Fitch Affirms Telecom Italia at 'BBB'; Outlook Negative
Fitch Ratings has affirmed Telecom Italia's (TI) Long-term Issuer Default Rating (IDR) at 'BBB'. The Outlook on the Long-term IDR is Negative.
The affirmation reflects that the company's intention to strengthen the balance sheet by halving shareholder dividends and issuing EUR3bn of hybrid bonds in the next 24 months partly offsets the weaker than expected domestic performance. Management has shown it is committed to reducing leverage but Fitch is concerned that TI will have fewer debt reduction options in future to address further deterioration in the business, whether due to continued regulatory and competitive pressure or a weaker economy.
Leverage Remains High
TI ended 2012 with leverage - measured by unadjusted net debt to EBITDA, excluding Telecom Argentina - at around 2.75x, broadly unchanged since 2010. With continued declines in EBITDA, Fitch expects leverage will increase in 2013. Fitch's scenario analysis shows that under certain conditions, driven by a worsening macro-economic environment, and sluggish Brazilian growth, TI's leverage could breach the key 3.0x threshold, which would result in negative rating action.
Domestic Strength and Weakness
TI's key strength is its strong position in the domestic fixed-line business, which underpins the high domestic EBITDA margin. A lack of cable competition in Italy means that TI is not facing an immediate threat from a triple-play competitor with a superior network advantage. It does not have the same pressure to rollout a fibre network as some other European incumbents. TI is relying on management's disciplined approach to controlling operating costs and capex to offset the pressure on the domestic business, as well as the increasing impact from a weak economy.
Protecting Cash Flow Generation
The challenge facing TI is to maintain its domestic market position in an increasingly price competitive market while protecting free cash flow generation and reducing leverage. Improving efficiency in operations and capital expenditure should go some way to preserve profitability. Continued investment in long-term evolution mobile network upgrades and fibre deployment should allow TI to increasingly differentiate its service offering based on network quality.
Limited Contribution from Brazil
Brazil currently provides just under 10% of the group's EBITDA less capex (excluding Telecom Argentina). Revenue growth expectations for 2013 and 2014 have been scaled back due to a slowing economy and higher than expected mobile termination rate cuts. Growth in 2015 and beyond could increase as economic growth picks up and regulatory and competitive challenges are overcome. TI also has to contest a legal case brought by the Brazilian tax authorities, claiming EUR550m in unpaid taxes. The judicial process is likely to be lengthy. TI believes it is in a good position and does not expect to incur any charges and therefore has not made any provision to cover this potential liability.
TI has been considering spinning off its fixed network. The impact of such a transaction on TI's rating is difficult to assess at 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 the factors that Fitch would consider in assessing such a move).