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Announcement:

Moody's reviews X5's ratings for possible downgrade following announcement of Kopeyka acquisition

Global Credit Research - 10 Dec 2010

Moscow, December 10, 2010 -- Moody's Investors Service has today placed the B1 corporate family and probability of default rating of X5 Retail Group N.V. ("X5") on review for possible downgrade. At the same time, Moody's Interfax Rating Agency, which is majority-owned by Moody's, has launched a similar review of the A1.ru national scale credit rating of X5.

The review follows the announcement that X5 signed an agreement to acquire OJSC Trade House Kopeyka ("Kopeyka"), a discount food retailer in Russia, in a RUB51.5 billion (around US$1,661 million) transaction structured as cash payment for 100% of the equity of Kopeyka and assumption of net debt of no more than RUB16.5 billion (around US$532 million). X5 expects to fund the transaction by a 5-year rouble-denominated credit facility equivalent to US$1 billion and by utilizing headroom under other long-term facilities with Sberbank, Russia's leading state-controlled bank. The transaction was approved by the Russian Federal Anti-Monopoly Service and is expected to be closed in the second half of December 2010.

Moody's recognizes X5's solid business fundamentals of a leading player in Russia's food retail market and the company's reasonable operating performance. Moody's views the Kopeya acquisition transaction as well fit into X5's growth strategy in the very fragmented domestic market. The key benefits include (i) X5's strengthened position in its best performing discounter format and in Russia's most attractive regional markets of the city of Moscow and the Moscow region; and (ii) opportunities to improve margins and increase cash flow generation due to the economy of scale and improved operating efficiency. The pro-forma LTM H1 2010 retail turnover and EBITDA are estimated to be respectively 20% and 16% above X5's respective standalone turnover and EBITDA.

However, the transaction is large and debt-funded. So the review reflects the expected transaction-driven weakening of the company's financial profile beyond the tolerance level set for Moody's B1 for businesses operating in the emerging markets and the currently limited visibility of the management's appetite for further growth in leverage. If X5 were to follow a very ambitious capex programme, its deleveraging towards the level supportive for the B1 might not take place within 12-18 months after the close of the transaction, while at the same time pressuring the company's liquidity within the current rating category. Moody's understands that X5 is reasonably flexible with its investments and the pace of a recovery of its financial profile within the current rating category is to a high degree the issue of its management's choice and commitment. X5 has not provided specific investment guidance for the 2011 and for a medium-term period but it has confirmed its plans to aggressively grow. So Moody's has launched the ratings review process to further assess the prospect, the timing and degree of a recovery of the company's financial profile.

Moody's anticipates that following the transaction the company's end-2010 pro-forma Debt/EBITDA could rise to around 4.8x, while EBITA/Interest and RCF/Net Debt could weaken towards 2.2x and below 15%, respectively (all ratios incorporate Moody's standard adjustments), thereby materially deviating from Moody's rating guidance for the leverage trending below 4x, EBITA/Interest above 2.5x and RCF/Net Debt at around 20%. Moody's notes the execution and integration risks associated with the transaction. However, the agency see these as manageable within the current rating level, taking into account X5's expertise in the soft discounter format and its track record of both the implemented acquisitions and negotiations and interactions with Kopeyka before the transaction.

Moody's would view X5's post-transaction liquidity profile as satisfactory, but for the uncertainty with its capex plans and appetite to leverage. The agency would expect X5's end-2010 post-transaction debt-maturity profile to be long-term, factoring in the available acquisition facility and assumed Kopeyka's debt. X5's end-2010 short-term debt is expected to be represented by put-option obligations under its domestic bond of RUR8 billion (around US$258 million), which should account for less than 10% of the end-2010 total debt of around US$3.4 billion in dollar terms. These obligations are more than covered by unused funds under long-term committed facilities available for the company. However, Moody's notes that X5's liquidity position may become increasingly dependent on the company's cash flow generation ability going forward, should X5 significantly increase its capex plans. At the same time, the agency sees the discretionary nature of the company's capex as a mitigant of the risk of liquidity issues. Moody's notes the company's reasonable headroom under its financial covenants and expects X5 to be able to maintain it at least at 20% within the current rating.

During its review process, Moody's will focus on the company's integration cost budget and its capex plan for 2011-2012, the management's commitment to deleveraging under Moody's ratings guidance and the expected pace of the deleveraging, and the likely liquidity profile evolution.

X5's ratings could be cut if there were concerns that X5 might not be able or willing to reduce its leverage towards around 4x and restore EBITA/Interest and RCF/Net Debt to above 2.5x and around 20%, respectively in the intermediate term. Concerns over a material deterioration of the liquidity profile, including reduced headroom under covenants below 20%, could also prompt a downgrade of the ratings. However, taking into account X5's solid business fundamentals and benefits from the transactions, the global scale rating is unlikely to be downgraded by more than one notch if at all.

The last rating action on X5 was implemented on 21 August 2008, when Moody's changed the outlook on the B1/A1.ru ratings to stable from positive.

The principal methodology used in rating X5 is Moody's Global Retail Methodology, December 2006, which can be found at moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

Headquartered in the Netherlands, X5 is the leading multi-format Russian food retailer. X5's 2009 net revenues were US$ 8.7 billion, with soft discounter format, supermarkets and hypermarkets accounting for around 50%, 31% and 19%, respectively. X5 is a member of the Alfa Group Consortium, one of a few Russia-focused private industrial and financial conglomerates. The parent company of the consortium is the ultimate parent company of X5. Alfa Group beneficiary shareholders control 47.9% of X5, while the management of the latter holds 1.9%.

Moscow
Ekaterina Botvinova
Vice President - Senior Analyst
Corporate Finance Group
Moody's Eastern Europe LLC
Telephone: +7 495 228 6060
Facsimile: +7 495 228 6091

Paris
Eric de Bodard
MD - Corporate Finance
Corporate Finance Group
Moody's France SAS
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Moody's Eastern Europe LLC
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Telephone: +7 495 228 6060
Facsimile: +7 495 228 6091

Moody's reviews X5's ratings for possible downgrade following announcement of Kopeyka acquisition
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