NOS, SGPS, S.A. Primary Credit Analyst: Thibaud Lagache, Paris + 33 14 420 6789; [email protected] Secondary Contact: Xavier Buffon, Paris + 33 14 420 6675; [email protected] Table Of Contents Credit Highlights Outlook Our Base-Case Scenario Company Description Peer Comparison Business Risk Our assessment of NOS' business risk is balanced by: Financial Risk Liquidity Covenant Analysis Issue Ratings - Subordination Risk Analysis Ratings Score Snapshot Related Criteria WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 22, 2021 1 NOS, SGPS, S.A. 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 no. 2 position in the postpaid mobile services market. platforms 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 ongoing 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 2.9% satellite capacity, subscriber acquisitions costs, and catching up with over 2014-2019. competitors in terms of 4g mobile coverage. A strong balance sheet and sound financial policy with targeted Entrance of Masmovil (via Nowo) in the Portuguese market, together leverage of about 2.0x. The ability to monetize its mobile network with the rising penetration of over-the-top (OT) providers intensify infrastructure provides additional flexibility. competition. The COVID-19 pandemic did not materially affect NOS, SGPS, S.A.'s (NOS) telecom operations and overall credit metrics. NOS' telecom segment, which represents about 95% of total revenues (pre-COVID-19), has been relatively resilient to the pandemic. Revenues declined by 2.6% year-on-year (excluding the diposal of NOS' international Voice Carrier unit) as lower roaming revenues--which have been negatively impacted by pandemic-related travel restrictions--were partially offset by increased revenues from broadband services, as contract upgrades to faster internet speeds were fostered by remote working and stay-at-home orders. Lockdowns and delayed movie production severely limited cinema and audiovisuals operations in 2020 which declined by 55%. As the cinema and audiovisual segment only account for a small part of total revenue and roaming is a low margin activity, group EBITDA (IFRS 16) only declined by about 6% (including the disposal of NOS' international Voice Carrier unit) to €603 million, from €641 million in 2019, while margins rose slightly above 44%, from about 40% in 2019. As a result, and despite adjusting for NOS' provisions for losses due to the impact of the pandemic (about €43 million), impact on credit ratios in 2020 were contained. S&P Global Ratings expects that NOS will continue to show low organic single-digit revenue growth supported by improving macroeconomic conditions and a sustained pace of growth in more value-added convergent bundles, despite tough competition. We anticipate NOS' telecom revenues to grow by about 2.0% on average per year over 2021-2023, WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 22, 2021 2 NOS, SGPS, S.A. combined with flat growth for the audiovisual and cinemas segment in 2021 and progressive recovery by 2022. We believe this will be driven by a recovery in roaming revenues and sustained demand for broadband services and high-margin convergent bundles. NOS' integrated and convergent subscribers represented about 62% (977,000) of the total fixed customer base, leaving additional room for growth. 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 two reciprocal network sharing agreements it concluded in the past: fixed-network sharing agreement reached with Vodafone in 2017, and DS Telecom in 2019. We expect that, by 2022, about 70% of NOS' footprint (3.3 million Portuguese households) will use fiber to the home (FTTH) technology compared with 40% today. In 2020, NOS signed a mobile network sharing agreement with Vodafone that encompasses passive infrastructure (towers and poles) across Portugal and active mobile network elements (i.e. radio equipment, antennas, and amplifiers) in low-density areas only. Additionally, we believe NOS' margins and cash flow will likely improve further thanks to the reduction of future operating costs and network investments, which will increase its operating leverage. The competitive landscape is set to evolve, but we do not expect a material impact in the medium term. The terms and conditions of the 5G spectrum auction in Portugal allowed the entrance of Masmovil via Nowo (Masmovil raised its stake to 100% from 49.99% in November 2020). However, we see only a limited risk in the medium term, as this will require significant investments and costs to compete against the three established players. This is because Nowo is operating through an underinvested, small cable network (docsis 3.0) covering only about 0.9 million homes in medium-density areas, has sold its business-to-business activities (Oni) and has no mobile network, except small spectrum holdings for now. Mobile and fixed network accesses are available in the market, but at a cost: both PT and NOS sold their tower portfolio to Cellnex, and PT sold a 49.99% stake in its FTTH network to Morgan Stanley Infrastructure, for a combined amount of €3.0 billion. In addition, Nowo has only limited pay-tv offerings and no access to major sport events. Sport rights are equally shared among the established players and Global Media Group, through a joint venture and secured until 2028. Given that pay-tv offering is fundamental in Portugal--because of the relatively poor Free to Air offer--and that the telecom market is mostly convergent (households penetration of mobile and fixed bundled service, or 4/5 play (p), is at around 51%), competition would most likely start on the lower-margin, single, or dual play market. We believe NOS' strong brand recognition , pay-TV offering (sport, local contents), outside of over-the-top services, and strong share of convergent customers (NOS 4/5P customers represented 62% of its fixed access customer base) will continue to provide solid protection against competition. NOS has set ambitious targets and sought partnerships to deploy fiber and to remain broadly independent from Altice's FTTH network. We believe this will continue to support solid pay-TV net customer additions, which are the basis for upselling its convergent offers. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 22, 2021 3 NOS, SGPS, S.A. Chart 1 WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 22, 2021 4 NOS, SGPS, S.A. Chart 2 NOS 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 over 90% of households through FTTH (about 40%) and Docsis3.1 cable (about 60%) as of Dec. 31, 2020. NOS' well-invested fixed networks, which provides 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 average revenue per customer (ARPU) than competitors. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 22, 2021 5 NOS, SGPS, S.A. Chart 3 Chart 4 WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 22, 2021 6 NOS, SGPS, S.A. Chart 5 WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 22, 2021 7 NOS, SGPS, S.A. Chart 6 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. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT APRIL 22, 2021 8 NOS, SGPS, S.A. Our Base-Case Scenario Assumptions • The Portuguese telecom market will expand primarily from price increases and rising convergence adoption or service migration (vDSL/FTTB to FTTH), rather than from subscriber or household growth, which we expect will increase in line with inflation. We believe this is due to the already high penetration of telecom services (about 170% mobile penetration per population, about 87% and 91% of broadband and pay-TV penetration per household, respectively). • NOS' total revenue will increase by about 3.0% per year on average over 2021-2023, driven by business, wholesale, and telecom services.