Fitch: Pressure on Telecom Italia Rating Showing Signs of Easing
Weak domestic revenue and EBITDA are the key drivers of the Negative Outlook, but both may now have reached an inflection point after the pace of decline slowed significantly in 2H14. Underlying EBITDA was still down 3% in 4Q14, but that is a marked improvement on the 7% drop in 3Q14 or the 9% fall for 1H14.
This improving trend makes TI's guidance for stable domestic EBITDA by 2016 appear achievable. But we will need further evidence of stabilisation and continued improvements in free cash flow generation before we take any action on the Outlook, and a reversion to weaker domestic trends would probably maintain downgrade pressure.
One of the reasons for the group's improving domestic prospects is that Italy's mobile telecoms price war appears to have abated. The mobile market has become polarised, with Telecom Italia Mobile and Vodafone investing in networks and marketing services on the basis of network quality, while Wind and Hutchison's 3 remain focused on value and price. There is potential for consolidation from four main groups to three, as has happened in Germany, Ireland and Austria. We believe this would be positive for TI as it would reduce competition and support trends toward more rational market pricing. Consolidation is not essential for TI to stabilise its domestic performance, and has not been factored into our rating.
TI has pencilled in an additional EUR1.0bn of domestic capex in its new 2015-2017 three-year plan compared to its 2014-2016 plan - mainly investment in fibre and LTE mobile coverage. This could put pressure on free cash flow in the short term, but we consider the plan positive in the medium term as these investments should enable TI to differentiate its service offering, help reverse the trend in fixed-line losses and sustain progress in mobile. A commitment to network quality is an important differentiator, particularly for incumbents and operators competing at the high end of the market.
The three-year plan also aims for a reduction in net debt/EBITDA from 3.0x to 2.5x by 2017. TI has missed previous leverage targets and we will therefore monitor evidence of progress. But leverage at the end of the year was slightly better than we expected and TI has a EUR1.3bn mandatory convertible instrument that will convert to equity in 2016, reducing leverage by up to 0.15x. TI's statement also suggests it will suspend its ordinary dividend for a further year. This will have a negligible impact on leverage, but shows its strategy takes account of creditor interests and the need to support free cash flow.