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Telecom Italia Regains Full Control Of The Italian Broadband Cable Network

As I discussed here, this year, an interesting combination of positive factors has taken shape for Telecom Italia SpA (OTC:TI).

The company is engaged in deleveraging its balance sheet through the valorization (and monetization) of its assets, without losing its control over them.

After the successful sale of a minority stake in INWIT [MILAN:INW] (OTC:IFSUF) (a telecom tower company spun off from TI in 2015) and the subsequent deal with Ardian Infrastructure, the Italian Telco sold 37.5% of its secondary fiber/copper wire network to the American fund KKR for €1.8B.

Source: Company’s presentation

TI will retain about 58% of the NewCo, owner of the secondary network, which, according to a signed LOI, should merge with Open Fiber, a state-backed company founded a few years ago to compete with TI (see the picture below).

The resulting company is supposed to be named AccessCo.

Source: Company’s presentation

Open Fiber Valuation

As shown before, the merge between TI’s subsidiary FiberCorp and Open Fiber will follow an independent value estimation of the two firms by a third-party auditor. But, while FiberCorp’s fair value is easy to calculate, given the recent stake sale to KKR, which implies a total company value (equity+debt-cash) of about €7B, OF’s price is much more difficult to estimate.

OF was founded in late 2015, under a decisive initiative from the then Italian government in order to accelerate the country’s transition towards a full-fiber broadband network. At the time, Telecom Italia and Fastweb S.p.A. (which owned its own fiber network through the subsidiary Metroweb) were the only vertically integrated telecommunication providers in Italy.

However, TI owned the entire secondary network (going from road cabinets to homes), which was copper-based, and a vast primary fiber network (going up to the cabinets), which was much larger than Metroweb’s.

OF started to develop its own fiber-based network and, in 2016, it acquired Metroweb with a €714M deal.

The previously-mentioned LOI states that TI will retain a stake in AccessCo of at least 50.1%. The exact percentage will depend on OF’s valuation. According to the latest data available (FY2019), the company keeps on running with a bottom line which is in deep red (€117M), despite a strong top-line growth YoY of +63% and an equity value of around €800M. With these numbers, it’s hard to value the company any higher than its net asset value, although, surprisingly enough, the Australian fund Macquarie (MGU) is rumored to have recently offered Enel S.p.A.(OTCPK:ESOCF) as much as €3.5B to acquire its 50% stake of the society.

I would argue that the final valuation will fall in a middle range between €800M (equity value) and the (supposed) premium offer of €7B, namely about €3.5B.

That means TI’s stake (through the FiberCorp vehicle) in AccessCo will rise until it reaches about 70%. Yet, the real ownership of TI will be about 41%, as it owned just 58% of FiberCorp.

To be fair, it’s not that clear if the minimum 50.1% ownership agreed with CDP refers to the FiberCorp’s quote or just the TI’s quote. According to a literal interpretation, the latter is true: in that case, OF’s final valuation will not exceed €1B, or just 20% more than its equity value.

Catalysts for Telecom Italia

Regardless of the final valuation, which is admittedly important, the deal results in several positive outcomes for TI.

First and foremost, within the Italian telecom infrastructure, it eliminates a competitor, which, although much smaller in size, could undoubtedly affect IT and force it to change its strategy, in other words, undermine its profitability. It’s worth mentioning that OF is suing TI for abuse of its dominant position and is seeking damages for as much as €1.5B. The merge will eliminate this issue, at the very least.

Moreover, the need to further invest in an inefficient development of the fiber network will cease to exist. Now that TI controls the whole infrastructure, it will concentrate its investments where they are more needed in terms of long-term profitability, asset preservation and CapEx optimization. Furthermore, without competitors, it will be easier for TI to acquire the funds the UE allocates to the development of digital infrastructure, like Horizon and Digital Europe.

Finally, the merge will allow TI to successfully unlock the value of its assets in order to further deleverage its balance sheet, which carries a significant load of debt (even though, on average, TI’s International peers carry a similar one).

Bottom Line

As I discussed in a recent article of mine, Telecom Italia’s shares are trading close to their historical lows: a very depressed level which stands at a price-to-book value of just 0.4 (at the time I am writing this) and a total cap of less than 10 times the current earnings. That is definitely too low for the incumbent Telco leader in Italy (and one of the main operators in Brazil too).

The recent developments, namely a deal with KKR for the sale of a minority stake in its secondary physical network and an agreement to merge with Open Fiber, just confirm the dominant position Telecom Italia holds in its market of reference.

Debt load is still worrisome, but it is already discounted in the SP at this point and the plan to deleverage TI’s balance sheet through the monetization of its many assets seems to have gained traction.

Moreover, thanks to the historically low rates, the interest is quite manageable and, arguably, below the return of the invested assets. Therefore, the company should be able to deleverage its balance sheet through normal execution for many years.

It is also important to mention the spread between TI’s ordinary and preferred shares. As shown in the picture below, the preferred ones (Telecom Italia Risparmio [MILAN:TITR]) are currently traded just slightly above the ordinary shares in the Italian Stock Exchange: that is hard to justify because the preferred ones obviously pay a much more generous dividend. The current yield for the preferred stands at 7.8% and it is absolutely covered. A buyer here will get this annual income, while owning a stock which, at the moment, is traded around its historical lows and with the reasonable potential to double in a relative short time. From 2017 to 2019, the company’s FCF averaged €1B annually: in the first 6 months of 2020, FCF amounted to €531M. On the base of this, a DCF valuation can virtually put TI’s value at €17B, or 2.5 times the current cap.

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