Telecom Italia's Debt Outlook Changed to Negative
Moody's Investors Service has changed the outlook on blocks of Telecom Italia (TI) debt to negative from stable due to concerns about the company's ability to pay down its debt in an increasingly competitive market.
"Challenging operating conditions may be exacerbated by negative effects on consumer spending from slow economic growth and government austerity measures," says Carlos Winzer, a Moody's Senior Vice President and lead analyst for TI. "As a result, we expect continued pressure on TI's revenues, which will challenge the company's ability to reduce its debt and improve its credit metrics this year."
Although Moody's expects TI's performance to improve in the second half of the year, following weakness in the first half, the outlook change considers TI's difficulties in delivering organic growth to sustain cash flow and contribute to its deleveraging plan. In order to offset pressures on its domestic operations, Moody's expects TI to continue to cut operating expenditures, and enhance both its fixed and mobile service offerings through competitive pricing and bundled offers. The company will also continue to benefit from its growing business in Brazil and Argentina.
Moody's notes that although Telecom Argentina is fully accounted for under the global consolidation method, TI has an economic interest of only 21%. While this appears to be sufficient for TI to effectively control Telecom Argentina, Moody's expects no cash up-streaming until 2013 at the earliest.
Given the challenging operating conditions in Italy, TI's management may find it difficult to meet its commitments for deleveraging. Financial metrics are marginally positioned for the rating and ratings could come under pressure if the company is not able to achieve the planned improvements in its financial profile.
More specifically, Moody's expects TI to comply with management's guidance to the market, which for 2011 includes broadly stable, consolidated organic group revenues of approximately EUR29.5 billion and reported EBITDA of EUR12.5 billion. Moody's also expects management to maintain the reported group EBITDA margin above 40% and to use free cash flow (FCF) to further reduce its debt at a rate of approximately EUR2 billion per year, as a priority over shareholder remuneration. This is in line with the company's continued commitment to debt reductions and financial discipline. In fact, management has recently publicly stated that TI is on track to achieve cumulative reported FCF before dividends of approximately EUR12 billion in 2011-13, which will enable the company to reduce its reported net debt to around EUR25 billion by 2013 (and will represent a debt reduction of EUR6.5 billion). This includes (i) TI's recent investment of EUR700 million in the Brazilian fibre-optic company Aes Atimus; and (ii) the company's payment of EUR4 billion in cumulative dividends through 2013, which represents a 15% annual increase.
Management projections do not include cash payments for spectrum auctions, although Moody's expects these not to exceed EUR1 billion.
Downward pressure on the rating could result if TI were to deviate from management's plan for 2011 and beyond. This could be reflected by signs that the company were failing to prevent a deterioration in its domestic revenue. The negative outlook reflects that there are as yet no clear signals of such an improvement in TI's domestic market, despite the company stating that it expects a recovery in the third quarter of 2011.
Although TI continues to make a significant effort to cut its operating costs in Italy, the company's domestic revenues continue to decline (single digits) and Moody's remains uncertain as to when they will stabilise. TI's international diversification into Latam (67% ownership of TIM Brazil and 21% ownership of Telecom Argentina) has contributed to the company's revenue growth, but might be not enough to offset the deterioration in its cash flow generation prospects in Italy.
In the mobile segment, competition remains fierce, with Vodafone holding a similar market share as TI (34%), followed by Wind (22%) and Hutchinson (10%). Migration into voice bundles is boosting traffic but elasticity remains negative, despite the increase in traffic volumes. Price per minute continued to fall by approximately 20% per annum as a consequence of the 2010 price reductions. Moody's expects prices to gradually stabilise in the second half of 2011. The fact that TI avoids mobile handset subsidies and has resisted the industry's attempts to reduce its prices has helped it to maintain high margins.
Moody's recognises that TI enjoys the highest margins in the rated telecoms sector and considers that this, combined with its strong market positions and management's discipline, will enable the company to fulfil its financial strategy. Opex reductions will continue to be supported by further employee layoffs, but Moody's recognises that related costs such as marketing and general administration are more difficult to cut.
In Moody's view, TI's liquidity profile is more than sufficient to cover its near-term debt maturities and other cash demands, including capex and dividend payments. As of June 2011, the group had around EUR4 billion in cash and cash equivalents and marketable securities. TI's external liquidity sources are robust, with EUR7.8 billion in unused committed credit lines. The credit lines are not subject to material adverse change or financial covenants. Moody's expects TI to maintain a liquidity backstop (cash position plus unused committed bank lines) that will cover at least 12-18 months of debt maturities. There is no significant structural subordination of creditors at the TI level, given TI's policy of avoiding external debt at the operating subsidiary level.
Although not currently expected in view of today's action, Moody's could consider a rating upgrade to Baa1 if TI's debt protection ratios were to strengthen significantly as a result of improvements in its operational cash flows and further reduction in debt. The rating could come under positive pressure if it became clear that the group would achieve sustainable improvements in its debt protection ratios, such as an adjusted RCF /net debt ratio of above 25% and adjusted net debt/EBITDA of approximately 2.0x.
Negative pressure on the rating could arise if TI were to deviate from its debt reduction plan or step up its investment strategy or other uses of cash, causing a deviation from management's committed financial discipline and business plan. Resulting metrics would include an RCF/net adjusted debt ratio of less than 20% and a net adjusted debt/EBITDA ratio that does not gradually improve towards 2.5x in the medium term.