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Morningstar | Telecom Italia Reports Weak 4Q EBITDA; We Are Likely to Reduce FVE; Shares Undervalued

Telecom Italia reported 2018 revenue spot on with our projections, but margins dropped significantly in the fourth quarter, falling short of our expectations. In the quarter, the firm’s EBITDA margin was just 34.7% versus 42.4% for the first nine months of the year. This brought the full-year EBITDA margin down to 40.4% versus our estimate of 41.2%. Management expects EBITDA to decline further in 2019 before returning to growth in 2020. While Telecom Italia has held up better than the other operators following Iliad’s Italian entrance, Iliad is having a greater effect than we’d anticipated. Additionally, we believe the company is being hurt by infighting for operational control by Vivendi and Elliott Management. Thus, we expect to reduce our EUR 0.85 per local share fair value estimate, likely by about 10%. Our narrow moat remains unchanged, and despite the lower fair value estimate, we believe the shares are undervalued. That said, we think there are better opportunities in European telecoms, particularly Telefonica, Vodafone, and BT Group.

Telecom Italia reported revenue of EUR 19.1 billion for the year, down 3.6%. Strong revenue growth of 5.2% in Brazilian reais terms at its Brazilian subsidiary were more than offset by the decline in the real versus the euro. While we expect a slower decline over the next couple of years, the recent decline in the real will impede the firm’s revenue growth. For more on TIM Brasil’s results, please see our note under symbol TSU.

In Italy, revenue declined 1.1% year over year. The consumer division was hurt by Iliad’s entrance, as all operators lowered prices in response. Its wireless service revenue fell 3.7%. While it grew its wireless subscriber base 3.5% for the year to 31.8 million, its average revenue per user, or ARPU, dropped 8%, with a bigger hit of 16.2% in the fourth quarter. The weak fourth-quarter ARPU presages additional problems in 2019.

The Italian fixed-line side is also being pressured from Open Fiber and Fastweb, which are building their own fibre networks and have agreed to work together. Telecom Italia historically benefited on the broadband side from not having any cable competition, but this is now being offset by fibre competitors. That said, the Italian government has been pushing for a merger of Open Fiber and Telecom Italia’s fixed-line network. Both sides have agreed to hire advisors and discussions are ongoing. If some kind of agreement can be worked out so that multiple fibre networks aren’t built, this should benefit everyone long term.

Meanwhile, Telecom Italia and Vodafone have entered an agreement to share wireless infrastructure with the potential of merging both companies’ tower networks into a joint venture and building a 5G network together. The further the two companies integrate their networks the greater the cost savings could be.

On the business side, revenue grew 1.4% helping offset the weakness in the consumer division. Telecom Italia is doing a better job of taking advantage of its superior network and marketing new services, such as information and communications technology and security services. We think it should be able to continue grow this division’s revenue.