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Fitch Places Oi on Rating Watch Negative

  Fitch Places Oi on Rating Watch Negative  Business Wire  CHICAGO -- February 26, 2014  Fitch Ratings has placed Oi S.A.'s (Oi) 'BBB-' foreign and local currency Long-term Issuer Default Rating (IDR) and senior unsecured bonds on Rating Watch Negative (RWN). Fitch has also placed Oi's 'AA+(bra)' National Long-term Rating and local debentures on Negative Watch.  The Negative Watch reflects Fitch's view that following the proposed merger between Oi and Portugal Telecom (BBB-/RWN) the financial profile of the post-merger entity is less likely to support a 'BBB-' rating. The Negative Watch will be resolved following the closing of the transaction.  Oi continues to be rated on a standalone basis. Fitch expects the proposed merger between Oi and Portugal Telecom (PT) will proceed, with the enlarged group benefiting from increased scale and geographic diversification, merger synergies, and a simpler group structure.  PT will have to recapitalise the intermediate holdings prior to the transaction and therefore increase its leverage. As such the deleveraging benefits from the BRL8 billion capital increase are likely to be modest, with pro-forma opening leverage of the merged group likely to be inconsistent with current ratings.  Financial pressures were evident in 2013 results from both companies, while Oi's Brazilian operations are in the midst of a turn-around, which is taking longer to deliver and requiring heightened levels of investment. PT's domestic EBITDA declined by 9.1% in 2013, while Oi's underlying EBITDA was down 7.6% and leverage (net debt to EBITDA) was 4.0x at year end. Pro-forma leverage of the post- merger group, estimated by Fitch at around 3.8x, with the absence of any material free cash flow, in Fitch's view, is unlikely to allow the company to deleverage for some time.  Assuming outstanding regulatory approvals and other conditions to the merger are met, significant pressure is likely to remain on the merged entity's financial performance over the medium term, increasing the likelihood that ratings for the combined entity may be lower than the current 'BBB-' rating.  Pro-forma 2013 revenues and EBITDA of the combined entity were BRL37.8 billion and BRL11.3 billion, of which approximately 67% of EBITDA originates from Brazil.  KEY RATING DRIVERS (for Oi on a standalone basis)  Continued Margin Suppression: Fitch does not expect Oi's operating margin to show material improvement in the short term due to operational challenges. Although the recurring EBITDA margin has somewhat recovered to 30.1% and 27.7% in 3Q'13 and 4Q'13, respectively, from 25.4% in 2Q'13, any further recovery will be difficult given the competitive pressure in the Brazil telecom market, increasing employee-related expenses, as well as high rental expenses, partly due to on-going network asset sales. Fitch forecasts that its EBITDA margin will remain below 30% in 2014 and 2015.  Deleveraging Unlikely in the Short-term: Oi is expected to continue its negative free cash flow (FCF) generation in 2014 and 2015 due to on-going margin erosion and high capex. It is the agency's view that its capex requirement of about BRL5 billion and dividend payment of about BRL500 million, from 2015, will not be fully covered by its cash flow from operations (CFO). The company also has been disposing its non-core assets to raise cash but its impact on net debt has been and will remain limited as non-operating cash outflows, such as licenses, concessions, and judicial deposits, will mostly offset the sales proceeds. Therefore, its net financial leverage is highly likely to be sustained over 3.5x - negative rating action guideline for Oi's standalone ratings - over the medium term.  RATING SENSITIVITIES  Fitch's existing guidelines will apply until the merger as proposed is effective. Guidelines for the combined group will be developed once the transaction closes.  The current guidelines are as follows:  Negative: Consistently having a net leverage close to 3.5x or perception by Fitch that the company is not making progress toward reducing the net leverage due to weak operating results, higher investments/distributions to shareholders or weak economic conditions are likely to pressure the ratings.  Positive: Making firm progress towards reducing net leverage to or below 3x in conjunction with stable operating performance and cash flow generation or improved operating performance and profitability can support a positive rating action.  Additional information is available on  Applicable Criteria and Related Research:  --'Corporate Rating Methodology' (Aug. 05, 2013);  --'Rating Telecom Companies' (Aug. 09, 2012).  Applicable Criteria and Related Research:  Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage  Rating Telecom Companies  Additional Disclosure  Solicitation Status  ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.  Contact:  Fitch Ratings, Inc. Primary Analyst Alvin Lim, CFA, +1-312-368-3114 Director Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 or Secondary Analyst Mauro Storino, +55-21-4503-2600 Senior Director or Committee Chairperson Ricardo Carvalho, +55-21-4503-2600 Senior Director or Media Relations Elizabeth Fogerty, +1-212-908-0526