impasse that had blocked dividends for the past five years has been resolved - a USD1.5bn payment covering 2010-2014 was made in May 2015. A seven member board of independent directors is appointed by the Capital Markets Authority, with each of the principle shareholders - TeliaSonera (TLSN), Alfa Group and Cukurova, given the opportunity to nominate. Fitch understands from TCELL that only TLSN alone has taken advantage of this opportunity. Transparency of reporting and management autonomy including public statements around financial policy and strategy suggest a pragmatic and normalised governance approach is being adopted.
Financial Policy; Leverage Target
Management has said it will pursue a more efficiently capitalised balance sheet and stated publicly that net debt-to-EBITDA could be tolerated up to 2.0x. Fitch expects a normalised range is more likely to evolve in the region of 1.0x-1.5x. With a delta to Fitch's guidance metric of funds from operation (FFO) net lease adjusted leverage of around 0.7x, unadjusted leverage that is managed below 1.5x would be below Fitch's downgrade guideline of 2.25x.
Fitch acknowledges TCELL's business and operational profile can support higher debt than at present. Areas of investment deemed likely to increase leverage include spectrum payments, M&A and ongoing fibre investment. Fitch's current base case forecasts FFO net leverage settling at around 1.6x by 2019. The normalised metric takes account of a period of heightened capex given scheduled spectrum costs payments that will impact cash flow through to 2018.
FX Mismatch and Volatility
Although with its currently unlevered balance sheet a mismatch between hard currency- denominated debt and a mainly lira-based cash flow do not impact its financial profile - this will become a risk factor as the capital structure evolves and leverage increases. The recapitalisation of both its Ukraine and Belarusian subsidiaries has removed a significant debt currency mismatch. Fitch nonetheless expects future holdco debt to be raised largely in hard currency, which will leave the company exposed to leverage shocks in the event of accelerated lira depreciation.
Our base case assumes an ongoing and gradual depreciation of the Turkish lira. A progressive depreciation sensitivity which assumes a further 20% decline in 2016 (after what has been a fall by around 38% this year), is forecast to push FFO adjusted net leverage to a peak of around 2.2x in 2017, before falling thereafter. Although metrics at this level would remain below our downgrade guidance of 2.25x this outcome would remove rating headroom. A combination of events that include significant M&A or heightened content investment, combined with such an FX outcome, would put pressure on the downgrade metric and potentially undermine the company's investment grade rating.
Ratings Effectively Capped
At 'BBB-' TCELL's IDR is in line with the Turkish sovereign and in line with incumbent telecom, TT. Given its current business profile the company is primarily a domestic business with ambitions to diversify internationally. TCELL exhibits similar operational strengths to the incumbent and a lower financial risk profile - the latter will change as management implement stated leverage targets and execute expansion plans.
Fitch considers a degree of execution risk exists, which along with other risk factors - FX risk, M&A event risk, a period of heightened investment and risk of TV content cost inflation - constrain the ratings at the current level. These factors add the potential for rating volatility, depending on how disciplined management prove in adhering to its stated financial policy.
KEY ASSUMPTIONS
-Underlying revenue growth of around 10% per year in Turkish operations in 2015-2018
-USD reported revenue to decline in low 20% range due to FX movements in 2015
-Group EBITDA margin of 31% in 2015, expanding moderately thereafter
-Minimum dividend payout ratio of 50%; no share buybacks
-USD2.2bn of spectrum payments - four six monthly instalments starting in 3Q15
-USD100m payment for acquisition of 100% of Astelit; no further M&A assumed
-Weaker results from international operations due to adverse movements in FX rates during 2015/16
-Underlying capex (excl. spectrum) to remain high, peaking at 25% of sales in 2016 before declining to 18% in 2018
-Ongoing gradual currency depreciation of the Turkish lira against the US dollar
-The GSM concession which expires in 2023 is successfully renewed
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Expectation that FFO adjusted net leverage will remain above 2.25x (which corresponds to approximately net debt/EBITDA of 1.5x) on a sustained basis
- Material deterioration in TCELL's operating conditions or competitive environment to the extent financial performance is expected to materially underperform Fitch's rating case.
- Free cash flow performance materially below Fitch's rating case - particularly if the result of a substantive change in dividend or distribution policy or an escalation of ongoing investment needs.
- A reassertion of governance issues to the extent these affect management's ability to remain within targeted financial policies or implement key business decisions, or result in the absorption of liabilities not currently considered within Fitch's rating case.
- It is unlikely that the company would be rated above the sovereign. A downgrade of Turkey's rating, or a change in the Outlook to Negative would result in a negative rating action for TCELL.
LIQUIDITY
TCELL reported cash of USD1.6bn at end-June 2015, a value that will be augmented in the near term by the expected proceeds of a planned bond issue. In addition the company has committed bank facilities totalling USD1bn - in place to fund ongoing investment and corporate expansion. Free cash flow (FCF) is forecast to be negative over the next three years given exceptional capex. Underlying FCF is positive and liquidity considered sound.
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