Rioforte: Fitch cuts Oi, Portugal Telecom ratings

Fitch downgraded the ratings of Brazilian carrier Oi and parent company Portugal Telecom to junk after Rioforte Investments did not repay a short-term debt owed to Portugal Telecom that matured on Tuesday.

Oi and Portugal Telecom long-term debt ratings were cut to BB+ from BBB-, the agency said on Wednesday.

Fitch also lowered the domestic credit rating of Oi on the Brazilian market to AA from AA+.

Rioforte is a unit of Portuguese conglomerate Espírito Santo Group (GES), holds around 10% of Portugal Telecom and is currently financially troubled. Portugal Telecom has a 2% stake in GES.

A few weeks ago it emerged that Portugal Telecom had acquired nearly 900mn euros (US$1.22bn) in commercial paper from Rioforte in two deals, calling it a treasury transaction.

The news prompted an internal crisis at Portugal Telecom, causing board resignations, regulatory probes and clarification requests from Oi and its shareholder BNDES. As feared by the market, Rio Forte failed to repay the first debt on Tuesday, entering into "technical default."

The day after, Oi announced it had revised the terms of its planned merger with Portugal Telecom. Now, the Portuguese will have their stake in CorpCo, the company to be formed after the merger is completed, reduced to 25.6% from 39.6%.

Oi also said that the debt that matured on Tuesday, as well as a second paper worth 50mn euros that matured on Thursday, have a "cure" period of seven days to be paid before they go into default

First reactions following Oi's announcement indicated that the market had received the new Oi-Portugal Telecom merger terms well, with shares recovering from sequential dips.

Fitch did not see it that way, though.

"Based on the assumption that Oi will not recover any cash from the defaulted Rioforte commercial paper, net leverage for the merged entity will increase a modest 0.2x-0.3x," the agency said.

"While the increase in net leverage is not alone sufficient to warrant a ratings downgrade, Portugal Telecom's decision to invest a significant amount of cash, close to 40% of its total cash and equivalents at end-2013, into the debt security of a 10% shareholder raises several concerns, and may indicate a higher risk tolerance for its investments, and a more aggressive management strategy that are not in line with an investment grade category risk profile."

Fitch stressed it was confident that the merger would proceed based on the new terms announced by the companies.