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Rating Action:

MOODY'S ASSIGNS (P)B3 RATING TO SITRONICS' PROPOSED NOTE ISSUANCE AND (P)B3 CORPORATE FAMILY RATING

16 Feb 2006
MOODY'S ASSIGNS (P)B3 RATING TO SITRONICS' PROPOSED NOTE ISSUANCE AND (P)B3 CORPORATE FAMILY RATING

First-time ratings

London, 16 February 2006 -- Moody's Investors Service has today assigned a provisional (P)B3 corporate family rating to the Joint Stock Company Concern Sitronics ("Sitronics" or "the company"). Concurrently, Moody's assigned a provisional (P)B3 rating to the proposed notes of up to US$200 million to be issued by Sitronics Finance S.A. The outlook on the ratings is stable.

Moody's issues provisional ratings in advance of the final sale of securities, and these ratings only represent Moody's preliminary opinion. Upon a conclusive review of the transaction and associated documentation, Moody's will endeavour to assign a definitive rating to the securities. A definitive rating may differ from a provisional rating.

The (P)B3 corporate family rating reflects the following credit weaknesses: (i) significant event risk due to the company's intentions to continue to grow through acquisitions; (ii) high business risk associated with the company's operating activities in the technology sector; (iii) the competitive nature of the markets in which the company operates; (iv) the complex corporate structure due to a number of business lines, their geographic dispersion and the presence of minority shareholders; (v) relatively high leverage on a pro-forma 2005 EBITDA basis; (vi) dependence on dividends and intercompany loan payments to service the notes; and (vii) negative cash flow from operations for the first nine months of 2005, although this is expected to have turned positive for the quarter in Q4 2005.

More positively, the rating reflects the following credit strengths: (i) the company's 94.5% ownership by JSFC Sistema (rated B1/Stable) and the latter's recent equity contribution to Sitronics' share capital; (ii) Sitronics' strong track record of revenue and EBITDA growth; (iii) cross-selling opportunities to other Sistema subsidiaries such as Mobile TeleSystems OJSC (rated Ba3/Stable) and Moscow City Telephone Network PJSC (rated Ba3/Stable); and (iv) the potential for growth given the increasing demand in Russia and the CIS for technology products in industries such as telecommunications, defence and banking.

CREDIT WEAKNESSES

Sitronics is anticipating strong revenue growth over the next three years as a result of the combination of organic growth and acquisitions. In 2006, M&A activities are expected to account for a significant part of revenue and EBITDA. For example, Sitronics recently announced the signing of a non-binding offer to purchase a 51% stake in Intracom Telecom for approximately EUR120 million. The (P)B3 rating factors in event risk within parameters currently assumed in the company's business plan.

Sitronics' primary activity is technology business, which inherently carries a relatively high business risk. The company's info-communication division (represented by its two main subsidiaries Strom Telecom a.s. and Closed Joint Stock Company Mediatel) faces the ongoing challenges of keeping up with new developments in the telecommunications industry with a view to offer products such as Next Generation Networks, whilst Sitronics' information technology business (represented by Kvazar-Micro Corporation B.V. and its subsidiary companies) is aiming to increase its share in the system integration market -- a more technologically demanding and higher-margin business. In addition, the microelectronics division will need to introduce more advanced technology for the production of microchips and smart cards.

Sitronics is currently in the midst of a significant business transformation entailing the launch of new products and technologies, its entry into new markets (the CIS, other emerging markets such as India and Brazil as well as markets in Western Europe and the USA) and changes to its product mix in the existing businesses to increase profitability. Moody's notes that this organic growth is associated with execution risk with regard to the company's business plan, which could result in revenue and EBITDA growth below levels as outlined in the plan. Additionally, Sitronics will face integration risk as it continues to grow through M&A activities.

Sitronics operates in highly competitive markets. For example, in the info-communications market the company has to compete with multinational companies such as Siemens, Alcatel, Ericsson and Huawei. In its consumer electronics division, Sitronics faces competition from domestic producers for low-priced products as well as from international well-recognised producers for high-quality products. Imports currently represent over 80% of all products on the Russian consumer electronics market. Overall, Sitronics has modest market shares in most of its product lines.

In Moody's view, Sitronics is highly leveraged for a company with high business risk operating in the emerging markets. Following the bond issuance, the company's leverage will be approximately 1.85x Total Debt to 2005 expected EBITDA. The absolute debt level is expected to increase further in the course of 2006 mainly due to the acquisition activity including debt associated with Intracom acquisition. Moody's notes that in 2006 de-leveraging through improved profitability will be largely underpinned by M&A activities, thus creating some uncertainty as regards the company's financial profile over the next 12 to 18 months.

Moody's notes that Sitronics generated negative free cash flow from operations in 2003, 2004 and the first nine months of 2005. However, the company has indicated that it anticipates that cash flow from operations turned positive for the quarter in Q4 2005. The (P)B3 corporate family rating assumes that Sitronics will generate positive cash flow from operations going forward.

CREDIT STRENGHS

The (P)B3 rating is supported by Sitronics' 94.5% ownership by Sistema, which recently made an equity contribution to the company's share capital in the amount of approximately US$200 million. Due to Sitronics' expected revenue contribution, the company falls under the definition of a principal subsidiary for cross-default provisions in Sistema's borrowings.

The rating also reflects Sitronics strong revenue and EBITDA growth over the past several years, although some of this growth is due to acquisitions. Moody's believes that Sitronics is well positioned to benefit from cross-selling to other Sistema subsidiaries such as MTS and MGTS. For example, both companies are major customers of the info-communication division. Sitronics' microelectronics division plans to sell smart cards to Sistema's banking division once production commences. Furthermore, Sitronics is well positioned to benefit from the growing demand for technology products such as microchips for e-passports.

RATING OUTLOOK

The stable outlook on the ratings assumes that the company's external growth will be within the financial parameters as currently factored into the rating. Furthermore, the ratings rely on Moody's expectation that the company will de-leverage from its current levels of debt over the next 12 to 18 months. In the event the company does not turn operating cash flow positive or increases its debt levels beyond the expectations currently embedded in the corporate family rating, negative pressure on the rating could develop.

STRUCTURAL CONSIDERATIONS

The (P)B3 rating on the bonds reflects dependence on dividend and intercompany loan payments for debt service on the proposed bond issuance without previous track record of such cash up-streaming. Moody's notes that the majority of dividend payments are anticipated to derive from the company's info-communication division and, over the medium term, the information technology division.

At the same time, the proposed terms and conditions of the notes limit debt incurrence at Sitronics' subsidiaries to 10% of the company's consolidated debt. In the event that an acquired subsidiary retains its debt after a specified period of time, it has to provide a guarantee to the bonds, which will rank pari-passu with its existing and future unsecured and unsubordinated debt obligations.

COMPANY SUMMARY

Sitronics, headquartered in Moscow, is a large diversified group of technology companies with operations in Russia, Ukraine and Eastern Europe. For the first nine months of 2005, the company generated US$652.3 million in revenue and US$143.6 million in EBITDA on a consolidated basis.

London
Jenya Brown
Analyst
Corporate Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
David G. Staples
Managing Director
Corporate Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

No Related Data.
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