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Rating Action:

Moody's affirms Oi's Baa3/Aa1.br rating with a negative outlook following announced merger with Portugal Telecom

Global Credit Research - 02 Oct 2013

NOTE: On October 18, 2013, the press release was revised as follows: Corrected the methodology publication date from December 2010 to December 2007 in the first sentence of the first paragraph of the principal methodology section and removed the last two duplicate sentences in the Regulatory Disclosures section. Revised release follows.

Sao Paulo, October 02, 2013 -- Moody's América Latina ("Moody's") has today affirmed the Baa3/Aa1.br senior unsecured ratings of Oi S.A. ("Oi") and maintained its negative outlook, following the announcement that Oi has reached an agreement with Portugal Telecom, SGPS, S.A. ("PT", Ba2/neg) to merge the two entities. Concurrently, Moody's has affirmed Telemar Participaçoes' Ba1/Aa2.br rating and negative outlook, but expects to withdraw its ratings once the transaction is completed.

Ratings affirmed:

Issuer: Oi S.A.

-Issuer rating: Baa3

- NSR Issuer Rating: Aa1.br

-Senior Unsecured Bonds/Debentures: Baa3/Aa1.br

Issuer: Telemar Participações S.A.

- Senior Unsecured (domestic currency): Ba1

- NSR: Aa2.br

- Senior Unsecured Debentures: Ba1/Aa2.br

The outlook for all ratings is negative.

The new combined entity will benefit from a minimum BRL7.0 billion cash capital increase that could reach up to BRL 8.0 billion, of which BRL 2.5-3.5 billion will be injected into Oi while the remaining BRL 4.5 billion will be used to repay the debt at Oi's holding company, Telemar Participaçoes, and its ultimate holding companies: LF Tel S.A. and AG Telecom. Additionally, the combination is expected to result in mainly tax-related and procurement-related synergies, as well as an improved organizational structure and corporate governance standards.

"We have affirmed Oi's existing Baa3 rating due to the expected benefits of size and scale in an equity financed transaction and some benefits of synergies but more importantly, sharing of best practices to help Oi's future revenue growth path," says Soummo Mukherjee, a Moody's Vice President -- Senior Credit Officer and lead analyst for Oi. "The combined entity would benefit from an expected cash capital increase of BRL 7-8 billion plus an additional BRL7 billion from the combined group's cash balance that is expected to be used towards debt reduction."

On a pro-forma basis based on Oi's LTM figures ended 06/30/2013 and PT's 2012 year-end numbers, the combination would have resulted in Total Debt to EBITDA of around 4.1 times, which we still consider high for the Baa3 rating category and is the main reason why we still maintain our negative outlook on Oi's rating.

The proposed transaction is subject to shareholder and regulatory approval in Brazil, U.S. and Portugal and expected to close by the end of Q2 2014.

RATINGS RATIONALE

Today's rating action reflects Moody's view that if successfully completed, the combination with Portugal Telecom will benefit Oi as it will become part of a larger group with improved size and scale. Moreover, the combined entity would benefit from an expected capital increase of approximately BRL 7-8 billion (US$3.2-3.6 bn) and total synergies of around BRL5.5 billion (US$2.5 bn), and Moody's expects that it will start generating positive free cash flow by the end of 2015.

The combined entity will have 2012 pro-forma revenues of BRL37.5 billion (US$17 billion), making it the largest Brazilian telecom operator in terms of revenues, with more than 100 million customers in three different regions of the world (Brazil, Portugal and Angola). We also believe that the merger will allow Oi to better leverage Portugal Telecom's experience with fiber and 4G deployment, convergence and innovation, while Portugal Telecom will benefit from Brazil's better growth opportunities and stronger balance sheet.

The deal, however, will leave the company with about 22% revenue and 28.5% EBITDA exposure to Portugal (Ba3/neg), which has been struggling economically. Portugal Telecom faces considerable challenges because of regulatory and competitive pressures in Europe and subdued consumer spending in its domestic market. Consolidated operating revenues fell by double-digit percent in the first half of 2013, reflecting the impact of the depreciation of the Brazilian real against the euro (Oi's revenues and EBITDA comprise approximately 42%-46% of the enlarged consolidated group) and a 4.8% year-on-year decline in domestic revenues in the second quarter. These challenges continue to put pressure on PT's revenues and we expect further deterioration this year, albeit at a slower pace as mobile termination rates cuts have ended and new pricing initiatives gain traction. We also expect further price erosion to weaken its domestic EBITDA margin. At the same time, competition with America Movil (A2 on review for downgrade) and its subsidiaries: Embratel (Baa2 positive) and Net Serviços (Baa3 positive), as well as with Telefonica Brasil (Baa1 stable) and other cable and Pay-TV operators will remain fierce in the Brazilian market.

As part of the transaction, Oi's and Portugal Telecom's current complex organization and legal structure will be greatly simplified as all of the main operating assets are combined into one with one holding company that will be listed in a single class of shares in the Novo Mercado in BMF Bovespa in Brazil and NYSE Euronext (New York and Lisbon). As a result the current debt of approximately BRL4.5 billion ($2.05) at Oi's current holding company, Telemar Participações, and its holdings AG Telecom and LF Tel, will be fully repaid. Oi will then adhere to the highest standards of corporate governance with the planned creation of an audit committee with fully independent members, as defined by Sarbanes Oxley standards.

WHAT COULD CHANGE THE RATINGS UP/DOWN

A stabilization of Oi's ratings would require the company's leverage, as measured by Total Debt to EBITDA, moving toward 3.5 times while evidencing that the combined company's revenue growth and EBITDA margin improvement are not derailed due to competition or weaker than expected operating performance in any of its markets.

Conversely, Moody's could downgrade Oi's rating due to overall negative revenue growth or a decline in the company's market share and margins due to a stronger competitive market, as well as due to weaker than expected operating performance in Portugal and/or Africa, post closing of the transaction. Specifically, Oi's rating could come under downward pressure if: adjusted Total Debt to EBITDA ratio goes above 4.2 times for an extended period of time and/or if the company's free cash flow remains negative beyond the end of 2015.

PRINCIPAL METHODOLOGY

The principal methodology used in this rating was the Global Telecommunications Industry Methodology published in December 2007. Please see the Credit Policy page on www.moodys.com.br for a copy of this methodology.

Headquartered in the city of Rio de Janeiro, Oi is the largest telecom operator in Brazil in terms of fixed-line access. At the end of 30 June 2013, it had revenues of BRL28.5 billion ($13 billion) and EBITDA of approximately BRL10 billion ($.4.5 billion).

Moody's National Scale Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody's global scale ratings in that they are not globally comparable with the full universe of Moody's rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a ".nn" country modifier signifying the relevant country, as in ".mx" for Mexico. For further information on Moody's approach to national scale ratings, please refer to Moody's Rating Methodology published in October 2012 entitled "Mapping Moody's National Scale Ratings to Global Scale Ratings".

REGULATORY DISCLOSURES

Information sources used to prepare the rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's information.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a rating.

Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

The rating has been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

Please see the ratings disclosure page on www.moodys.com.br for general disclosure on potential conflicts of interests.

The rated entity has received a Rating Assessment Service within the last 12 months preceding the Credit Rating Action.

Moody's America Latina, Ltda. may have provided Other Permissible Service(s) to the rated entity or its related third parties within the 12 months preceding the credit rating action. Please see the special report "Services provided to entities rated by Moody's America Latina, Ltda." on our website www.moodys.com.br for further information.

Entities rated by Moody's America Latina Ltda. (and the rated entities' related parties) may also receive products/services provided by parties related to Mood's America Latina, Ltda. engaging in credit ratings activities. Please go to www.moodys.com.br for a list of entities receiving products/services from these related entities and the products/services received. This list is updated on a quarterly basis.

The date of the last Credit Rating Action was 30/10/2012.

Moody's ratings are constantly monitored, unless designated as point-in-time ratings in the initial press release. All Moody's ratings are reviewed at least once during every 12-month period.

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.br.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Please see ratings tab on the issuer/entity page on www.moodys.com.br for the last rating action and the rating history. The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com.br for further information.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com.br for further information on the meaning of each rating category and the definition of default and recovery.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com.br for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com.br for additional regulatory disclosures for each credit rating.

Soummo Mukherjee
VP - Senior Credit Officer
Corporate Finance Group
Moody's America Latina Ltda.
Avenida Nacoes Unidas, 12.551
16th Floor, Room 1601
Sao Paulo, SP 04578-903
Brazil
JOURNALISTS: 800-891-2518
SUBSCRIBERS: 55-11-3043-7300

Marianna Waltz, CFA
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 800-891-2518
SUBSCRIBERS: 55-11-3043-7300

Releasing Office:
Moody's America Latina Ltda.
Avenida Nacoes Unidas, 12.551
16th Floor, Room 1601
Sao Paulo, SP 04578-903
Brazil
JOURNALISTS: 800-891-2518
SUBSCRIBERS: 55-11-3043-7300

Moody's affirms Oi's Baa3/Aa1.br rating with a negative outlook following announced merger with Portugal Telecom
No Related Data.

 

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