Nos, Sgps, S.A

Home , NOS (Portuguese company), SONAE, Vodafone Portugal

NOS, SGPS, S.A.

Primary Credit Analyst: Thibaud Lagache, Paris (33) 1-4420-6789; [email protected]

Secondary Contact: Xavier Buffon, Paris (33) 1-4420-6675; [email protected]

Table Of Contents

Credit Highlights

Outlook

Our Base-Case Scenario

Company Description

Business Risk

Financial Risk

Liquidity

Covenant Analysis

Issue Ratings - Subordination Risk Analysis

Reconciliation

Ratings Score Snapshot

Related Criteria

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Business Risk: SATISFACTORY Issuer Credit Rating Vulnerable Excellent

bbb- bbb- bbb-

BBB-/Stable/-- Financial Risk: INTERMEDIATE

Highly leveraged Minimal

Anchor Modifiers Group/Gov't

Credit Highlights

Overview

Key strengths Key risks Leading position in Portugal's pay-TV market, a well-established Direct competition with two other strong brands (Altice, owned by presence in fixed broadband as the close no. 2 operator, and a distant Portugal Telecom (PT) and Vodafone), that operate overlapping platforms no. 2 position in the postpaid mobile services market. and offer converged services within Portugal's small service area. Well-invested fixed networks provide over 100 megabits per second Mature, highly penetrated market, and on-going fiber deployment will (Mbps) to more than 73% of broadband customers, supporting higher further limit network and speed differentiation. fixed average revenue per user than for competitors. Flexible fixed-mobile offering, strong local content, and a Heavy capital expenditure (capex), including spending on networks, well-established brand have fueled solid organic growth of about satellite capacity, subscriber acquisitions costs, and catching up with 3.3% over 2014-2018. competitors in terms of 4g mobile coverage. A strong balance sheet and sound financial policy with targeted Entrance of Masmovil (via a stake in Cabovisao/Oni) in the Portuguese leverage of about 2.0x. The ability to monetize its mobile network market, together with the rising penetration of over-the-top (OT) providers infrastructure provides additional flexibility. could intensify competition.

NOS, SGPS, S.A. is Portugal's second largest national and converged operator. The company's historically strong pay-TV offering and its no. 1 position in the pay-TV market has resulted in a solid share of net adds across all services since mid-2014, thanks to a nationwide next generation network (NGN) covering about 90% of households through fiber to the home (FTTH; about 31%) and Docsis3.1 cable (about 69%) as of Sept. 30, 2019. NOS' well-invested fixed networks providing broadband speed of over 100Mbps to more than 73% of broadband customers, strong local content, and very flexible "pick and mix" tariff plans have led to high revenue generating units (RGU) per subscribers, supporting higher fixed ARPU than competitors.

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S&P Global Ratings expects NOS will continue to show organic single-digit revenue growth, supported by improving macroeconomic conditions, a sustained pace of growth in more value-added convergent bundles, and steady price increases despite tough competition. We expect this growth will also be supported by the increasing coverage of its 4G+ mobile network and the ongoing upgrade of its fixed network. This follows the reciprocal fixed-network sharing agreement it reached with Vodafone in 2017 and DS Telecom in 2019 to swap approximately 2.6 million and 1.2 million households, respectively, to fiber-to-the-home (FTTH) technology by 2022. We expect that, by 2022, about 70% of NOS' footprint (3.1 million Portuguese households) will use FTTH technology compared with 31% today. NOS' integrated and convergent subscribers represents about 60% (914,800) of the total base, leaving additional room for growth. Additionally, we believe NOS' margins will likely improve further due to increasing operating leverage.

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The mature, highly penetrated nature of the Portuguese market, as well as fiber deployment, will further limit network and speed differentiation. Although customer acquisition and retention capex have declined since 2014 from 14.5% of revenue, we expect they will remain at about 9%-10% in 2020 and beyond due to Altice's intense fiber deployment, and rising competition from new market entrants. That said, we believe NOS' strong brand recognition and local content offering (sport, and local shows for example), outside of OTT services, will continue to provide solid protection against price competition. NOS has set ambitious targets and sought partnerships to deploy fiber and to remain independent from Altice's FTTH network, which we believe will continue to support solid pay-TV net customer additions, which are the basis for upselling its convergent offers.

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Outlook: Stable

The stable outlook reflects our expectation that NOS will continue to leverage its attractive brand and solid market position, deliver organic revenue growth, and gradually increase margins. We think this will position the company comfortably at our 'BBB-' rating level, with S&P Global Ratings' adjusted leverage comfortably below 2.5x and free operating cash flow (FOCF) to debt over 10%, steadily rising on moderating investments and increasing absolute EBITDA.

Downside scenario

We could take a negative rating action if adjusted leverage increased for a prolonged period above 2.75x, or if FOCF to debt deteriorated significantly below 10%. In our view, this could occur from a more aggressive financial policy than we foresee, if NOS experienced declining revenue, or if margins started to deteriorate, for example as a result of a market-wide price decline, which seems unlikely at this stage.

Upside scenario

We could raise the rating if NOS' performance is stronger than our base-case expectation and translates into FOCF to debt significantly above 15%, and adjusted leverage sustainably reducing toward 2.0x.

Our Base-Case Scenario

Assumptions Key Metrics

• Portuguese GDP per capita will reach above $25,000 by 2021, following GDP growth of about 2.1% in 2018a* 2019e 2020f 2018 and about 1.6%-1.8% over 2019-2020, mainly Revenue growth (%) 0.9 1.3 1.1 driven by continued solid economic growth; and the Adjusted EBITDA margin (%) 39.3 37.9 39.2 unemployment rate will decline to 6.0% by 2019. Capex/sales (%) 26.9 26.3 26.0 Adjusted debt/EBITDA (x) 2.2 2.3 2.3 • The Portuguese telecom market will expand primarily from price increases and rising Adjusted FFO/debt (%) 42.8 40.0-41.0 40.0-41.0 convergence adoption or service migration Adjusted FOCF/debt (%) 17.4 10.0-12.0 12.0-13.0 (vDSL/FTTB to FTTH), rather than from subscriber or household growth, which we expect will increase *2018 includes the positive impact of a non-recurrent in line with inflation. We believe this is due to the inflow related with the receipt of a legal settlement in already high penetration of telecom services (about favors of NOS. 170% mobile penetration per population, about 75% and 90% of broadband and pay-TV penetration per a--Actual. e--Estimate. f--Forecast. FFO--Funds from households, respectively). operations. • NOS' total revenue will increase by about 1.2% over 2019-2021, driven by business and wholesale, telecom and audiovisuals, and cinema.

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• We anticipate consumer revenue will increase by 0.3% on average per year over 2019-2021, driven by yearly price increases (slightly above inflation rate) in convergent packages, further adoption of quad-play packages, with convergent customers reaching about 60% of the pay-TV base by 2020, and NOS' network expansion. We expect this will in turn support continuous, although moderate, RGU growth (1% on average per year) and fixed ARPU growth. • Business and wholesale revenue will increase by 2.3% on average per year, supported by additional contract wins, RGU growth, and price increases. • About 2% growth in the audiovisual and cinema business. • S&P Global Ratings' reported EBITDA margins (after leases) will improve to 38%-39% over 2019-2021, from 37%-38% in 2017-2018, stemming from revenue growth and an improved customer mix. • Total reported capex (including long-term contracts) will remain at 25.0%-26.0% of revenue over 2019–2021, from 26%-28% in 2017-2018, excluding spectrum costs for 5G. Capex will mainly stem from the continuing FTTH upgrade and mobile network overhaul that NOS initiated in late 2017 to optimize spectrum utilization and improve capacity for 4G+ technology, while complying with coverage obligations. We expect capex could be slightly lower if NOS and Vodafone go ahead with sharing their full mobile networks. • Our expectation of distribution of the bulk of reported FOCF (after leases) in dividends (€180 million paid in 2019)

Base-case projections We expect solid reported cash flow (after leases) conversion and growth will continue, driven by network expansion and continued subscriber migration. We forecast reported FOCF after leases will increase by about 15% on average per year over 2019-2021.

Adjusted leverage will remain at about 2x. Stable capex of about 26% of revenue and ongoing EBITDA growth will keep leverage well below 2.5x, despite moderately increasing revenue and shareholder distributions.

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Company Description

NOS is the no.2 largest telecom operator in Portugal, behind the incumbent PT (acquired by Altice in January 2015) and ahead of Vodafone Portugal. Both in terms of revenue and subscribers, NOS is the no.1 in pay-TV, close no.2 in fixed broadband, and no.2 in postpaid mobile.

Its services include mobile and fixed broadband, as well as video production, sales and distribution, and cinema exhibitions (about 7% of total revenue), for the consumer segment, which greatly contributes to its solid brand recognition. NOS has about 226 screens in its own network, and enjoys an above 65% cinema distribution market share in Portugal. NOS has also significant business-to-business and wholesale activities (1.5 million RGUs, €460 million revenue in 2018) with very large contracts won from PT, and a sizeable wholesale business.

NOS' footprint extends across Portugal through a nationwide NGN network covering about 90% of households (4.6 million) through two technologies: FTTH (about 31%) and Docsis3.1 cable ( about 69%), as of Sept. 30, 2019.

NOS was formed in 2013 from the merger between Portugal's no.1 cable and audiovisual company Zon Multimedia (owned by Isabel Dos Santos), and the no.3 mobile operator Optimus (owned by Sonae, no.1 retailer in Portugal), in response to PT's launch of convergent offers (packages that include fixed and mobile services). This was the first convergent merger in Europe.

Isabel Dos Santos and Sonae equally own 52.15%, with the rest in free float.

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Business Risk: Satisfactory

Our assessment of NOS' business risk is supported by:

• The company's 4G mobile network, which covers 91% of the Portuguese population, combined with its well-invested next generation fixed network, which covers about 90% of domestic households through FTTH and Docsis3.1 cable. The company's fixed network provides speeds of 100 Mbps to more to 73% of its fixed broadband customers, which supports higher consumer fixed ARPU (€44 per month on average) than competitors (PT: €32 per month on average).

• Fixed network overbuild in Portugal allows a certain degree of independence and sound network competition.

• NOS owns a sizable number of tower sites, and shares about 500 sites with Vodafone under a Radio Access Network-sharing agreement. NOS owns a hybrid fiber-coaxial network (fully upgraded eurodcosis 3.1) covering about 3.2 million households. It has also entered shared FTTH network agreements with Vodafone and DSTelecom (1.2 million homes) which will help it cover the entire country.

• NOS' no. 1 position in pay-TV and its attractive brand, which successfully supported the upselling of fixed and mobile services with competitive convergent offerings. NOS has a strong track record of net customer gains,

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translating into subscriber market shares of above 36% in fixed broadband (PT 40%), about 41% in pay-TV (PT 40%), and about 2.8 million of total postpaid mobile customers, which is well above the no. 3 operator Vodafone's 2.0 million, although behind PT's 4.7 million customers.

• NOS' leading convergent position in terms of multiplay revenue market share (share of about 42%, compared with Vodafone's 14% and PT's 41%) and in quad-play bundles (46% revenue share compared with PT's 44%, and Vodafone's 8%).

• NOS' good customer service, which is illustrated by its relatively low churn, mitigating a more difficult network differentiation in a mature and highly penetrated market.

• Limited exposure to content cost inflation, as the rights for broadcasting major sporting events are equally shared among players through a joint venture and costs are frozen until 2027-2028, which is a unique model compared with the rest of Europe.

• Likely absent onerous regulatory risks, other than the recent roaming policy across Europe. Lower mobile termination rates (namely the fee one telecommunications operator charges another for terminating calls on its network) are largely offset by annual price increases.

Our assessment of NOS' business risk is balanced by:

• NOS having to compete with two other large players that operate overlapping platforms and also offer converged services, within Portugal's relatively small service area (10.3 million inhabitants, about 5.5 million households).

• The company's relatively limited scale and operations compared with market incumbent PT, which has a slightly larger network footprint of 5.2 million households versus NOS' 4.6 million,and with 3.8 million households connected to FTTH against 1.2 million for NOS. PT has a larger business and wholesale segment than NOS, although NOS has gained market share in recent years from PT.

• NOS' S&P Global Ratings-reported EBITDA margin (after leases), which is lower than that of PT and other European cable players.

• The uncertain impact of Altice's full and partial network disposals on competition.

Peer comparison Table 1 NOS, SGPS, S.A.--Peer Comparison

Industry sector: Cable Tv

Sunrise Altice NOS, SGPS, Communications Koninklijke KPN Telekom Austria International S.A. Holdings S.A. N.V. AG DNA PLC S.a.r.l. Ratings as of Jan. BBB-/Stable/-- BBB-/Stable/-- BBB/Stable/A-2 BBB+/Stable/A-2 BBB+/Stable/-- B/Negative/-- 30, 2020 --Fiscal year ended Dec. 31, 2018-- (Mil. €) Revenue 1,576.2 1,665.6 5,638.0 4,435.4 911.8 4,184.7 EBITDA 618.8 614.1 2,341.5 1,408.6 335.7 1,538.4 Funds from 576.0 493.9 2,036.1 1,197.8 303.6 880.4 operations (FFO) Interest expense 32.4 75.9 335.1 122.2 25.0 648.8

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Table 1 NOS, SGPS, S.A.--Peer Comparison (cont.)

Industry sector: Cable Tv

Sunrise Altice NOS, SGPS, Communications Koninklijke KPN Telekom Austria International S.A. Holdings S.A. N.V. AG DNA PLC S.a.r.l. Cash interest paid 39.2 75.8 314.4 147.1 19.7 566.0 Cash flow from 658.7 442.8 2,103.1 1,166.4 243.3 871.5 operations Capital expenditure 425.2 262.1 1,107.0 768.1 145.1 859.4 Free operating 233.5 180.7 996.1 398.4 98.2 12.1 cash flow (FOCF) Discretionary cash 76.5 20.6 431.1 264.8 (47.1) (4.2) flow (DCF) Cash and 2.2 373.6 644.0 63.6 22.7 597.3 short-term investments Debt 1,344.6 1,753.5 6,939.9 3,344.9 526.0 10,568.9 Equity 1,083.9 1,314.8 2,408.5 2,409.5 586.0 25.0

Adjusted ratios EBITDA margin 39.3 36.9 41.5 31.8 36.8 36.8 (%) Return on capital 8.3 6.6 8.9 6.9 14.2 6.4 (%) EBITDA interest 19.1 8.1 7.0 11.5 13.4 2.4 coverage (x) FFO cash interest 15.7 7.5 7.5 9.1 16.4 2.6 coverage (x) Debt/EBITDA (x) 2.2 2.9 3.0 2.4 1.6 6.9 FFO/debt (%) 42.8 28.2 29.3 35.8 57.7 8.3 Cash flow from 49.0 25.3 30.3 34.9 46.2 8.2 operations/debt (%) FOCF/debt (%) 17.4 10.3 14.4 11.9 18.7 0.1 DCF/debt (%) 5.7 1.2 6.2 7.9 (9.0) (0.0)

Financial Risk: Intermediate

Our view of NOS' financial risk profile is supported by its solid balance sheet, with relatively low leverage of 2.2x at end-2018, sound FOCF generation, and a conservative financial policy targeting about 2.0x net reported leverage. Despite our forecast that NOS will distribute most of its FOCF to shareholders, we expect its S&P Global Ratings' adjusted leverage will slightly improve thanks to EBITDA growth, and will remain well below 2.5x over our forecast horizon through 2020.

Financial summary

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Table 2 NOS, SGPS, S.A.--Financial Summary

Industry sector: Cable Tv --Fiscal year ended Dec. 31--

2018 2017 2016 2015 2014

(Mil. €) Revenue 1,576.2 1,561.8 1,515.0 1,444.3 1,383.9 EBITDA 618.8 596.8 560.9 542.0 540.0 Funds from operations (FFO) 576.0 537.2 497.5 486.8 480.5 Interest expense 32.4 33.0 33.1 39.0 50.4 Cash interest paid 39.2 42.3 42.1 52.2 72.3 Cash flow from operations 658.7 507.9 491.9 527.5 516.6 Capital expenditure 425.2 355.9 398.0 439.0 377.7 Free operating cash flow (FOCF) 233.5 152.1 93.9 88.5 138.9 Discretionary cash flow (DCF) 76.5 49.4 (8.9) 8.3 46.4 Cash and short-term investments 2.2 3.0 2.3 9.9 21.1 Gross available cash 2.2 3.0 2.3 9.9 21.1 Debt 1,344.6 1,444.3 1,479.3 1,313.3 1,289.4 Equity 1,083.9 1,086.4 1,053.1 1,063.5 1,060.1

Adjusted ratios EBITDA margin (%) 39.3 38.2 37.0 37.5 39.0 Return on capital (%) 8.3 7.6 6.7 7.4 7.8 EBITDA interest coverage (x) 19.1 18.1 17.0 13.9 10.7 FFO cash interest coverage (x) 15.7 13.7 12.8 10.3 7.6 Debt/EBITDA (x) 2.2 2.4 2.6 2.4 2.4 FFO/debt (%) 42.8 37.2 33.6 37.1 37.3 Cash flow from operations/debt (%) 49.0 35.2 33.3 40.2 40.1 FOCF/debt (%) 17.4 10.5 6.3 6.7 10.8 DCF/debt (%) 5.7 3.4 (0.6) 0.6 3.6

Liquidity: Adequate

We assess NOS' liquidity as adequate, based on our view that the company has a satisfactory standing in credit and equity markets, sound relationships with banks, and generally prudent risk management. We also expect that sources will cover uses by more than 1.2x over the 12 months from Sept. 30, 2019.

Principal Liquidity Sources Principal Liquidity Uses

• Funds from operations of about €588 million. • Debt maturities of about €20 million within the next six months. • Availability under undrawn committed lines of €275 million. • Working capital outflows of about €10 million.

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• Cash on balance sheet of €31 million. • Capex of about €420 million. • Dividend distributions of about €190 million.

Debt maturities No meaningful debt maturity before 2022.

Covenant Analysis

NOS' debt does not have financial maintenance covenants.

Issue Ratings - Subordination Risk Analysis

Capital structure NOS' capital structure consists of public and private unsecured debt issued at the company's level.

Analytical conclusions The rating on the debt is at the same level as our long-term issuer credit rating on NOS, reflecting the absence of significant subordination risk, further supported by NOS' low leverage.

Reconciliation

Table 3 Reconciliation Of NOS, SGPS, S.A. Reported Amounts With S&P Global Ratings' Adjusted Amounts (Mil. €) --Fiscal year ended Dec. 31, 2018--

NOS, SGPS, S.A. reported amounts

S&P Global Ratings' Cash flow Shareholders' Operating Interest adjusted from Capital Debt equity EBITDA income expense EBITDA operations expenditure Reported 1045.1 1076.6 590.8 200.8 18.2 618.8 658.6 452.1

S&P Global Ratings' adjustments Cash taxes paid ------(3.6) -- -- Cash taxes paid: ------Other Cash interest paid ------(25.1) -- -- Reported lease 88.0 ------liabilities Operating leases 186.9 -- 59.8 12.9 12.9 (12.9) 46.9 -- Accessible cash and (2.2) ------liquid investments Capitalized interest ------1.3 (1.3) (1.3) (1.3)

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Table 3 Reconciliation Of NOS, SGPS, S.A. Reported Amounts With S&P Global Ratings' Adjusted Amounts (Mil. €) (cont.) Capitalized -- -- (25.6) 2.6 -- -- (25.6) (25.6) development costs Share-based -- -- 3.5 ------compensation expense Asset retirement 26.8 ------obligations Nonoperating income ------(1.4) ------(expense) Reclassification of ------(19.9) -- interest and dividend cash flows Noncontrolling -- 7.3 ------interest/minority interest EBITDA: Gain/(loss) -- -- (9.7) (9.7) ------on disposals of PP&E Total adjustments 299.5 7.3 28.0 4.4 14.2 (42.8) 0.1 (26.9)

S&P Global Ratings' adjusted amounts

Cash flow Interest Funds from from Capital Debt Equity EBITDA EBIT expense operations operations expenditure Adjusted 1344.6 1083.9 618.8 205.2 32.4 576.0 658.7 425.2

Ratings Score Snapshot

Issuer Credit Rating BBB-/Stable/--

Business risk: Satisfactory • Country risk: Intermediate • Industry risk: Intermediate • Competitive position: Satisfactory

Financial risk: Intermediate • Cash flow/leverage: Intermediate

Anchor: bbb-

Modifiers • Diversification/portfolio effect: Neutral (no impact) • Capital structure: Neutral (no impact) • Financial policy: Neutral (no impact) • Liquidity: Adequate (no impact)

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• Management and governance: Satisfactory (no impact) • Comparable rating analysis: Neutral (no impact)

Related Criteria

• Criteria - Corporates - General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018

• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017

• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014

• Criteria - Corporates - Industrials: Key Credit Factors For The Telecommunications And Cable Industry, June 22, 2014

• General Criteria: Group Rating Methodology, Nov. 19, 2013

• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013

• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013

• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013

• General Criteria: Methodology: Industry Risk, Nov. 19, 2013

• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012

• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009

Business And Financial Risk Matrix

Financial Risk Profile Business Risk Profile Minimal Modest Intermediate Significant Aggressive Highly leveraged Excellent aaa/aa+ aa a+/a a- bbb bbb-/bb+ Strong aa/aa- a+/a a-/bbb+ bbb bb+ bb

Satisfactory a/a- bbb+ bbb/bbb- bbb-/bb+ bb b+ Fair bbb/bbb- bbb- bb+ bb bb- b Weak bb+ bb+ bb bb- b+ b/b- Vulnerable bb- bb- bb-/b+ b+ b b-

Ratings Detail (As Of February 12, 2020)* NOS, SGPS, S.A. Issuer Credit Rating BBB-/Stable/-- Senior Unsecured BBB- Issuer Credit Ratings History 14-Mar-2018 BBB-/Stable/-- *Unless otherwise noted, all ratings in this report are global scale ratings. S&P Global Ratings’ credit ratings on the global scale are comparable across countries. S&P Global Ratings’ credit ratings on a national scale are relative to obligors or obligations within that specific country. Issue and debt ratings could include debt guaranteed by another entity, and rated debt that an entity guarantees.

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