Fitch Affirms Telecom Italia at 'BBB'; Outlook Negative
Fitch Ratings has affirmed Telecom Italia's Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB'. The Outlook on the Long-term IDR is Negative. The senior unsecured ratings of Telecom Italia Capital and Telecom Italia Finance have also been affirmed at 'BBB'.
The affirmation is based on TI's ability to preserve cash flow generation and keeping a focus on deleveraging while facing increasing competition and the effects of austerity in its domestic market. The Negative Outlook reflects the weak macroeconomic backdrop which could reduce demand for telecom services and negatively impact TI's domestic revenue and profitability. In addition, any extended period of sovereign weakness could impair the company's access to capital markets to refinance debt maturities.
The challenge for TI is to maintain its domestic market position in an increasingly price competitive market while protecting free cash flow generation. Improving efficiency of operating costs and capital expenditure should go some way to preserve profitability. Continued investment in LTE and fibre deployment should allow TI to increasingly differentiate its service offering based on network quality. TI's Brazilian operations currently provide around 10% of the group's EBITDA less capex (excluding Telecom Argentina). Medium-term growth prospects could see this contribution increase with well-managed capital investment and as regulatory and competitive challenges are overcome.
Any expectation that TI could not maintain leverage as measured by unadjusted net debt to EBITDA (excluding Telecom Argentina) sustainable below 3.0x could result in TI's IDR being downgraded to 'BBB-'. Another key consideration for further negative rating action would be a worsening of the company's domestic business's operating and financial profile. Fitch anticipates leverage - as measured by unadjusted net debt to EBITDA, excluding Telecom Argentina - will reach 2.7x at the end of 2012. However, Fitch's scenario analysis shows that under certain conditions, TI's leverage could breach the key 3.0x threshold.
TI's key strength is its strong market position in the domestic fixed line business, which underpins TI's high domestic EBITDA margin and cash flow generation. A lack of cable competition in Italy means that TI has the ability to phase capex as required without significantly impacting its competitive position. This gives TI an important financial lever in preserving cash flow generation at times when EBITDA comes under pressure.
TI is relying on management's disciplined approach to controlling operating costs and capex, to offset the drag from the domestic mobile business. To some extent, TI can also rely increasing cash flow generation from its operations in Brazil, although regulatory pressures such as declining mobile termination rates and network quality issues may dampen growth in 2012. TI also has to contest a legal case brought by the Brazilian tax authorities, claiming EUR550m in unpaid taxes. TI believes it is in a good position and does not expect to incur any charges and therefore has not made provision to cover this potential liability.
There have been numerous press reports about Telecom Italia considering spinning off its fixed network. The impact of such a transaction on TI's rating is unclear as this stage given the different possible outcomes and therefore is treated as event risk (see "Fitch: Impact of Possible Tel Italia Network Spin-off Unclear" dated 26 September 2012 for details of what factors Fitch would consider in assessing such a move).
For the purpose of calculating leverage and credit metrics, Fitch does not take into account the full contribution of Telecom Argentina, in which TI has a 22.7% indirect economic interest.
Liquidity at TI remains healthy. Excluding cash held at its Brazilian and Argentine subsidiaries, TI had EUR5.7bn of cash and cash equivalents on its balance sheet at the end of June 2012 as well as EUR7.0bn undrawn committed facilities (which includes EUR4bn available till May 2017). Together, this liquidity should allow TI to cover debt maturities well into 2014.