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S&P affirms United Group's 'B' ratings on Tele2 Croatia acquisition, outlook stable

Author Iskra Pavlova
S&P affirms United Group's 'B' ratings on Tele2 Croatia acquisition, outlook stable Photo: All Rights Reserved

ZAGREB (Croatia), June 21 (SeeNews) - S&P Global Ratings said it has affirmed the 'B' ratings of United Group, a leading multi-play telecommunications and media services provider in Southeast Europe (SEE), following the recent announcement of the group's pending acquisition of the Croatian business of Swedish peer Tele2 for 220 million euro ($249 million).

The ratings' outlook remains stable to reflect the S&P's view that United Group will continue to benefit from strong organic revenue growth and will successfully manage the Tele2 Croatia operations, the ratings agency said in a statement late on Thursday.

In particular, the S&P is affirming its 'B' issuer credit rating on United Group, as well as the 'B' issue ratings on its existing senior secured notes,  and the 'B-' issue rating on the 306 million euro payment-in-kind (PIK) notes.

United Group announced on June 3 it has agreed to buy Tele2 Croatia, saying the transaction is subject to regulatory approval and is expected to close by the end of 2019.

Here is what else the S&P said in the statement:

"The affirmation reflects our view that United Group's announced acquisition of Tele2's Croatian mobile business at an EV of 220 million euro will be broadly leverage neutral in 2019. This is because we expect that the 200 million euro additional debt raised by tapping the existing senior secured notes due in 2024 will be balanced by Tele2 Croatia's 30 million-35 million euro adjusted EBITDA (based on 2018 figures), as well as our expectations for continued organic growth both for United Group and Tele2 Croatia. As a result, we expect that United Group's consolidated adjusted leverage will remain at about 7.0x in 2019 (similar to 2018), before declining to about 6.5x and below in 2020 and 2021. We also expect interest coverage ratios to remain relatively solid at nearly 3x.

We expect the acquisition of Tele2 Croatia will add about 20% and 10%-15% to United Group's consolidated revenue and EBITDA, respectively, in 2019. It will also increase the group's exposure to a wealthier country than Serbia and Bosnia-Herzegovina. In our view, the acquisition is supportive of the group's operational diversity and growth prospects, but it also incorporates some execution challenges. This is mainly because Tele2 Croatia largely relies on national roaming agreements since it has significantly less coverage than its competitors. As a result, its profit margins are relatively low (EBITDA margin below about 20% in 2018), which makes it harder for the company to market unlimited data offers to data-heavy users. In addition, Tele2 is a mobile-only player competing with two fixed, mobile convergent, and financially sound operators (subsidiaries of Deutsche Telekom and Telekom Austria), which hold 45% and 37% of the market by subscribers compared with Tele2's 18%. Management estimates this translates to a 21% market share by revenue. Although Tele2 has successfully expanded its customer base and average revenue per user (ARPU) despite being a mobile-only player, it may be disadvantaged over the longer term in some areas if convergence gains significant traction in the market and fixed-line players subsidize their mobile offers within a bundle of fixed and mobile services.

That said, United Group's management is planning for margin improvement and increased operating efficiency going forward, including lower national roaming fees in Croatia. This includes significant investment in expanding its coverage by increasing the number of sites by about 50%, which would likely bring the Croatian mobile business' margins to about 20% in 2020. Furthermore, we expect steady margin increases thereafter from rising monthly ARPU as more customers migrate to unlimited data bundles and carriage fees from the recently acquired media assets.

In addition, we believe the group has a proven track record, having successfully managed a mobile operator in Slovenia, including in areas where it does not have fixed broadband coverage and is effectively operating as a mobile-only provider. In 2015, United Group acquired Slovenian mobile operator Tusmobil, which, similarly to Tele2 Croatia, is the No. 3 mobile challenger. Following the acquisition, United Group managed to improve Tusmobil's market share from about 14% to about 21% and modernized the network. It currently provides 4G coverage to 94% of the population. That being said, we do not expect any material near-term synergies of the acquired mobile business with United Group's existing assets in Croatia--namely pay-TV content assets like Nova TV and other channels, internet portals, and potentially an over-the-top service.

Despite strong EBITDA growth after the acquisitions in 2018-2019, we expect United Group to continue generating negative free operating cash flow (FOCF) due to significant capital expenditure (capex) that we estimate at 26% of sales in 2020, compared with 26% in 2017 and 29% in 2018. This compares with management's estimate of just below 25% in 2020. Investments in 2018 included equipment on customer premises, programming rights, and a new headquarters in Slovenia. Excluding any potential spectrum costs, we assume that capex intensity will decrease in 2019 to about 22% of sales, with less intense network and other investments being partly offset by investments in media content production. However, we expect a rebound of capex to revenue in 2020 because United Group will likely need to invest in spectrum and new mobile sites in Croatia. As a result, we do not expect a significant improvement in FOCF generation in 2019-2020 due to our assumption of greater interest payments and higher capex. We therefore do not anticipate any significantly positive FOCF before 2021.

The stable outlook reflects our view that that United Group will continue to benefit from strong organic revenue growth of more than 10% and successfully manage the Tele2 Croatia operations, helping it reduce adjusted leverage to less than 6.5x by 2021. We forecast funds from operations (FFO) cash interest coverage of 2.8x-3.0x over 2019-2020.

We could lower our ratings if we expect adjusted gross leverage to remain above 7.0x from 2019, if FFO cash interest declines to less than 2.5x, or if underperformance leads to sustained significant negative FOCF, which is not offset by strong commercial success. We could also lower the rating if we view liquidity as less than adequate, for example, if the group draws a very significant amount on its revolving credit facility (RCF).

We are unlikely to raise the rating over the next 12-24 months because we do not anticipate any significant and sustainable reduction in leverage under United Group's financial sponsor ownership. Additionally, the rating will likely remain constrained by the group's limited FOCF generation prospects due to its ambitious growth plans, which we anticipate will result in continued high capex and bolt-on acquisitions."

($=0.8840 euro)