FROM NEUTRAL TLIT.MI / TIT IM

Transcription

1 EQUITIES TELECOM OPERATORS TELECOM ITALIA UNDERPERFORM FROM NEUTRAL EUR0.55 TARGET PRICE EUR0.38 (DOWNSIDE 31%) TARGET PRICE EPS 18e EPS 19e -37% -6% -12% Bargain Hunters Beware 3 SEPTEMBER 2018 at 16:41* Sam McHugh (+44) sam.mchugh@exanebnpparibas.com San Dhillon (+44) Kohulan Paramaguru, CFA (+44) Alexandre Roncier (+44) telecoms@exanebnpparibas.com Specialist sales Gareth Hollis (+44) Downgrading TI to Underperform; TI is likely to remain a value trap TI has fallen ~23% YTD, underperforming the SXKP by 12%, which itself has underperformed the SXXP by 13%. A quick look at any comp sheet will show you it is trading at around 4.75x EV/EBITDA (Bloomberg) a hefty ~25% discount to peers. So as investors search for value one can understand why TI often comes up. However our latest work on The Future of Fibre (published today) has led us to challenge our own long term growth assumptions for TI. In short we have become significantly more bearish, leading to significant cuts to our medium term estimates. We cut our price target from EUR0.60 to EUR0.38 (c30% downside) & downgrade TI to Underperform. Our work identifies Italy and TI as facing the biggest risk to the fixed line outlook in Europe Our work shows TI s wireline business is over-earning relative to peers. Critically now that Open Fiber has secured project financing and Iliad has launched, we think the downside risks will begin to be crystallised. Firstly we think the market still underestimates the negative impact Open Fiber s rollout will have on broadband ARPUs, voice telephony revenues and TI s market share. Secondly as the market has focused on the impact of Iliad on the wireless market, the impact on the wireline market has been overlooked. We believe falling mobile data prices will increase the attractiveness of mobile broadband to the marginal fixed broadband consumer, constraining broadband ARPU and penetration. Whilst mobile voice pricing/allowances at TIM/Vodafone have reached a level where they will start exerting structural downward pressure on TI s fixed voice ARPU s. Iliad s launch has triggered further mobile price cuts and Brazil at a turning point Elsewhere, after a brief period of stabilisation, Italian mobile prices have fallen further over the summer as the outlook continues to deteriorate. We also review the outlook for TIM Brasil who has operated in a unique sweet spot for 18 months, but now several supportive factors are beginning to turn against them, leading us to conclude the outlook is more challenging than consensus believes. We cut our Brazilian valuation by 15%. Our group level OpFCF estimates are 10% below consensus by 20, our FCF estimates are 30% below guidance and we expect leverage to remain >3.0x until at least In our view TI will remain a value trap for a long time. Price (31 August 2018) EUR0.55 Performance (1) 1w 1m 3m 12m Market cap (EURbn) 14.5 Absolute(%) (8) (17) (20) (32) Free float (EURbn) 9.1 Rel. Telco Operators(%) (5) (11) (17) (22) EV (EURbn) 49.2 Rel. MSCI Europe(%) (8) (15) (20) (35) 3m avg volume (EURm) 60.1 Reuters / Bloomberg TLIT.MI / TIT IM Country / Sub Sector Italy / Incumbent Telcos Financials 12/17 12/18e 12/19e 12/20e Valuation metrics (2) 12/17 12/18e 12/19e 12/20e EPS, Adjusted (EUR) P/E (x) EPS, IBES (EUR) Net yield (%) Net dividend (EUR) FCF yield (%) EV/Sales (x) Sales (EURm) 19,828 19,143 18,787 18,494 EV/EBITDA (x) EBITA, Adj. (EURm) 4,204 3,770 3,795 3,785 EV/EBITA (x) Net profit, Adj.(EURm) 1,778 1,295 1,429 1,375 EV/CE (x) ROCE (%) Net Debt/EBITDA, Adj. (x) Source: Exane BNPP (estimates), Thomson Reuters (consensus) (1) In listing currency, with dividend reinvested (2) Yearly average price for FY ended 12/17 * Date and time (London Time) on which the investment recommendation was finalised. It may differ from the date and time of broad dissemination on the website. See Appendix (on p45) for Analyst Certification, Important Disclosures and Non-US Research Analyst disclosures.

2 TELECOM ITALIA (Underperform) Price at 31 Aug. 18 / 12m Target Price EUR0.55 / EUR % Reuters / Bloomberg: TLIT.MI / TIT IM Analyst: Sam McHugh (+44) Incumbent Telcos Telecom Operators - Italy Company Highlights EURm 2.4 Enterprise value 49,194 Market capitalisation 14,542 Free float 9, m average volume Performance (*) 1m 3m 12m Absolute (17%) (20%) (32%) Rel. Sector (11%) (17%) (22%) 0.8 Rel. MSCI Europe (15%) (20%) (35%) 12m Hi/Lo (EUR) : % / % CAGR 2006/ /2020 EPS restated (**) (8%) 3% Target Price 0.4 CFPS (7%) (1%) Price 3.8*CFPS Relative to MSCI Europe Price (yearly avg from Dec. 07 to Dec. 17) PER SHARE DATA (EUR) Dec. 07 Dec. 08 Dec. 09 Dec. 10 Dec. 11 Dec. 12 Dec. 13 Dec. 14 Dec. 15 Dec. 16 Dec. 17 Dec. 18e Dec. 19e Dec. 20e No of shares year end, basic, (m) Avg no of shares, diluted, excl. treasury stocks (m) EPS reported, Gaap (0.25) (0.08) (0.03) 0.07 (0.00) EPS company definition EPS restated, fully diluted (0.01) % change (14.3%) (15.7%) (23.7%) 41.8% (75.4%) 150.8% (56.3%) 3.0% NS NS (3.2%) (24.7%) 9.9% (3.6%) Book value (BVPS) (a) Net dividend STOCKMARKET RATIOS Dec. 07 Dec. 08 Dec. 09 Dec. 10 Dec. 11 Dec. 12 Dec. 13 Dec. 14 Dec. 15 Dec. 16 Dec. 17 Dec. 18e Dec. 19e Dec. 20e P / E (P/ EPS restated) 15.0x 10.9x 11.3x 7.8x 28.8x 9.5x 17.4x 23.8x NC 9.5x 9.5x 8.6x 7.8x 8.1x P / E relative to MSCI Europe 136% 99% 73% 63% 244% 70% 104% 136% NC 53% 61% 60% 60% 67% P / CF 4.7x 3.0x 3.0x 2.9x 3.7x 2.4x 3.1x 5.4x 4.6x 3.5x 3.2x 2.3x 2.3x 2.3x FCF yield 6.8% 9.4% 7.0% 9.7% 7.4% 13.8% 10.9% 2.8% (4.8%) 1.7% 2.7% 3.7% 5.0% 5.4% P / BVPS 1.93x 1.22x 0.98x 0.86x 0.98x 0.95x 0.87x 1.16x 1.52x 1.01x 0.97x 0.63x 0.60x 0.57x Net yield 3.7% 3.8% 4.8% 5.7% 4.6% 2.6% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Payout 55.5% 41.2% 53.9% 44.1% 132.8% 24.3% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% EV / Sales 2.84x 2.28x 2.31x 2.23x 2.00x 1.81x 2.05x 2.56x 3.22x 2.72x 2.78x 2.57x 2.58x 2.58x EV / Restated EBITDA 7.5x 5.9x 5.5x 5.2x 4.9x 4.6x 5.0x 6.3x 8.2x 6.3x 6.4x 6.1x 6.0x 6.0x EV / Restated EBITA 14.7x 11.8x 10.9x 9.8x 8.8x 8.4x 9.4x 12.4x 17.4x 13.2x 13.1x 13.0x 12.8x 12.6x EV / NOPAT 23.4x 18.8x 17.3x 15.6x 12.2x 11.7x 13.0x 17.2x 24.2x 18.4x 18.2x 18.1x 17.7x 17.5x EV / OpFCF 14.1x 11.9x 10.3x 10.5x 10.4x 8.9x 10.0x 17.4x 79.5x 19.7x 18.0x 17.2x 16.3x 15.5x EV / Capital employed (incl. gross goodwill) 1.4x 1.1x 1.0x 1.0x 1.0x 1.0x 1.0x 1.1x 1.3x 1.0x 1.1x 0.9x 0.9x 0.9x ENTERPRISE VALUE (EURm) 89,021 68,690 62,799 61,557 59,914 53,472 47,946 55,330 63,493 51,674 55,179 49,194 48,457 47,646 Market cap 52,074 31,494 24,724 24,655 22,624 18,572 14,830 20,763 26,622 20,723 21,721 14,542 14,542 14,542 + Adjusted net debt 35,701 37,378 38,893 35,711 35,237 32,708 30,829 32,077 33,304 30,561 29,289 29,573 28,936 28,225 + Other liabilities and commitments 2,500 2,500 2,500 2,399 2,643 2,429 2,523 2,515 2,809 2,722 5,142 5,042 4,942 4,842 + Revalued minority interests 1, ,409 3,875 3,483 2,716 4,067 5,628 2,292 2,243 3,252 3,252 3,252 - Revalued investments 2,793 3,339 4,146 3,617 4,465 3,720 2,952 4,092 4,870 4,624 3,215 3,215 3,215 3,215 P & L HIGHLIGHTS (EURm) Dec. 07 Dec. 08 Dec. 09 Dec. 10 Dec. 11 Dec. 12 Dec. 13 Dec. 14 Dec. 15 Dec. 16 Dec. 17 Dec. 18e Dec. 19e Dec. 20e Sales 31,310 30,158 27,163 27,571 29,957 29,503 23,407 21,573 19,718 19,025 19,828 19,143 18,787 18,494 Restated EBITDA (b) 11,822 11,682 11,383 11,801 12,302 11,703 9,668 8,757 7,782 8,199 8,677 8,123 8,055 8,002 Depreciation (5,784) (5,874) (5,622) (5,547) (5,493) (5,340) (4,548) (4,284) (4,135) (4,291) (4,473) (4,353) (4,260) (4,216) Restated EBITA (b) (**) 6,038 5,808 5,761 6,283 6,809 6,363 5,120 4,473 3,647 3,908 4,204 3,770 3,795 3,785 Reported operating profit (loss) 5,864 5,493 5,493 5,813 (602) 1,926 2,718 4,530 2,961 3,722 3,291 3,769 3,795 3,785 Net financial income (charges) (1,749) (2,484) (2,221) (1,774) (1,982) (1,964) (2,186) (2,178) (2,515) (907) (1,495) (1,525) (1,334) (1,373) Affiliates (39) (6) 0 (5) 1 (16) (19) (19) (19) (19) Other 36 (29) (622) (7) (13) Tax (1,682) (653) (1,121) (548) (1,643) (1,235) (1,111) (928) (401) (880) (490) (690) (757) (742) Minorities (7) (1) (15) (451) (446) (350) (436) (610) (729) (158) (166) (241) (256) (276) Net attributable profit reported 2,462 2,394 1,581 3,132 (4,725) (1,627) (674) 1,350 (72) 1,808 1,121 1,294 1,429 1,375 Net attributable profit restated (c) 2,796 2,358 1,800 2, , (189) 1,895 1,778 1,295 1,429 1,375 CASH FLOW HIGHLIGHTS (EURm) Dec. 07 Dec. 08 Dec. 09 Dec. 10 Dec. 11 Dec. 12 Dec. 13 Dec. 14 Dec. 15 Dec. 16 Dec. 17 Dec. 18e Dec. 19e Dec. 20e EBITDA (reported) 11,648 11,367 11,115 11,423 12,249 11,698 9,453 8,815 7,340 8,016 7,801 8,122 8,055 8,002 EBITDA adjustment (b) (58) Other items (174) (315) (268) (378) (131) (1,178) (235) (135) (277) (369) (354) (1) 0 0 Change in WCR 199 (209) (472) (974) (866) 213 (239) (789) (1,628) (548) (581) (1,000) (800) (800) Operating cash flow 11,847 11,158 10,643 10,449 11,305 10,738 9,194 7,833 5,877 7,282 7,742 7,122 7,255 7,202 Capex (5,520) (5,365) (4,543) (4,583) (5,538) (4,702) (4,391) (4,659) (5,078) (4,658) (4,684) (4,253) (4,282) (4,128) Operating free cash flow (OpFCF) 6,327 5,793 6,100 5,866 5,767 6,036 4,803 3, ,624 3,058 2,868 2,973 3,074 Net financial items + tax paid (2,707) (2,779) (4,320) (3,235) (3,798) (2,991) (2,883) (2,489) (2,337) (2,234) (2,419) (2,214) (2,091) (2,115) Free cash flow 3,620 3,014 1,780 2,631 1,969 3,045 1, (1,538) Net financial investments & acquisitions (277) (609) (700) 0 0 Other 858 (443) (1,428) 216 (4,197) (1,404) (600) 584 1, Capital increase (decrease) , Dividends paid (2,886) (1,691) (1,060) (1,122) (1,326) (964) (537) (252) (204) (227) (235) (239) (245) (248) Increase (decrease) in net financial debt (1,600) (1,662) 708 (2,653) 3,143 (2,529) (1,879) 1,248 1,227 (2,743) (1,272) 284 (637) (711) Cash flow, group share 8,919 8,584 6,739 6,960 4,884 6,157 4,068 3,418 5,168 5,165 5,400 4,981 5,059 4,902 BALANCE SHEET HIGHLIGHTS (EURm ) Dec. 07 Dec. 08 Dec. 09 Dec. 10 Dec. 11 Dec. 12 Dec. 13 Dec. 14 Dec. 15 Dec. 16 Dec. 17 Dec. 18e Dec. 19e Dec. 20e Net operating assets 68,339 66,045 64,811 68,365 61,505 52,898 49,431 50,157 50,730 52,923 53,194 53,794 53,816 53,728 WCR (4,299) (5,094) (2,697) (4,597) 314 (1,743) (2,218) (499) (159) 506 (779) 221 1,021 1,821 Restated capital employed, incl. gross goodwill 64,040 60,951 62,114 63,768 61,819 51,155 47,213 49,658 50,571 53,429 52,415 54,015 54,837 55,549 Shareholders' funds, group share 26,985 26,126 25,952 28,819 22,791 19,378 17,061 18,145 17,610 21,207 21,557 22,657 23,888 25,071 Minorities 1, ,168 3,791 3,904 3,634 3,125 3,554 3,723 2,346 2,226 2,422 2,631 2,852 Provisions/ Other liabilities 2,640 2, ,989 2,737 1,957 1,822 2,214 2,294 2,478 2,826 2,846 2,865 2,884 Net financial debt (cash) 35,701 34,039 34,747 32,094 35,237 32,708 30,829 32,077 33,304 30,561 29,289 29,573 28,936 28,225 FINANCIAL RATIOS (%) Dec. 07 Dec. 08 Dec. 09 Dec. 10 Dec. 11 Dec. 12 Dec. 13 Dec. 14 Dec. 15 Dec. 16 Dec. 17 Dec. 18e Dec. 19e Dec. 20e Sales (% change) 0.1% (3.7%) (9.9%) 1.5% 8.7% (1.5%) (20.7%) (7.8%) (8.6%) (3.5%) 4.2% (3.5%) (1.9%) (1.6%) Organic sales grow th (1.3%) (2.3%) (5.6%) (3.8%) 2.7% 0.5% (5.2%) (5.4%) (4.6%) (3.5%) 4.2% (3.5%) (1.9%) (1.6%) Restated EBITA (% change) (**) (19.0%) (3.8%) (0.8%) 9.1% 8.4% (6.6%) (19.5%) (12.6%) (18.5%) 7.1% 7.6% (10.3%) 0.7% (0.3%) Restated attributable net profit (% change) (**) (14.3%) (15.7%) (23.7%) 41.9% (75.6%) 150.8% (54.4%) 7.5% NC NC (6.1%) (27.2%) 10.4% (3.8%) Personnel costs / Sales NC NC NC NC NC NC NC NC NC NC NC NC NC NC Restated EBITDA margin 37.8% 38.7% 41.9% 42.8% 41.1% 39.7% 41.3% 40.6% 39.5% 43.1% 43.8% 42.4% 42.9% 43.3% Restated EBITA margin 19.3% 19.3% 21.2% 22.8% 22.7% 21.6% 21.9% 20.7% 18.5% 20.5% 21.2% 19.7% 20.2% 20.5% Tax rate 40.9% 21.2% 33.6% 13.2% NC NC NC 39.5% NC 31.4% 27.6% 31.0% 31.0% 31.0% Net margin 9.0% 7.8% 6.7% 10.9% 3.6% 6.5% 4.9% 6.4% 2.7% 10.8% 9.8% 8.0% 9.0% 8.9% Capex / Sales 17.6% 17.8% 16.7% 16.6% 18.5% 15.9% 18.8% 21.6% 25.8% 24.5% 23.6% 22.2% 22.8% 22.3% OpFCF / Sales 20.2% 19.2% 22.5% 21.3% 19.3% 20.5% 20.5% 14.7% 4.1% 13.8% 15.4% 15.0% 15.8% 16.6% WCR / Sales (13.7%) (16.9%) (9.9%) (16.7%) 1.0% (5.9%) (9.5%) (2.3%) (0.8%) 2.7% (3.9%) 1.2% 5.4% 9.8% Capital employed (excl. gdw./intangibles) / Sales 40.4% 35.0% 44.9% 43.4% 54.3% 40.8% 47.0% 59.7% 74.6% 88.7% 79.5% 90.7% 96.8% 102.2% ROE 10.4% 9.0% 6.9% 8.9% 2.7% 8.1% 4.2% 4.2% (1.1%) 8.9% 8.2% 5.7% 6.0% 5.5% Gearing 127% 139% 143% 110% 132% 142% 153% 148% 156% 130% 123% 118% 109% 101% EBITDA / Financial charges 6.8x 4.7x 5.1x 6.6x 6.2x 6.0x 4.4x 4.0x 3.1x 9.0x 5.8x 5.3x 6.0x 5.8x Adjusted financial debt / EBITDA 3.0x 3.2x 3.4x 3.0x 2.9x 2.8x 3.2x 3.7x 4.3x 3.7x 3.4x 3.6x 3.6x 3.5x ROCE, excl. gdw./intangibles 30.1% 34.6% 29.7% 33.1% 30.1% 38.0% 33.5% 25.0% 17.9% 16.7% 19.2% 15.6% 15.0% 14.4% ROCE, incl. gross goodw ill 5.9% 6.0% 5.8% 6.2% 7.9% 9.0% 7.8% 6.5% 5.2% 5.3% 5.8% 5.0% 5.0% 4.9% WACC 8.1% 8.2% 9.5% 9.8% 10.5% 9.5% 8.1% 8.9% 9.6% 8.9% 9.0% 8.0% 8.0% 8.0% Latest Model update: 01 Sep. 18 (a) Intangibles: EUR36,654.00m, or EUR1 per share. (b) adjusted for capital gains/losses, impairment charges, exceptional restructuring charges, capitalized R&D, pension charge replaced by service cost (c) adj.for capital gains losses, imp.charges, capitalized R&D, am. of intangibles from M&A, exceptional restructuring, (*) In listing currency, with div. reinvested, (**) also adjusted for am. of intangibles from M&A, or for am. of gwill for pre IFRS year Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 2

3 Contents Investment summary 4 What s New? 5 Summary Conclusions 6 Estimates, guidance, consensus and valuation 16 The outlook for TI s wireline business is worse than consensus thinks21 Latest on Italian Mobile 34 The Sweet Spot for TIM Brasil is Over 39 Investment case, valuation and risks 44 Company profile and financial highlights 49 Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 3

4 Investment summary Downgrading Telecom Italia to Underperform, TP EUR0.38 Telecom Italia s shares have already fallen by 23% YTD and 12% relative to the SXKP as Italian political drama; Iliad s more aggressive mobile launch; the roll-back of 28 day billing and the admission at 2Q results that FY17 EBITDA had been flattered by oneoffs have all weighed on the stock. This is despite the revelation in March 18 that Elliott Advisors had built a stake in the stock and the subsequent upheaval saw Vivendi lose control of the board. So are we at the bottom? In an accompanying report also published today, The Future of Fibre we argue that consensus is too optimistic on outlook for broadband revenue growth for the European Telecom sector, and specifically that broadband ARPUs are unlikely to grow sufficiently to offset other legacy revenue declines (voice telephony, B2B price premiums, cable TV). As part of this work we undertook a detailed review of market structure to determine which European markets were most structurally at risk of delivering disappointing fixed line revenue growth in the medium term. Unfortunately for TI, this work shows Italy is one of the worst fixed markets in Europe from a structural growth perspective and that TI screens as the most-at-risk incumbent across all of our coverage. This is despite a clear opportunity in terms of broadband penetration growth in Italy, which does lag behind other European countries. Critically Open Fiber secured project financing in August and Iliad has launched. We believe these events will prove to be significant catalysts to crystallise earnings downgrades and hamper future revenue growth at TI. We believe these factors are either underestimated or not well understood by consensus. This work has led us to re-visit our medium to long term assumptions for TI s fixed line business; whilst our near term (FY18) forecasts remain broadly unchanged, we cut our Wireline service revenue estimates by -0.9% in FY19, -2.0% in FY20, -4.5% in FY21 and upwards of -7% thereafter. On top of this we note that Iliad has been more aggressive than we initially expected (FREEconomics 2 - Ho, Ho, Ho), and our monthly tracking of mobile prices shows that July and August have seen further cuts following a period of relative stability. Lastly we review the outlook for TIM Brasil, where we caution the sweet spot that the company has been in for the last 18 months is set to end, which, combined with FX headwinds, is going to be a growing headwind for the TI Group in our view. This combination of factors leads to high teen cuts to our FCF forecasts in FY18-20, and our revised cumulative FCF estimates for FY18-20 (pre Spectrum and preminorities) of EUR3.1bn is some 30% below company guidance of EUR4.5bn. Our longer term FCF estimates fall by close to 30%, which drives a ~35% cut in our price target from EUR0.60 to EUR0.38, implying c30% downside. On our revised forecasts TI s leverage will remain >3.0x even by 2022, and hence those hoping to see a transfer of value from debt to equity will be left disappointed. On our estimates TI is trading on an unlevered FCF yield of as little as 3.1% in FY19 and a FCFE yield of 3.8%, leaving it trading at a material premium to peers on 5.1% and 6.9% respectively, especially when it also has no dividend support. To us TI remains a value trap, and bargain hunters should beware. We downgrade TI from Neutral to Underperform. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 4

5 What s New? What work have we done? Assessing the outlook for fixed ARPH growth In this report we expand on the work presented in The Future of Fibre by focusing on the potential for fixed service revenue growth for Telecom Italia. Specifically we analyse Italy and TI through the lens of five key tests that are aimed at judging which European markets are most vulnerable to ARPH (average revenue per household) declines despite growth in fibre. Specifically we look at; 1) Legacy revenue exposure; 2) Fixed line ARPH vs broadband speeds; 3) Fixed line ARPH vs value for money from competing mobile networks; 4) Market concentration (HHI s), and 5) Fibre overbuild risk Catalysts for change in the fixed market Whilst the above work gives us a good understanding of the potential risks, without a change in circumstances / market dynamic it is possible that the status-quo could be sustained. As a result we go on to analyse the market to understand if there are any catalysts for change. The latest on mobile pricing and Iliad s launch Having written in depth on the disruptive potential of Iliad s Italian mobile launch in November 2017, see FREEconomics 2 - Ho, Ho, Ho, we update some of the work initially presented in this note. Specifically we review the trends in mobile pricing and mobile service revenue trends following Iliad s actual launch in May, and we go on to update the work we first presented in Mobile Millennial. This helps us update our assessment of the impact from Iliad, and specifically to help us understand which operator (TIM, Vodafone or Wind-Tre) will be most impacted by Iliad s launch. Assessing the outlook for TIM Brasil Brazil may represent only 13% of TI in terms of EV but in terms of market cap it is far more important at around a third of TI equity. In this report we update our estimates for the latest FX rates, and also review the latest market dynamics in Brazil and the outlook for TIM Brasil for the next 12 months. What does all of this mean for our estimates, valuation and rating? We then explain how all of our work has changed our estimates on TI, and the implication on valuation and our rating. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 5

6 Summary Conclusions Italy screens as one of the most at risk fixed line markets in Europe Across the five tests Italy consistently appears as one of the most at risk countries in our review, specifically 1) Italy has above average exposure to legacy revenues. 2) Italians are probably getting the worst value for money from their fixed line offering in all of Europe, with an average speed of less than 40Mbps and a PPP adj. ARPH of EUR65, i.e. there is little broadband ARPU upsell potential in Italy even as delivered speeds increase. 3) When comparing the PPP adjusted fixed ARPH to the PPP adjusted cost of 1GB of data (adjusted for network quality) we find that Italy is again an outlier, with high fixed ARPH and relatively low mobile prices. This suggests mobile will be more of a cap on fixed line pricing and penetration in Italy relative to other markets. 4) Italy is behind only the UK and Spain in terms of the rate of decline in HHI in the broadband market i.e. competition is growing at one of the highest rates in Europe. 5) Italy has by far the worst fiber overbulild threat in all of Europe, with Open Fiber targeting a build to at least 70% of Italian homes, aided by subsidies for rural areas. We remain sceptical of a (value creative for TI) deal between Open Fiber and TI (see our pushbacks below). Figure 1: Italy screened as being the second worst European country in terms of risk to the fixed line revenue outlook Exane Fixed Line Scorecard 1. TI in particular screens as having high legacy revenues It is crucial to highlight that although a Country may be badly positioned in our analysis, this does not mean all the fixed operators in said Country are equally at risk. The burden may mostly be carried by the incumbent, or the cable operator, with alternative providers actually benefitting from some of the woes of competitors. However Italy, due to historical quirks, is one of a few markets in Europe where there is no cable infrastructure and where the incumbent, TI, still has relatively high market share in both retail and wholesale. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 6

7 Figure 2: TI has the highest exposure to legacy revenues of all incumbents under our coverage at 37% (!) of group EBITDA, perhaps understandable given they have 45% retail broadband share and 98% broadband infrastructure market share Legacy Revenue as a % of Domestic TSR and as a % of Group EBITDA Incumbent Broadband Market Share Legacy Revenue as % Domestic TSR 25% 20% 15% 10% 5% PT Telenor DT TEF Telia Orange Elisa KPN BT TI Proximus 0% 0% 10% 20% 30% 40% Legacy Revenue as % Group EBITDA %SUBSCRIBERS ON INCUMBENT INFRA. 100% 90% 80% 70% 60% 50% We think there are multiple catalysts ahead to crystallise earnings downgrades Having established that Italy, and TI in particular, face the most challenging fixed line outlook in Europe, the question then becomes is there anything that will change the status quo? The short answer is yes. We also believe that 2018 will prove a tipping point, where the catalysts required to crystallise the earnings downgrades are beginning play out. We have put these catalysts into three buckets the first we think is relatively well understood, but the 2 nd and 3 rd are in our view not well understood at all. Catalyst 1: Open Fiber market share loss is relatively well understood In early August 2018 Open Fiber signed a EUR2.5bn project finance package to fund their network rollout, whilst owners Enel and the CDP are also said to be willing to grant a further EUR950m of funding. This removes one of the key investor pushbacks on Open Fiber that they would not be able to secure financing. The company have now said that they will spend at least EUR1bn a year rolling out FTTH. Whilst the Open Fiber network only currently has ~300k subscribers (half of which are Fastweb subscribers in Milan on the old Metroweb network) they now have commercial commitments from over 3m subscribers (with the likes of Vodafone signing up) and netadditions have started to accelerate. SE UK FR NO 40% 30% 35% 40% 45% 50% %RETAIL SUBSCRIBER SHARE DE NL ES IT BE Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 7

8 Figure 3: We think the market does relatively well understand that growth at Open Fiber will come at the expense of Telecom Italia Structure of Italian Broadband Market, 2017, 2021 and Users Total broadband lines 16.5m Total Households 25m Network used Telecom Italia 15.1m OF FWA Service provider Telecom Italia 7.5m OLOs 7.8m OLOs TI Revenues Retail EUR2.1bn Wholesale EUR2.0bn 2021 Users Network used Service provider Total broadband lines 19.2m Telecom Italia 16m OF 2.3m Telecom Italia 8m OLOs 7.9m OLOs 3.3m FWA TI Revenues Retail EUR2.75bn Wholesale EUR1.9bn 2025 Users Total broadband lines 20.3m Network used Telecom Italia 14.5m OF 4.6m FWA Service provider Telecom Italia 8.2m OLOs 6.3m OLOs 5.8m TI Revenues Retail EUR2.85bn Wholesale EUR1.6bn NB: OF= Open Fiber Catalyst 2: Open Fiber the less well understood impact of FTTH rollout Whilst these immediate first order implications of Open Fiber s rollout may be well understood there are several second order implications which we believe are neither well understood by the market, nor included in consensus estimates for Telecom Italia. Specifically we believe consensus underestimates the negative impact on both ARPU and market share for TI. 2.1 Open Fiber rollout likely to cap TI s broadband ARPU growth Perhaps the best place to start is to revisit one of our tests from above namely looking at the delivered broadband speed relative to ARPH. As detailed above Italy stands out as having very high ARPH and very low relative broadband speeds if we add on some of the retail offers of those using the Open Fiber network today we see that Vodafone Italy are selling a 1Gbps FTTH plan for just EUR30/month (or EUR33 if PPP adjusted), which is inclusive of unlimited domestic and international fixed and mobile voice calling. This clearly compares very favourably to the current legacy position in Italy where ARPH is EUR65 and the average speeds are less than 40Mbps. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 8

9 Figure 4: Italian Fixed ARPH is extremely high relative to the quality of the broadband packages sold, and as Open Fiber rolls out FTTH we expect ARPH to fall significantly Adjusted ARPH (EUR/month) versus average speed of packages purchased (Mbps) "OVER-EARNING" Spain PPP Adjusted Fixed ARPH (EUR/m) Italy Germany "UNDER-EARNING" Norway UK Finland Belgium Europe France Portugal Sweden Netherlands Average speed of broadband packages taken (Mbps) Vodafone Italy are selling 1Gbps FTTH for EUR30/month, inclusive of unlimited domestic and international calls to fixed and mobile 2.2 OF rollout will accelerate the decline of TI s fixed voice revenues (EUR3.2bn) Whilst there are not lots of precedents, if we look at the Japanese and Korean markets then it is very clear that the launch of FTTH coincides with a period of accelerating or sustained line losses and voice telephony revenues. Intuitively this makes sense greater availability of higher quality broadband connectivity, especially today with the proliferation of VoIP services as well as video services (Skype, FaceTime etc), results in an acceleration in the decline in usage of legacy fixed voice. Figure 5: As FTTH penetration accelerates, so does the loss in telephony lines and decline revenues In Japan NTT Commercialised FTTH in 2001, while in Korea KT launched FTTH in 2006 NTT Line Losses (m) vs. Japan FTTH Penetration (%) KT Telephony Rev Growth (%) vs. FTTH Penetration (%) '03 '05 '07 '09 '11 '13 '15 ' Line Losses FTTH Pen. Telephony Rev. Growth Effective FTTH/B Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 9

10 Part of the reason that ARPH is so high in Italy is, we think, due to the fact that TI has a lot of legacy revenue in voice (discussed in our analysis above). Whilst TI does disclose fixed voice revenues (EUR3.2bn in 2017) they do not split these between variable voice calling and line rental, translating into a voice ARPU of close to EUR30/month (inc VAT). It is clear that TI is making a lot of money from this legacy product. As discussed above we are sceptical of TI being able to deliver sustained broadband growth with broadband ARPU s of over EUR32/month (inc VAT), so they cannot shift profitability away from voice and into the broadband bucket. As a result we expect TI s voice line losses and voice revenue declines to accelerate in the medium to long term as Open Fiber s rollout gains traction. 2.3 New entrant risk: The disruptive impact of Sky s (and potentially Iliad s) broadband launches are underestimated One of the other key takeaways from our work on Japan is that FTTH rollout has led to a proliferation of retail competition. In the case of Italy we already have one confirmed new-entrant and one very obvious potential new entrant Sky Italia and Iliad respectively. Sky has confirmed they will launch broadband on Open Fiber in summer Whilst Sky has confirmed their launch we think current consensus estimates for TI reflect little to zero impact of Sky launching broadband in Italy. We think this will prove a mistake, and using data from our STAMP 2018 survey we show that Sky (with close to 5m subscribers in Italy) has market leading NPS scores, better pricing power than TIM vision, and their customer base over-indexes to TI broadband subs. I.e. they have some of the right tools to build up a broadband business. Figure 6: Our analysis suggests that Italy will undergo one of the biggest increases in retail competition across Europe over the next 4 years, and this is before we even factor in a broadband launch at Iliad Broadband HHI (2022) vs Change in Broadband (2022 vs 2017) Change in Broadband HHI 2022 vs 2017 (Exane est.) 2% 0% (2%) (4%) (6%) (8%) (10%) (12%) (14%) "JAPAN IS AT ~2,100" Germany Norway Sweden UK Europe Italy "LOW HHI, CONCENTRATION DECLINING" "HIGH HHI, CONCENTRATION GROWING" France Spain Portugal Belgium Finland Netherlands "HIGH HHI, CONCENTRATION DECLINING" (16%) 2,000 2,200 2,400 2,600 2,800 3,000 3,200 3,400 3,600 3,800 4, HHI (Exane est) Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 10

11 We are currently taking a very cautious approach to forecasting growth at Sky and Iliad. In our forecasts we assume Sky reaches just 200k subscribes by 2022, or 4% of their TV customer base, and we do not currently forecast any subscribers for Iliad. We think this is a very conservative approach, and could be a source of further downside to our TI estimates. Even on these numbers if we revisit our earlier HHI analysis and roll forward our analysis to look at how HHI changes from 2017 to 2022 then we clearly see that Italy moves from being around the market average to being one of the worst markets over the next 4 years. Catalyst 3: Iliad the overlooked impact of Iliad s mobile launch on the broadband market Much has been made of Iliad s mobile launch in the Italian market in May this year, and as discussed later in this note, Iliad has probably been more aggressive on pricing than we anticipated pre-launch. Most of our discussions with investors and market commentary in relation to Iliad s mobile launch have centred on the impact on mobile service revenue in Italy. However we believe that when we look back at their launch in 5 years time, we will also realise that their launch had a significant impact on the fixed line market in Italy. At the moment we think consensus totally overlooks this impact and is thus too optimistic in their outlook for fixed revenue growth in Italy. 3.1 Falling mobile data prices will serve to increase the attractiveness of mobile broadband to the marginal fixed broadband consumers limiting fixed ARPU growth and penetration gains Average mobile data prices in Italy have fallen 80% (on a per GB basis) over the last two years from ~EUR4/GB to just EUR0.8, and Iliad is now selling 40GB of mobile data for just EUR6.99 (we discuss and analyse some of these trends in the below section on the mobile market). As discussed in Test 3 above, there is a good correlation between fixed ARPH and the cost of mobile data, with Italy screening as one of the big outliers where fixed line ARPH looks very high relative to the (quality adjusted) value for money offered by mobile plans. Taking this analysis one step further, if we add Iliad s current mobile offer into our analysis (adjusted for the network quality of Wind-Tre) then it becomes immediately clear that the relative attractiveness of a mobile-only home broadband solution to the marginal customer is growing in Italy, and in particular that it has grown materially following Iliad s launch, and as a result we think Iliad s aggressive mobile offers are likely to put incremental downward pressure on both Fixed ARPH and broadband penetration in Italy. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 11

12 Figure 7: Iliad s cheap mobile plans will serve to constrain both broadband growth and penetration as mobile broadband becomes a more attractive proposition for the marginal consumer of fixed broadband Adjusted Fixed ARPH (EUR/month) versus mobile VFM 80 "Italy appears to overearn in Fixed given the reasonable cost and quality of mobile offers - furthermore Iliad's entry into the mobile market has further reduced the cost per GB even when adjusted for the poor quality of the Wind-Tre network" Spain 70 (2) Iliad Mobile (1) Italy Today Belgium Norway PPP Adjusted Fixed ARPH Our work suggests that Italian fixed ARPH could fall by up to 30-40%, in part due to growing pressure from mobile as a substitute to fixed Japan Europe South Korea Netherlands Sweden France UK Germany (3) Italy 2025? WORSE MOBILE VFM Finland Mobile VFM Score: PPP Adj. EUR/month per GB adjusted for network quality (speed and availability) 3.2 The widespread availability of unlimited voice calls at EUR6.99/month will also accelerate fixed voice declines Lastly prior to the announcement of Iliad s launch (2016) the cost of unlimited voice calls on TI or Vodafone s mobile network was close to 40% more expensive than getting unlimited voice calls from TI s fixed network. However subsequent to the news that Iliad would launch in mobile in Italy this premium has evaporated, such that today you can get unlimited voice calls (from mobile to mobile/landlines) from Vodafone for as little as EUR11/month as part of their Vodafone Smart plan with 2GB of data, i.e. a >60% discount to the equivalent price on TI s fixed network. We believe this will also exert structural downward pressure on TI s fixed voice ARPU s. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 12

13 Figure 8: We think mobile voice pricing has now fallen enough to have a growing impact on fixed voice revenue at TI Monthly cost of TI fixed line with unlimited voice vs the cost of a mobile plan with unlimited calls (EUR/month) Historically getting unlimited mobile callling in Italy was more expensive than it was on TI's fixed network However the gap between the cost of getting unlimited mobile calling has fallen materially below the cost of unlimited calling on TI's fixed network EUR / Month Aug-16 Aug-17 Aug-18 Iliad Cheapest TI or Vod mobile plan with Unlimited Voice Calls Iliad's launch has futher extended this gap TI Fixed Voice ARPU (inc VAT) Three potential mobile headwinds In December 2017, we published our second deep dive note on Iliad s launch in Italy, see FREEconomics 2 - Ho, Ho, Ho, in which we argued mobile prices in Italy were actually higher than first appears, implying that there was an opportunity for Iliad to disrupt the market. Given we have already written in-depth on this topic in prior notes, in this note we focus on updating that view and summarising what we think are three incremental downside risks to TI s mobile business. In this regard we note that our monthly pricing analysis shows that having reached some level of stabilisation through mid-2018, mobile prices have fallen further in July and August 2018, all but confirming MSR trends will deteriorate again in 3Q as the operators face lower prices and a full quarter of competition from Iliad. Secondly we go on to demonstrate why TI has a long term demographic problem and lastly we also provide an update on our latest expectations for the upcoming spectrum auction in Italy, where we raise our expectation for TI s spend to EUR700m, and caution that the eventual cost could be higher again given the potential competitive intensity of bidding. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 13

14 Figure 9: Price per GB in Italy has been more than halved in the last 18 months all but confirming 3Q trends will be worse than 2Q Price per GB trend per data bucket cohorts* Average Cost per GB in a 6-30GB Plan Average Price for a 6-30GB Plan Mar 16 May 16 Jul 16 Sep 16 Nov 16 Jan 17 Mar 17 May 17 Jul 17 Sep 17 Nov 17 Jan 18 Mar 18 May 18 Pricing pressures re-accellerated this summer Jul Apr 16 Jun 16 Aug 16 Oct 16 Dec 16 Feb 17 Apr 17 Jun 17 Aug 17 Oct 17 Dec 17 Feb 18 Apr 18 Iliad still priced a 50% discount Jun 18 Aug ILIAD ITALIA ILIAD ITALIA * note these are 3 month trailing average prices The sweet spot for TIM Brasil is over Brazil may represent only 13% of TI in terms of EV but in terms of market cap it is far more important at around a third. Given the importance of Brazil it is worth taking a little time to consider what is happening in this market to understand if there is any upside or downside risk. In short we believe that TIM Brasil has been in a real sweet spot for the last 18 months as multiple factors have contributed to their success (namely a first mover advantage in 4G, Oi s balance sheet problems and macro improvement). However we believe consensus estimates are extrapolating this improvement into the future, whereas we believe these three factors are now reversing and as a result we are more cautious on the outlook for TIM Brasil vs consensus specifically our local currency OpFCF estimates are 9% below Bloomberg consensus by This together with currency headwinds is another source of downgrades we believe consensus will need to put through for TI group over the next 12 months. What does this mean for our group estimates and price target? Our longer term FCF estimates fall by close to 30%. We conclude TI will not meet their medium term FCF guidance EUR3.1bn vs EUR4.5bn guidance), whilst our EBITDA estimates are 10% below consensus. In addition the upcoming spectrum auction in Italy is an incremental headwind and if we adjust for the impact of IFRS 15 we expect TI to remain >3.0x levered all the way through to Our revised forecasts drive a ~37% cut in our price target from EUR0.60 to EUR0.38, some 30% downside. On our estimates TI is trading on an unlevered FCF yield of as little as 3.1% in FY19 and a FCFE yield of 3.8%, leaving it trading at a material premium to peers on 5.1% and 6.9% respectively. Pushbacks Due to the nature of our work (it takes a long term and structural view) we do caution that this is not per se a call on the next quarter or two at TI (indeed recent price increases in broadband and the employee solidarity agreements should help TI in 3Q18 vs 2Q18 and we expect domestic Adj. EBITDA to decline just -0.5% vs -6.5% in 2Q18. However we believe any relief will prove short lived and would use any strength to add to short positions. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 14

15 Doesn t TI have loads of cost cutting? Yes, we agree in fact nearly all incumbent telcos are over-staffed and inefficient. Within the addressable domestic cost base of ~EUR7.2bn in FY17 we credit TI with a significant net EUR450m (or 6%) reduction in Opex between FY17 and FY20. However we caution that growing competitive intensity and investment in content may mean we are overly generous in our net cost cutting assumptions. Won t they do a deal with Open Fiber / spin off the network? In taking a stake in TI earlier this year Elliott argued that TI should spin-off their network in order to benefit from multiple arbitrage and to try to crystallise a deal with Open Fiber. In addition TI is currently engaged in a process with the regulator which is seeing them attempt to create a more independent NetCo within the business (with more clearly demarked reporting, much like Openreach with BT). This in itself is not a spinoff, although is seen investors as a precursor to any such move. However we remain sceptical that a spin-off can be achieved, and even if it is, whether it will be value creative for TI shareholders. Our fundamental issue is that Open Fiber now has secured financing and clearly do not need TI s network in the near term to progress, and it is very unclear to us why the government (ultimately 50% owners of Open Fiber through the CDP) would do a deal that would benefit non-italian private shareholders (read Vivendi and Elliott). Putting a value on any potential Net Co is fraught with difficulty given the overbuild risk, and the fact that unlike regulated utilities like water, a fibre network is not a closed utility and faces competition from mobile as a substitute. Won t they sell assets? Over the last 12 months TI have discussed the potential for asset sales, with broadcasting company Persidera and international wholesale business Sparkle being the most often discussed. At 2Q18 results management stated that Persidera was the only thing on the block at the moment. As per TI s 2017 annual report, Persidera generated ~EUR40m of EBITDA. The domestic stub trades on ~5.0x EBITDA every 1.0x turn of EBITDA higher they receive is worth EUR40m and would add 0.5% to our price target. Given the sale has reportedly fallen through twice we are sceptical that anything will materialise here. On Sparkle it's worth noting a couple of important points firstly EBITDA in Sparkle declined around 40% in 1H18 (to around EUR50m), and EBIT was negative. In their presentation on the turnaround of TI, Elliott claimed that Sparkle was worth ~EUR1bn to TI today and could be worth EUR2bn in the future. The reality is KPN recently sold a similar business, ibasis, for what we understand was a ~4x EV/EBITDA multiple, implying Sparkle is probably worth closer to EUR400m. This would clearly be disappointing vs expectations, which may well explain why they haven't been able to sell it yet. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 15

16 Estimates, guidance, consensus and valuation Changes to estimates As discussed in this note we have reviewed our long term assumptions and estimates predominantly for TI s wireline business. Our work has led us to cut our estimates for wireline service revenue by -0.9% in FY19, -2.0% in FY20, -4.5% in FY21 and upwards of -7% thereafter. On top of this we note that Iliad has been more aggressive than we initially expected and our monthly tracking of mobile prices shows that July and August have seen further cuts following a period of relative stability. We cut our wireless service revenue estimates by 1-2% over our forecast period. Lastly we update for FX, with the EUR/BRL exchange rate now at 4.84 vs 4.48 in our previously published model. This results in high-single digit cuts to our Brazilian estimates. The combination of all of these factors results in a ~30% cut to our long term FCF estimates. Our detailed model and estimates are available on request. Figure 10: We have cut out long term FCF estimates by upwards of 30% EBNPP Es tim ates EXANE - NEW ESTIMATES CHANGE (%) (EURm) REVENUES 19,143 18,787 18,494 18,122 17, % -2.1% -2.8% -4.0% -5.5% Domestic 15,321 15,170 14,870 14,513 14, % -0.7% -1.6% -3.0% -5.0% Wireline 10,682 10,707 10,570 10,333 10, % -0.9% -2.0% -4.5% -7.2% Wireless Service 4,603 4,422 4,247 4,112 4, % -1.3% -1.8% -0.5% -1.1% Wireless Equipment % 3.5% 3.5% 3.5% 3.5% Brasil 3,850 3,645 3,651 3,636 3, % -7.5% -7.5% -7.5% -7.5% Wireline % -7.5% -7.5% -7.5% -7.5% Wireless Service 3,495 3,297 3,301 3,291 3, % -7.5% -7.5% -7.5% -7.5% Wireless Equipment % -7.5% -7.5% -7.5% -7.5% EBITDA 8,122 8,055 8,002 7,748 7, % -3.4% -3.4% -6.1% -9.9% Domestic 6,677 6,646 6,575 6,315 6, % -2.6% -2.5% -5.9% -10.6% Brasil 1,461 1,425 1,442 1,450 1, % -6.8% -7.2% -6.9% -6.9% Domestic EBITDA (adj.) 6,902 6,896 6,825 6,515 6, % -2.2% -1.7% -5.7% -9.8% EBIT 3,769 3,795 3,785 3,581 3, % -6.2% -7.1% -12.1% -20.0% Domestic 3,243 3,232 3,171 2,929 2, % -6.2% -7.1% -13.2% -22.8% Brasil % -5.9% -6.8% -6.3% -6.4% Interest Costs -1,524-1,334-1,373-1,365-1, % 5.6% 10.7% 11.5% 15.7% Taxes % -11.7% -15.0% -22.3% -34.4% NET INCOME 1,294 1,429 1,375 1,224 1, % -12.8% -16.7% -25.6% -39.9% NET INCOME (Exane) 1,295 1,429 1,375 1,224 1, % -12.8% -16.7% -25.6% -39.9% EPS (EURc) % -12.4% -16.1% -24.8% -38.6% CAPEX 4,753 4,082 3,928 3,761 3, % 1.6% 2.9% -10.3% -1.7% Domestic 3,841 3,262 3,123 2,975 2, % 4.1% 6.0% -11.0% 0.0% Brasil % -7.5% -7.5% -7.5% -7.5% Adjusted OpFCF 3,368 3,973 4,074 3,988 3, % -8.0% -8.8% -1.7% -16.5% FCF (TI Definition) 855 1,082 1,159 1,302 1, % -22.5% -25.4% -28.4% -31.8% Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 16

17 Exane vs Guidance TI has medium term guidance and our estimates are now below on all the critical factors, namely; Guidance: Low single digit domestic adjusted EBITDA growth CAGR. Exane: we now expect domestic adj. EBITDA to decline -1.1% CAGR Guidance: Group adjusted net-debt/ebitda of ~2.7x (ex-spectrum) in 2018 and further reducing in 2019 and Exane: Our revised estimates have leverage at 3.1x in 2018 reducing to just 2.9x by TI are also in the middle of adopting IFRS 15 which is expected to have a ~EUR300m annualised negative impact on EBITDA. Adjusting for this leaves TI at >3.0x net-debt to EBITDA through to at least Our estimates include spectrum costs of EUR700m in Guidance: Group cumulative equity FCF of ~EUR4.5bn Exane: Our estimates are ~30% below guidance at EUR3.1bn of FCF over this period (notably adjusting for minorities, finance leases and spectrum we expect TI to generate just ~EUR840m of FCF cumulatively between 2018 and Figure 11: We expect TI s net-debt to EBITDA (IFRS15 adj.) to remain >3.0x for the foreseeable future whilst our FCF estimates are ~30% below guidance TI Net-Debt / EBITDA TI Cumulative FCF (pre-spectrum, pre-minorities and pre-dividend) 3.7x 3.5x 3.2x 3.0x 2.7x 2.5x 2.2x TI Adj. Net Debt / EBITDA IFRS 15 Adjusted Net Debt / EBITDA Guidance Exane Cumulative FCF Exane vs Consensus TI does not distribute a company compiled consensus with annual estimates, so we have to rely on Bloomberg estimates. We note that these only go out as far as 2020, with outer years not having enough contributing analysts to be reasonable benchmarks. Below we also compare our TIM Brasil estimates to the consensus estimates for the locally listed subsidiary. In aggregate our group revenue estimates are 4% below consensus by 2020, our EBITDA estimates are 7% below consensus and our OpFCF estimates are ~10% below consensus by Meanwhile our net-debt estimates are ~13% above consensus and leverage is 20% above consensus by Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 17

18 Within the mix we estimate that our revenue estimates for Italy and Brazil are both ~4% below consensus by 2020, but at the EBITDA level we are more bearish vs consensus on Italy (-7% by 2020) than we are vs consensus on Brazil ( just 4% below consensus by 2020). Figure 12: Our TI estimates are below consensus nearly across the board with a greater difference between us and consensus in Italian EBITDA vs Brazilian numbers Exane vs Consensus EBNPP Estimates CONSENSUS - BLOOMBERG EXANE - LIVE DELTA (%) (EURm) REVENUES 19,322 19,258 19,253 19,143 18,787 18, % -2.4% -3.9% Dome stic 15,458 15,528 15,462 15,321 15,170 14, % -2.3% -3.8% Wireline 10,682 10,682 10,682 Wireless Service 4,603 4,422 4,247 Wireless Equipment Brasil 3,864 3,730 3,791 3,850 3,645 3, % -2.3% -3.7% EBITDA 8,361 8,495 8,589 8,122 8,055 8, % -5.2% -6.8% Domestic 6,909 7,042 7,084 6,677 6,646 6, % -5.6% -7.2% Domestic (adj.) 7,134 7,292 7,334 6,902 6,896 6, % -5.4% -6.9% Brasil 1,452 1,453 1,505 1,461 1,425 1, % -1.9% -4.2% CAPEX 4,397 4,103 3,971 4,753 4,082 3, % -0.5% -1.1% Domestic 3,490 3,265 3,164 3,841 3,262 3, % -0.1% -1.3% Brasil % -2.1% -0.3% o/w Spectrum OpFCF (Adj. EBITDA) 4,189 4,642 4,868 3,609 4,239 4, % -8.7% -10.9% Net-Debt 24,800 23,620 22,146 26,375 25,738 25, % 9.0% 13.0% Net-Debt / Adj. EBITDA 2.9x 2.7x 2.5x 3.2x 3.1x 3.0x 9.2% 14.5% 20.8% TIM Brasil (BRL) REVENUES 17,077 18,053 19,044 17,015 17,641 18, % -2.3% -3.7% EBITDA 6,464 7,035 7,562 6,505 6,898 7, % -1.9% -4.2% CAPEX 4,059 4,056 4,055 4,084 3,969 4, % -2.1% -0.3% OpFCF 2,405 2,979 3,507 2,422 2,929 3, % -1.7% -8.7%, Bloomberg, Based on TI Earnings and Net debt definitions Change in price target As a result of our revised forecasts our price target falls from EUR0.60 to EUR0.38 in terms of contributing factors updating for the latest FX rates has taken EUR0.04/share from our price target, revision to the underlying value of TIM Brazil (fair value from R$13 to R$11) reduce this by a further EUR0.04/share, whilst our revised Italian estimates reduce this further by EUR0.14/share. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 18

19 Figure 13: We cut our price target from EUR0.6 to EUR0.38 Exane Change in TI Price Target Bridge (0.04) (0.04) (0.14) Old Price Target Brazilian FX Underlying Brazil Valuation Italian Estimates New Price Target Figure 14: Our revised price target is 0.38 TI SOTP Relative Valuation Our price target implies a ~4.7x EV/EBITDA multiple for TI s Italian business, broadly similar to our target multiple for the group. A better indicator of value is we think unlevered FCF and FCF to equity. Adjusting for minority leakage we estimate that TI is currently trading on a ~3.1% unlevered FCF yield in 2019 and a 3.8% equity FCF yield in the same year. This puts the company on a significant premium vs their peer group on 5.1% and 6.9% respectively. Our price target implies TI trades on a ~3.7% unlevered FCF yield and a 7.2% equity FCF yield in 2019, with the latter being broadly in line with peers despite TI s higher leverage and Brazilian exposure. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 19

20 Figure 15: We think TI is materially more expensive than many think Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 20

21 The outlook for TI s wireline business is worse than consensus thinks Our structural test identify Italy and TI as facing the biggest risk to the fixed line outlook in all of Europe, critically we also believe that the catalysts necessary to crystallise this risk are beginning to play out. Some of these are relatively well understood i.e. the first order impact of Open Fiber s FTTH rollout. However we think the market still underestimates 1) the disruptive impact of Sky s (and potentially Iliad s) broadband launches and 2) the negative impact FTTH rollout will have on broadband ARPUs and legacy voice telephony revenues. In addition we think the market has overlooked the negative impact of Iliad s mobile launch on the fixed line market, as 1) falling mobile data prices serve to increase the attractiveness of mobile-only to the marginal broadband consumer (constraining ARPU upsell and penetration gains) and 2) the widespread availability of unlimited voice calls at a low price will accelerate declines in legacy voice telephony. Italy screens as one of the most at risk fixed line markets in our structural review In this report we expand on the work presented in The Future of Fibre - Inglorious Masters by focusing on the potential for fixed service revenue growth for Italy and Telecom Italia in particular. Some of the terms and tests used in this analysis are taken from this note, and as a result we would redirect the reader to this note in order to get a better understanding of the methodology and rationale behind some of this analysis. Specifically we analyse Italy and TI through the lens of five key tests that are aimed at judging which European markets are most vulnerable to ARPH (average revenue per household) declines despite growth in fibre. Specifically we look at; i. Legacy revenue exposure; ii. iii. iv. Fixed line ARPH vs broadband speeds; Fixed line ARPH vs value for money from competing mobile networks; Market concentration (HHI s), and v. Fibre overbuild risk Across the five tests Italy consistently appears as one of the most at risk countries in our review, specifically; Test 1: Legacy revenue exposure; Italy has above average exposure to legacy revenues, which represent ~13% of total service revenue vs 12% for the European average, but especially when compared to income adjusted ARPH on this basis TI has high legacy exposure with a limited opportunity to increase price to offset those legacy declines. TI in particular screens as having high legacy revenues It is crucial to highlight that although a Country may be badly positioned in our analysis, this does not mean all the fixed operators in said Country are equally at risk. The burden may mostly be carried by the incumbent, or the cable operator, with alternative providers actually benefitting from of the woes of competitors. However Italy, due to historical quirks, is one of a few markets in Europe where there is no cable infrastructure and where the incumbent, TI, still has relatively high market share in both retail (45%) and on the wholesale level (95%). Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 21

22 Figure 16: UK, Belgium and Italy may struggle to offset legacy declines via consumer broadband, while Portugal, Spain and Norway appear to over-earn on broadband. Finland and France offer the best mix. Legacy exposure in TSR (%) versus Income Adjusted ARPH (EUR/home) 19% 17% Belgium "HIGH LEGACY EXPOSURE, LIMITED BROADBAND GROWTH OPPORTUNITY" Legacy Revenues as % of TSR 15% 13% 11% 9% Finland Germany Sweden Netherlands Europe UK Italy Portugal Spain 7% "LOW/AVERAGE LEGACY EXPOSURE, BROADBAND OPPORTUNITY" Figure 17: TI has the highest exposure to legacy revenues of all incumbents under our coverage at 37% (!) of group EBITDA, perhaps understandable given they have 45% retail broadband share and 95% broadband infrastructure market share Legacy Revenue as a % of Domestic TSR and as a % of Group EBITDA France Norway 5% Legacy Revenue as % Domestic TSR 25% 20% 15% 10% 5% PT Telenor DT TEF Telia Orange Elisa KPN BT Income Adjusted ARPH (EURm) TI Proximus 0% 0% 10% 20% 30% 40% Legacy Revenue as % Group EBITDA %SUBSCRIBERS ON INCUMBENT INFRA. "AVERAGE LEGACY EXPOSURE, BUT POTENTIALLY OVER- EARNING ON BROADBAND " Incumbent Retail vs Wholesale Broadband Market Share 100% 90% 80% 70% 60% 50% SE UK FR NO 40% 30% 35% 40% 45% 50% %RETAIL SUBSCRIBER SHARE DE NL ES IT BE Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 22

23 Test 2: Monetisation: Fixed line ARPH vs broadband speeds; In our second test, we take our adjusted ARPH as calculated above, and compare it to the broadband speed. Crucially, we take the average speed of packages purchased, rather than the delivered speed as this theoretically should correlate better with ARPH. On this metric it is clear that Italians are probably getting the worst value for money from their fixed line offering in all of Europe, with an average speed of less than 40Mbps and a PPP adj. ARPH of EUR65, i.e. there is little broadband ARPU upsell potential in Italy even as delivered speeds increase. Figure 18: Italy is clearly over-earning in broadband relative to the speed of packages purchased by consumers Income Adjusted ARPH (EUR/month) versus average speed of packages purchased (Mbps) Italy Norway Belgium Spain Portugal Income Adjusted Fixed ARPH (EUR/m) "OVER-EARNING" Germany UK Europe "UNDER-EARNING" France Sweden Netherlands Finland Average speed of broadband packages taken (Mbps) JPN/SK have an ARPH of ~EUR55 for 500Mbps, and are selling 1Gbps for ~EUR40 on the frontbook. Test 3: Fixed line ARPH vs value for money from competing mobile networks; Our third test focused on looking at the value for money offered by mobile networks (by looking at the cost of 1GB of data, adjusted for the relative quality of the network) and to compare it to the PPP adjusted fixed ARPH. Looking at this data we immediately see that there is a pretty good correlation between these two factors i.e. mobile does seem to be a limiting factor on fixed ARPH. This makes some intuitive sense given mobile is a substitution product for fixed line broadband for the marginal consumer. So where does Italy sit on this chart? Unfortunately it is again an outlier with high fixed ARPH and relatively low mobile prices. This suggests mobile will be more of a cap on fixed line pricing and penetration in Italy relative to other markets. Exane BNP Paribas Research Telecom Italia 3 SEPTEMBER 2018 page 23