* We downgrade Telecom Italia to Underweight
We downgrade Telecom Italia’s senior bonds to Underweight. In 5y CDS (160) we move
to Buy Protection from Neutral. The downgrade reflects weakening operational trends
in Brazil, a slow recovery in Italy, the risk of negative ratings action, the potential for a
credit negative outcome in Brazil and the lack of clarity around Vivendi’s, and
particularly, Xavier Niel’s strategy. We see a risk that key shareholders could push for a
shareholder friendly deal in Brazil at the expense of a near-term deterioration of the
balance sheet. We view current spreads as tight in comparison to other high-BBs and
failing to compensate for the aforementioned risks.
* 3Q15 results do little to alleviate concerns
Group EBITDA came in-line with expectations but nevertheless fell 12% y/y in reported
terms. Underlying trends in Brazil do not bode well for the coming quarters while the
recovery in Italy has slowed.
* Moody’s downgrade risk increasing
Based on our current estimates we have Telecom Italia adjusted net debt/EBITDA at
3.7x for FY15. Moody’s state that it could downgrade the rating if the company’s net
adjusted debt/EBITDA deteriorates above 3.5x with no prospect of improvement. We see
scope for adjusted debt reduction in 2016 with the €1.3bn convertible, a disposal of
Inwit and the savings share conversion. However we believe all would be required to
fully stabilise Ba1 ratings.
* Xavier Niel’s strategy far from clear
Xavier Niel’s acquisition of a 15% interest in Telecom Italia has further increased the
uncertainty regarding the outlook for the company. Mr. Niel has stated that he is not
working with Vivendi (which would have triggered a mandatory offer for TI) however his
intentions remain far from clear. We view Niel’s involvement as a credit negative given
the potential to push for a strategy contrary to management’s (which has generally been
credit friendly) or cause governance issues by challenging Vivendi. We do not believe
that either party wishes to mount a full take-over of Telecom Italia.
* Outcome in Brazil uncertain
Recent press reports have suggested that Telecom Italia would only consider a merger
of Oi and Tim if it would have 51% of the new company. We view this positively given
the risks we have previously highlighted regarding a potential deconsolidation of Brazil
which would increase adjusted leverage c.0.7x (see page 5, and Brazilian consolidation
back on the table?, 26 October 2015). However we remain concerned that new
shareholders could push for a less credit friendly outcome.
* Valuations unappealing given risks
TI spreads have barely underperformed since the announcement of a potential deal in
Brazil, and trade inside Ba1 rated peers (see p.2). In our view spreads fail to take account
of the increased risk of credit negative outcome in Brazil and/or a downgrade as a result
of organic operating pressure. Conversely, even in a best case scenario, TI will stabilise
at Ba1, an outcome more than factored in to current spreads. We view fair value for the
3.25% €’23s at least +35bp wider at z+235bp.