Fitch Downgrades Oi S.A. to 'CCC'; Ratings Removed From Negative Watch

CHICAGO--()--Fitch Ratings has downgraded Oi S.A.'s (Oi) Long-term foreign- and local-currency Issuer Default Ratings (IDR) and its senior unsecured notes to 'CCC' from 'B'. Fitch has also downgraded the company's National Long-term rating and local debentures rating to 'CCC(bra)' from 'BBB-(bra)'. All the ratings have been removed from Negative Watch. A full list of rating actions follows at the end of this release.

The downgrades reflect the increased possibility for Oi to undergo debt restructuring in the near term, following the company's press release on March 9, 2016, regarding its engagement with PJT Partners to optimize its liquidity and debt profile. Fitch believes that any meaningful turnaround in the company's credit profile based on its stand-alone operational fundamentals is unlikely in the absence of industry consolidation. As such, Oi will likely face serious liquidity issues from 2017 as its access to capital markets for refinancing would remain constrained given its precarious balance sheet amid continued negative free cash flow (FCF) generation.

KEY RATING DRIVERS

Failed Merger Attempt

Fitch does not expect any meaningful improvement in Oi's credit profile in the absence of industry consolidation given its weakening market position and perennial cash burn. Oi has actively implemented cost-saving initiatives which enabled a modest EBITDA growth during the first nine months of 2015, but it has been insufficient to curb the ongoing negative FCF generation due to high interest expenses and capex requirement. EBITDA improvement driven by cost savings is unsustainable without gradual top-line growth, which Fitch does not expect to be achievable given the company's continued under-investments in network upgrades.

Refinancing Risk

Fitch forecasts Oi will face a serious liquidity problem from 2017 on, as its access to capital markets for refinancing will be limited because of investors' concerns as to the company's operational sustainability. Oi's debt maturities for 2016 and 2017 amount to BRL11.4 billion and BRL9 billion, respectively, of which capital market debt comprised about 54% and 75% of those maturities in 2016 and 2017, respectively. The company held a readily-available cash balance of BRL16.4 billion at end-September 2015, while it also signed an agreement with China Development Bank for a USD1.2 billion credit facility, which will help serve its debt obligation in 2016.

However, Fitch forecasts Oi's negative FCF generation to amount to about BRL4 billion in 2016. Without any refinancing, aside from the already-agreed-upon China Development Bank credit facility, Fitch expects the company will face difficulty in meeting its debt maturities in 2017, which could force a debt restructuring. In addition, there is low visibility on Oi's potential sale of its 75% stake in Africatel in the near term, given the ongoing legal disputes with other shareholders.

Weak Cash Flow; High Leverage

Oi's current capital structure is not deemed sustainable. The company's total gross debt, net of hedging derivatives, amounted to BRL53.7 billion as of Sept. 30, 2015, which compares to its LTM EBITDA generation of BRL7.6 billion, resulting in a net leverage ratio of 4.9x. Fitch estimates the company's interest expenses would consume more than 70% of its EBITDA generation in 2016, leaving limited room for other cash outflow items, such as capex, working capital requirements, as well as judicial deposits. As such, its uncurbed negative FCF generation will continue to erode its cash balance.

Oi's management is reviewing its strategic options as to how to turn around the company's financial profile. A lack of tangible evidence that it could improve its capital structure in a timely manner will immediately result in further ratings downgrade.

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 an 19% subscriber share. 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. Without industry consolidation, the competitive landscape will remain fierce, limiting any market share recovery for Oi.

KEY ASSUMPTIONS

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

--Muted revenue growth in 2016;

--EBITDA margin at around 26% in 2016

--Negative FCF generation, including judicial deposits, amount to BRL4 billion in 2016;

--Cash balance to fall to below BRL3 billion by end-2016.

RATING SENSITIVITIES

Fitch's key credit focus for Oi remains its ability to refinance its upcoming debt maturities given limited credit access. Further ratings downgrades will be forthcoming if there is a lack of indication that the company has secured viable refinancing sources.

Conversely, any positive rating action is unlikely at the current juncture given the company's weak cash flow generation and liquidity risk.

LIQUIDITY

Oi's medium-term liquidity profile is vulnerable given the large upcoming debt maturities in 2016 and 2017, and the company's limited access to capital markets. The company held a readily available cash balance of BRL16.4 billion as of Sept. 30, 2015 which compares to its debt maturities of BRL12.4 billion by end-2016, including the fourth quarter of 2015. Fitch projects this cash balance will be quickly eroded given continued negative FCF generation.

FULL LIST OF RATING ACTIONS

Fitch has downgraded and removed the following ratings for Negative Watch:

Oi S.A.

--Long-term foreign-currency and local-currency IDRs to 'CCC' from 'B';

--National Long-term rating to 'CCC(bra)' from 'BBB-(bra)';

--Telemar Norte Leste, S.A.'s (Telemar) senior notes, originally due 2017, 2019, and 2020, to 'CCC+/RR3' from 'B+/RR3';

--All outstanding foreign-currency senior unsecured notes to 'CCC'/RR4 from 'B'/RR4;

--Local debentures to 'CCC(bra)' from 'BBB-(bra)'.

Oi Brasil Holdings Cooperatief U.A. (Oi Netherlands)

--EUR600 million senior notes due 2021 to 'CCC/RR4' from 'B/RR4'.

Telemar notes, rated 'CCC+/RR3', reflect good recovery prospects in the event of default, given Telemar's position as the main cash flow generator with operating assets. Securities rated 'RR3' have characteristics consistent with securities historically recovering 51% - 70% of current principal and related interest. However, despite structural seniority compared to Oi's other unsecured notes, Fitch has low visibility as to whether these notes would be entitled to seniority under Brazil's legal system upon any potential reorganization or debt restructuring of Oi. Oi's other senior unsecured notes, with Recovery Ratings of 'RR4', represent average recovery prospects of 31% - 50% given default.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1000843

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000843

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Alvin Lim, CFA
Director
+1-312-368-3114
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Mauro Storino
Senior Director
+55-21-4503-2625
or
Committee Chairperson
Ricardo Carvalho
Senior Director
+55-21-4503-2627
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Alvin Lim, CFA
Director
+1-312-368-3114
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Mauro Storino
Senior Director
+55-21-4503-2625
or
Committee Chairperson
Ricardo Carvalho
Senior Director
+55-21-4503-2627
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com