Fitch Ratings has downgraded Oi S.A.'s Long-Term Local and Foreign Currency Issuer Default Ratings (IDRs) to 'CC' from 'CCC+'.

In addition, Fitch has downgraded Oi's unsecured senior notes due 2025 to 'CC'/'RR4' from 'CCC+'/'RR4', and Oi Movel S.A.'s secured 2026 notes to 'CC'/'RR4' from 'CCC+'/'RR4', and the National Long-Term Rating to 'CC(bra)' from 'B(bra)'.

The downgrades reflect the increased likelihood of a debt restructuring along with Oi's unsustainable leverage, due to weak cash flow prospects and limited expected dividends over the next several years from its approximate 35% stake in V.tal. The downgrades also reflect Fitch's expectations of interest coverage below 1x, as well as the underperformance relative to Fitch's prior expectations of Oi's improved capital structure following asset sales.

Key Rating Drivers

Debt Restructuring Increasingly Likely: Oi has hired financial advisors to assist in negotiations with its creditors under the framework of its Judicial Recovery Plan. Fitch believes Oi has undertaken these negotiations to avoid potential insolvency, given the company's strained capital structure. In Fitch's view, if the outcome of these negotiations result in a material reduction in terms compared with the contractual terms agreed under the 2018 restructuring, the agency would downgrade the company's ratings to 'C'.

Unsustainable Leverage: The company is projected to reach EBITDA of BRL1.5 billion by 2025. This level of EBITDA is insufficient to service debt of BRL35 billion at face value. In addition, the company needs to invest BRL1 billion to 1.2 billion of capex per year over the next several years to expand its broadband services strategy and migrate customers from copper to fiber optic solutions.

It is uncertain whether the company can capitalize on the optionality to take discounts on the face value of its debt for early repayment given that any meaningful inflow would need to come from the sale of its stake in V.tal, as the company is heavily FCF negative.

Lower than Expected Inflows: Net asset sales proceeds will be lower than previously expected as the company had BRL1.4 billion in locked box adjustments, BRL1.4 billion are being disputed by acquirers and proceeds from the secondary disposal of shares are being offset against payables linked to V.tal. In addition, Oi's stake in V.tal will be reduced to around 35% from 42% as a result of price adjustments and contract negotiations for the use of infrastructure assets.

Weak Operating Performance: Oi's top line revenue growth has underperformed Fitch's expectations. The company's revenue contribution from fiber broadband and business to business services (Core business) has been insufficient to offset the decline in legacy businesses tied to copper infrastructure (non-core). In 2021, Oi's core business grew BRL1.5 billion while its non-core business declined BRL1.8 billion. YTD to 2Q22, core revenues grew BRL600 million while the non-core business contracted BRL800 million.

Derivation Summary

Oi's ratings reflect its restructured financial profile and deteriorating outlook for its turnaround strategy. Compared to Latin American carriers in the low speculative grade/distressed territory, such as Digicel Group Holdings Limited (CCC-), Oi has a weaker cash flow profile. Fitch also expects Oi to carry higher leverage and lower profitability as a result of the divestments of the higher margin assets. Compared to American carriers that have either restructured or declared bankruptcy, such as Windstream and Frontier, Oi has a much weaker financial position.

The ratings are not constrained by Brazil's operating environment or country ceiling; however, the company is wholly exposed to fluctuations in the Brazilian macroeconomic environment.

Key Assumptions

Fitch's Key Assumptions Within the Rating Case for the Issuer:

New Oi revenues in the BRL8.0 billion-BRL9.0 billion range;

Homes passed grow in the four million to five million range;

Take up rates in the 20% to 21% range;

EBITDA margins of 12%-15%;

For the recovery analysis, Fitch estimates a going concern EBITDA of around BRL1.4 billion and uses a 4.0x multiple. Most of the enterprise value comes from Oi's 35% stake in V.tal, which is valued at approximately BRL20.0 billion.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch does not anticipate a positive rating action for Oi in the near term due to the expected high leverage and negative free cash flow.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

The ratings will be downgraded to 'C' if there are indications that a default or default-like process has begun;

The launch of an exchange offer, which Fitch deems a material reduction in terms compared with the original contractual terms, and the exchange is conducted to avoid bankruptcy, similar insolvency or intervention proceedings, or a traditional payment default.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Weak Liquidity: Oi's liquidity is weak. The company is projected to be negative FCF during the rating horizon due to its weak interest coverage below 1x and capex of around BRL1.2 billion. The company has high debt of BRL34 billion at face value. The weak interest coverage is despite grace periods in part of this debt. Oi's fair value of debt is BRL21 billion, which reflects discounts available to the company in the case of early repayment. However, given that the company is heavily FCF Negative with only BRL5 billion of cash and cash equivalents.

Issuer Profile

Oi owns copper telecommunications infrastructure and provides fiber optic and other digital services for residential and corporate customers.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Oi S.A. has an ESG Relevance Score of '4' for Financial Transparency. Reporting is adequate, but the complexity of the financial and operational restructuring weighs on the overall assessment of Transparency, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visitwww.fitchratings.com/esg.

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