Fitch Rates Cielo's 4th Debenture Issuance 'AAA(exp)(bra)'

RIO DE JANEIRO--()--Fitch Ratings has assigned a long-term National Scale rating of 'AAA(exp)(bra)' to Cielo S.A.'s (Cielo) 4th non-convertible debenture issuance, in the amount of BRL4.6 billion and due in 2018. The proceeds will be used to repay the company's first Issue of Commercial Promissory Notes.

Cielo's investment-grade ratings reflect the company's leading position in the Brazilian credit card payment industry and the strength and resilience of its business model, which is supported by the growing and predictable revenue stream from a diversified base of affiliated merchants. Cielo has a solid capital structure, liquidity position, and the ability to generate strong cash flow in its business.

Cielo's ratings also incorporate the low counterparty risks associated with the Brazilian banking system, as more than 95% of credit and debit transactions are settled with investment grade banks, or are guaranteed by Mastercard. The support and the strength of its controlling shareholders, Banco Bradesco S.A. (Bradesco; rated 'AAA(bra)' National Scale; local currency IDR 'A-' and foreign currency IDR 'BBB+' by Fitch] and Banco do Brasil S.A. (Banco do Brasil; rated 'AAA(bra)' National Scale; local and foreign currency IDR 'BBB'] are also incorporated in the ratings. Cielo's ratings are not limited by the credit profile of one of its main shareholders, Banco do Brasil, as it divides the control of the company with Bradesco and its access to Cielo's cash flow is restricted to dividends.

KEY RATING DRIVERS

Leading Position in the Brazilian Card Payment Industry

Cielo is the leading company in Brazil's merchant acquiring and payment processing industry with an estimated market share of 54%. The industry is extremely consolidated with the two largest players representing more than 90% of the market. The Brazilian card payment industry's high barriers to entry support Cielo's strong market position, which is viewed as sustainable in the medium term, despite the highly competitive environment.

Cielo has an important competitive advantage, as the company relies on the strong relationship and distribution network of Banco do Brasil, Bradesco, HSBC and Caixa. Together these banks have about 14,436 branches, and account for about 62% of the Brazilian banking system. Cielo's affiliation with these leading banks gives it access to their broad customer base to acquire merchant accounts and creates high barriers to entry; approximately 60% of Cielo's merchant accounts are prospected for by banks with which Cielo has agreements. The penetration of credit and debit cards in Brazil is still low, which supports Cielo's long-term growth prospects.

Low Risk of Credit Loss

Cielo currently has virtually no direct credit exposure to cardholders, as the card-issuing bank guarantees cardholders' payment. The company is, however, exposed to card-issuing bank defaults on a payment settlement for Visa transactions. The licensing agreement with Mastercard mitigates this risk, as it guarantees the settlement of all transactions. The risk associated with Visa transactions is mitigated by the fact that more than 95% of the volume of credit and debit transactions is concentrated with investment-grade rated banks. For non-investment grade banks, Cielo's risk management policy requires the card-issuing bank to pledge collateral. The joint venture (JV) with Banco do Brasil should not add risk to Cielo's business, as Cielo will remain with virtually no direct credit exposure to cardholders, while Banco do Brasil will be responsible for the credit analysis and concession of cardholders.

Cielo is exposed to merchants that accept cards processed by Cielo in terms of their performance, payment of the rental of the equipment, fraud, and losses due to customer charge-backs. These losses have been historically low and not representative of the company's net revenues.

Solid Liquidity and Robust Cash Flow

Cielo's liquidity position is strong. As of Dec. 31, 2014, Cielo had cash and marketable securities of BRL4 billion and BRL4.8 billion of short-term debt, and compares with BRL423 million and BRL273 million, respectively, at the end of 2013. This increase was a result of the issuance of BRL4.6 billion of Promissory Notes in December 2014, due in six months, to finance the creation of the JV between Cielo and Banco do Brasil. The proceeds from the proposed debenture issuance will be used to repay the Promissory Notes and extend its debt maturity profile.

In 2014, Cielo generated BRL5.6 billion of adjusted EBITDA, including financial income derived from the discounting and pre-payment of receivables to merchants, BRL3.7 billion in funds from operations (FFO), and BRL1.8 billion in cash flow from operations (CFFO). Cielo distributed dividends of BRL2 billion and invested BRL673 million, resulting in a negative free cash flow (FCF) of BRL856 million in the period, as the company reduced the volume of receivables discounted with the card-issuing bank.

Following the JV with Banco do Brasil, Cielo will benefit from increased revenue diversification in a resilient and growing business. The JV's main source of revenues will be the interchange fee over the relevant volume of credit and debit transactions under the 'Ourocard arrangement', with estimated EBITDA generation of more than BRL800 million. In Fitch's opinion, Cielo's cash flow generation capacity will improve and dividends are expected to decrease, as the company's management will propose to its Board of Directors to reduce its minimum dividends distribution to 30% of net profit, from 50%.

Recurring and Growing Revenues

Cielo's business model remains strong even during scenarios of different economic cycles. The revenue growth is generally driven by the increasing migration to an electronic payment system from a cash and check system and increasing card payment penetration in Brazil. In 2014, net revenue was BRL7.7 billion, compared to BRL6.7 billion in 2013. These figures do not include financial income from pre-payment of payables to merchants.

Cielo processed BRL518 billion of credit and debit card transactions in 2014, up 15% compared to BRL449 billion processed in 2013. Revenues from the rental of POS equipment and financial income from pre-payment/discounting of payables to merchants of BRL1.8 billion in 2014 also contributed to its business growth. In 2014, adjusted EBITDA was 58.9%, compared to 59.7% in 2013 and 63.1% in 2012, pressured by strong competition in the Brazilian card payment industry.

Capital Structure Remains Strong After the JV with Banco do Brasil

Cielo has strong credit metrics. The company's leverage will increase following the transaction, as the company's capital investment of BRL8.1 billion will be financed with debt. Fitch projects net debt/adjusted EBITDA, including financial income derived from the discounting and pre-payment of receivables to merchants, to increase to 1.6x in 2015, from 0.6x in 2014, still acceptable for the company's rating category. As of Dec. 31, 2014, Cielo had BRL7.3 billion of total debt. This debt consists primarily of USD875 million of senior notes, BRL430 million FINAME loans used to finance the purchase of POS equipment, and BRL4.6 billion of Promissory Notes. In February 2015, the company also issued three private debentures, totaling BRL3.5 billion and due in 2023, to finance the JV with Banco do Brasil.

Manageable Regulatory Risk

Regulatory risk is manageable. In October 2013, the Central Bank of Brazil was named as the regulator of the payment processing industry, approved under Law 12865/2013. Recently, the central bank announced the end of preferential agreements with other brands like Elo, American Express, Hiper, and food vouchers. As new transactions are captured and existing transactions are shared with the market, the impact on the company's cash flow generation capacity is expected to be limited.

KEY ASSUMPTIONS

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

--An increase of 12% in the volume of credit and debit transactions in 2015 and 10% in 2016.

--Net interchange fee to slowly reduce in upcoming years.

--The volume of pre-payment/discounting of payables to merchants to represent about 18% of the volume of credit transactions.

--Annual growth of 6% in the number of POS.

--EBITDA generation of about BRL6.5 billion in 2015.

RATING SENSITIVITIES

Future developments that may individually or collectively lead to a negative rating action include:

--An increase in the volume of credit and debit transactions with non-investment grade banks without collateral being pledged by the card-issuing bank or not guaranteed by Mastercard;

--A weakening credit profile of the main banks that operate with Cielo;

--A significant loss due to fraud and charge-backs;

--Effects on the business caused by the competitive environment and significant changes in the regulatory risk;

--Changes to Brazil's country ceiling rating.

For the sovereign rating of Brazil, the following sensitivities were outlined by Fitch in its Rating Action Commentary on July 10, 2014: The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change.

The main factors that individually, or collectively, could trigger a negative rating action on Brazil's sovereign rating include:

--Erosion of the policy framework leading to increased macroeconomic and financial vulnerabilities;

--Sustained economic under-performance and fiscal deterioration that undermines government debt dynamics;

--A severe deterioration in Brazil's international reserves position and/or government debt composition.

The main factors that individually, or collectively, could trigger a positive rating action on Brazil's sovereign rating include:

--Higher investment rates and growth trajectory;

--Fiscal consolidation that supports government debt reduction.

Ratings upgrades are not likely in the short- to medium-term. Cielo's foreign currency IDR is already positioned at the same level of Brazil's country ceiling of 'BBB+'.

Fitch currently rates Cielo's ratings as follows:

Cielo

--Foreign currency Issuer Default Ratings (IDR) 'BBB+';

--Local currency IDR 'BBB+';

--Long-term national scale rating 'AAA(bra)'.

Cielo USA Inc.

--Senior unsecured notes 'BBB+' due in 2022.

The Rating Outlook for the corporate ratings is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981090

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Contacts

Fitch Ratings
Primary Analyst:
Fernanda Rezende, +55-21-4503-2619
Director
Fitch Ratings Brasil Ltda.
Praca XV de Novembro
20 Sala 401 B - Centro
Rio de Janeiro - RJ - CEP: 20010-010
or
Secondary Analyst:
Gustavo Mueller, +55-21-4503-2632
Associate Director
or
Committee Chairperson:
Ricardo Carvalho, 55-21-4503-2627
Senior Director
or
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Fernanda Rezende, +55-21-4503-2619
Director
Fitch Ratings Brasil Ltda.
Praca XV de Novembro
20 Sala 401 B - Centro
Rio de Janeiro - RJ - CEP: 20010-010
or
Secondary Analyst:
Gustavo Mueller, +55-21-4503-2632
Associate Director
or
Committee Chairperson:
Ricardo Carvalho, 55-21-4503-2627
Senior Director
or
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com