February 9, 2017 / 5:25 PM / a year ago

Fitch Affirms Telecom Italia at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) LONDON, February 09 (Fitch) Fitch Ratings has affirmed Telecom Italia S.p.A's (TI) Long Term Issuer Default Rating (IDR) at 'BBB-'. The Outlook is Stable. A full list of rating actions is at the end of this commentary. TI's rating takes into account the progress the company has made in stabilising its domestic operations, improving cash flow performance and bringing leverage back below Fitch's downgrade threshold. We believe TI's actions in terms of operating efficiencies, network investment and its enhanced service offering support improving trends in Italy. These factors are important ahead of the entry of Iliad mobile, and the potential for stronger competition in fixed once Enel Open Fiber establishes scale. TI's acceleration of its fibre investment and positive financial trends support our view of a stable domestic business. KEY RATING DRIVERS Operating Profile Progress: TI's operating performance has improved over the past year, with operating efficiencies driving stronger financial results and investments in both its network and commercial offering improving physical metrics. The company continues to lose retail fixed access lines, but losses per quarter have slowed materially - 4Q16 loss of EUR83,000 was a record low and TI is targeting parity by 2018. LTE coverage is advanced at 96% at end-2016 and in line with Vodafone's. TI Mobile (TIM) maintains stable and leading share of the domestic mobile market; estimated customer market share of 32.4% and service revenue share of 34.4% at 3Q16. Domestic Performance and Leverage: Fitch's ratings' sensitivities have focused on a stabilisation of TI's domestic business and improvements in leverage. TI's domestic operations have shown solid progress, with the company reporting organic EBITDA in Italy ahead by 4.5% in 2016 with the pace of improvement accelerating in 2H16. Revenues show increasing signs of stabilising. Funds from operations (FFO) adjusted net leverage is estimated at 3.9x at end-2016, down from 4.3x at end-2015. Compared with a downgrade guideline of 4.2x rating headroom is limited. Recovery in financial results is nonetheless marked. Sustained cash flow improvement and leverage are important in maintaining a Stable Outlook. Evolving Competitive Environment: At present the market environment shows ongoing signs of stabilisation, with mobile market leaders - TIM and Vodafone - focused on sustaining market share and revenues while improving profitability. In the near term we expect more rational mobile pricing to be maintained following the WIND/Three Italia merger, although the entry of Iliad mobile by end-2017 and ongoing Enel Fiber investment present market uncertainties. Enel Open Fiber: We believe TI's fibre investment is gaining commercial momentum, at a time when the Enel Open Fiber project has yet to establish significant scale. The Enel project is currently building out coverage in five cities and targeting 1.5 million homes by 2018; and to reach 9.5 million homes by 2021. A scaled ultra-fast alternative fibre network presents risks, with Vodafone established as the anchor tenant and the network available to other service providers on commercially attractive terms. TI's upgraded fibre commitments including a coverage target of 95% or 23 million homes (of which 4 million fibre to the home) by 2019 are important and in Fitch's view should help defend ongoing improvements in TI's fixed operations. Iliad Mobile: Iliad is expected to enter the Italian mobile market by end-2017, having secured a competitive spectrum portfolio, tower assets and a national roaming agreement with the newly merged WIND/Three. The risk to TI is not insignificant, but our central case is that competition in the Italian mobile market does not worsen materially. Iliad's Free convergent offer has been very disruptive in the French market but it is less clear whether it can be as aggressive in Italy, a mobile market where pricing is already very low, where Iliad has no established fixed line base to sell into and where the premium end of the market may be put off by the new entrant's lack of brand or retail presence. Potential Future Guideline Tightening: TI's rating sensitivities have been set with a marginally looser leverage threshold than most incumbent peers, reflecting what Fitch views as a moderately advantageous competitive domestic environment, given the absence of a cable operator and therefore lower network-based competition than seen in some other European markets. Evidence of heightened retail competition, whether from the entry of Iliad in the mobile sector, or from improved convergent offers given the potential of a developed alternative high-speed broadband infrastructure in Enel Open Fiber, could lead to a tightening of our leverage sensitivity by 0.2x from 4.2x currently. DERIVATION SUMMARY TI's closest peers are TDC (BBB-/Stable) and KPN (BBB/Stable). TI's and TDC's ratings and downgrade thresholds reflect what so far have been considered a somewhat protected market; in TDC's case it owns the cable as well as incumbent telecom network in Denmark, while Italy has no cable network. Both companies have been under revenue pressure, with ratings supported by expectations of a gradual stabilisation and improvement in leverage. Relative to TDC, TI has slightly higher leverage with a Fitch 2017 forecast FFO net leverage of 4.0x vs. TDC's 3.8x. TI's revenue and cash flow outlook is nonetheless improving and metrics are expected to converge. A competitive and progressive market environment in the Netherlands, KPN's home market, underlines the importance of its fibre investment. Lower leverage and the more advanced stage of its market recovery are the key factors supporting the higher rating of the Dutch incumbent. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Flat to low-single digit revenue growth in Italy in 2017-2020; - Mid-single digit revenue decline in 2017 in Brazil with stabilisation in 2018 and moderate growth in 2019-2020; - Stable group EBITDA margin above 40% 2017-2020; - Flat capex yoy in 2017 (excluding spectrum), gradually declining to 20% of revenue by 2018; - EUR227 million dividends per year in 2017-2020, including the savings share and Inwit ordinary distribution; - EUR500 million spending on spectrum in 2017 (Fitch's estimate). RATING SENSITIVITIES Future developments that may, individually or collectively, lead to positive rating action include: - FFO adjusted net leverage below 3.7x on a sustained basis; - Sustained improvement in domestic and fixed and mobile operations as well as stabilisation of operations in Brazil. Future developments that may, individually or collectively, lead to negative rating action include: - FFO adjusted net leverage above 4.2x on a sustained basis; - Tangible worsening of operating conditions or the regulatory environment - leading to expectations of materially weaker free cash flow generation; - Sustained pressure from an aggressive entry of Iliad to the mobile market or signs of tangibly more competitive fixed line or convergent environment. LIQUIDITY Strong Liquidity: TI has a strong liquidity profile with EUR5.5 billion of cash and equivalents at end-2016 and EUR7 billion of available undrawn revolving credit facilities. The company's debt maturity is well spread out with existing liquidity covering refinancing needs to 2020. FULL LIST OF RATING ACTIONS Telecom Italia S.p.A. --Long-term IDR: affirmed at 'BBB-', Outlook Stable --Senior unsecured rating: affirmed at 'BBB-' Telecom Italia Capital --Senior unsecured: affirmed at 'BBB-' Telecom Italia Finance SA --Senior unsecured: affirmed at 'BBB-' Contact: Contact: Principal Analyst Slava Bunkov Director +7 495 956 9931 Supervisory Analyst Stuart Reid Senior Director +44 20 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Damien Chew, CFA Senior Director +44 20 3530 1424 Media Relations: Stefano Bravi, Milan, Tel: +39 02 879 087 281, Email: stefano.bravi@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Summary of Financial Statement Adjustments - Fitch applies a weighted multiple of 6.8x in relation to its lease adjusted debt calculation. The multiple is derived from estimates that roughly 60% of operating leases support assets with a long term economic benefit and the use of a 5x multiple in relation to the group's Brazilian operating leases. Italian leases are treated using a standard 8x multiple. Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1018792 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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