More than just Italian
Mired in the uncertainty of Italian politics and unresolved banking issues, investors have penalised Italian corporates over the past year. In 2016, Italy’s stock market was one of the worst performing globally^ and presented Antipodes Partners with an opportunity to acquire shares in Italy’s largest telecommunications company, Telecom Italia. As Italy’s incumbent operator, its business spans fixed line voice/broadband, mobile and other/wholesale services. The Company also owns two thirds of TIM Brasil, the only standalone mobile operator in Brazil. Like many of its European brethren, the past decade has been difficult for Telecom Italia. Both fixed and mobile revenues have declined substantially, with mobile voice pricing declining 70% since 2007. Average revenue per user (ARPU) has collapsed from around €28/month in 2007 to €12.50/month today. Fixed line revenues have also suffered from mobile substitution. This has resulted in once lucrative returns on capital contracting to cost of capital whilst the third and fourth ranked mobile competitors have been forced to merge. However, we think Italy’s long telecoms winter is beginning to thaw, though share prices are reflecting more of an ice age.
Multiple ways of winning
The telecoms market in Italy has the least developed broadband infrastructure of almost any country in Europe. Download speeds for Italian households are less than a third of the averages of France, Germany and the UK. Only Greece ranks below Italy in the uptake of broadband services. Uniquely, Italy has no competing cable infrastructure, which has tended to undermine Telecom fibre investment in most other countries. This suggests a great prize awaits the company that wins the land grab to switch Italy’s population onto high quality broadband over the next 5 years.
Source: Goldman Sachs
Italy has been slow to adopt online services but from our recent visit it was apparent both business and government are accelerating online initiatives. The EU Digital Single Market Agenda* ranks Italy 27th and 28th out of 28 member states on measures of “connectivity” and “use of internet” respectively, and 17th on “digital public services”. These statistics have prompted the Government to more aggressively promote investment in the nation’s broadband infrastructure. Telecom Italia’s dominance of the nascent broadband market far exceeds those of market share leaders in France, Germany or Spain. Accelerated investment in 2016 and 2017 will only enhance this advantage. By the end of 2017 Telecom Italia will have covered 80% of the population with next-generation fiber connectivity.
This infrastructure advantage should confer improved pricing power, evidence of which is already emerging with an 8% lift in broadband pricing reported in the September quarter.
Unsurprisingly, Telecom Italia’s lost decade has caught the interest of French media conglomerate Vivendi13 . Vivendi, in turn, is largely controlled by one of Europe’s leading industrialists come activists, Vincent Bollore. Vivendi’s arrival has heralded yet more change installing a new CEO at the beginning of 2016 with an incentive package linked aggressively to operating and capital efficiency outcomes. Based on benchmarking against European peers, the opportunity for greater efficiency seems real. For example, Telefonica of Spain generates almost the same revenue from its domestic operations but with 33% fewer people! Unsurprisingly, what followed was a wide ranging restructuring plan to address this somewhat bloated cost structure.
Market consolidation is a positive with the announced merger of the third and fourth ranked Italian mobile operators, opening the door for French operator Illiad. Illiad’s reputation precedes it, having upended the pricing model of the French mobile market upon entry in 2012. Investor fears of a repeat in Italy abound, though we view the circumstances differently. Pricing is already substantially lower virtually forcing the existing low-price disruptors to merge. Another observation is that mobile markets are bifurcating between high end “quality” and low end “budget” offers. The increasing array of services and consumer dependency on mobile phones is placing a premium on high quality connections. Illiad would have to undertake enormous investment to build a network able to compete at the high end, dominated today by Telecom Italia and Vodafone. Finally, by virtue of history, the Italian mobile market is wholly dependent on retail distribution of which Illiad will have little to none, making its foray even more challenging. Given its track record, Illiad can’t be ignored, but we see the threat as manageable and more than factored into Telecom Italia’s valuation.
Margin of Safety
Whilst the rear-view mirror perspective is unpleasant, Telecom Italia’s new management with a focused turnaround plan and sizable green-field opportunity in broadband make future prospects more promising. Yet at a multiple of just over 5x Enterprise Value to EBITDA, current valuations reflects more of the past and little of the future. European and U.S. telecom peers trade on average above 7x, providing significant scope for re-rating as management extract latent potential and some of Italy’s political discount evaporates. Further, we don’t rule out the possibility of an industrial buyer emerging to seize one the last great opportunities in European telecoms.
^At its low point in June the Italian stock market had fallen 28% ytd, though closed the year down 10%.