Telecom Italia Rising in Bonds With Austerity: Corporate Finance

Telecom Italia Rising in Bonds With Austerity
The Borsa Italiana, Italy's Stock Exchange, is reflected on the glass of a pay phone booth, operated by Telecom Italia SpA, in Milan. Telecom Italia SpA is rising to the top of the global corporate bond market as the loss-making phone operator cuts debt amid renewed demand for Italian assets. Photographer: Alessia Pierdomenico/Bloomberg

Telecom Italia SpA is rising to the top of the global corporate bond market as the loss-making phone operator cuts debt amid renewed demand for Italian assets.

Bonds of Italy’s biggest phone operator returned 2.9 percent in March, the most of the 50 biggest issuers in Bank of America Merrill Lynch’s Global Broad Market Corporate & High-Yield Index. The rally drove the average yield on Milan-based Telecom Italia debt down by 53 basis points to 5.09 percent.

The performance marks a turnaround from November, when Italian securities were roiled by speculation the country was becoming engulfed in Europe’s sovereign debt crisis. Telecom Italia, which posted a bigger-than-expected 2011 net loss of 4.7 billion euros ($6.3 billion), cut its shareholder dividend for the first time in four years and is relying on expansion in emerging markets to bolster its ability to pay debt.

“This company is committed to cutting debt and it’s willing to make sacrifices to do so,” said Mark Chapman, an analyst at CreditSights Inc. in London, who has an “outperform” rating on Telecom Italia’s bonds. “They’ve been able to stick to their debt reduction plans that most people in the market believed were impossible to reach.”

The phone company’s adjusted net debt will fall to 27.5 billion euros this year from 30.4 billion euros in 2011, it said in February. Telecom Italia reduced net debt to 2.5 times earnings before interest, tax, depreciation and amortization last year from 2.8 times in 2010.

Leverage Targets

The ratio should fall to below 2.5 times in 2013 and the company targets a cut to less than two times in 2014, according to Chapman.

Bond investors have taken notice. The dollar value of Telecom Italia’s bonds denominated in euros, pounds and dollars rose by $1 billion to $29 billion in March, according to the Bank of America Merrill Lynch index.

The yield on the company’s 1 billion euros of 7 percent notes due 2017 tumbled 83 basis points, or 0.83 percentage point, to 4.31 percent in March, Bloomberg Bond Trader prices show. That compares with a four basis-point drop to 4.12 percent in the broad Bank of America Merrill Lynch index, which tracks 12,302 notes issued by borrowers from America Movil SAB in Mexico to Brussels-based phone operator Belgacom SA.

The yield on Telecom Italia’s 2017 bonds fell to within 352 basis points of those on similar-maturity German government debt from a 642 basis-point spread at the end of 2011, according to data compiled by Bloomberg. The price of the notes has climbed 12 percent to 111.35 cents on the euro.

Spread Tightening

Telecom Italia “still has room to go as far as future spread tightening or opportunistic ability to pick up something from the yield,” Scott Kimball, a money manager in Miami at Taplin Canida & Habacht LLC, which manages $7 billion, said in a March 28 interview on Bloomberg Television’s “Inside Track.”

Company officials weren’t immediately available to comment. The Italian phone operator has 25.5 billion euros of bonds outstanding, with 1.8 billion euros due this year, according to data compiled by Bloomberg.

Telecom Italia is benefiting as a proxy for Italian government securities, which have soared since the European Central Bank flooded banks with more than $1 trillion of cheap loans to contain the credit crisis.

Prime Minister Mario Monti’s plans to implement 20 billion euros of austerity measures to balance the budget next year, coupled with ECB lending, convinced investors to return to Italy. The yield on Italy’s 10-year bonds has fallen 2.08 percentage points this year to 5.03 percent at 8:36 a.m. in London.

‘Lot of Credibility’

“Monti’s got a lot of credibility,” said Patrick McCullagh, the head of European credit research at Schroder Investment Management Ltd. in London, which oversees $63 billion of bonds. “The question about Telecom Italia bond spreads is clearly tied up with the sovereign and that’s outside the company’s hands.”

It’s taking advantage of the demand by seeking to extend the maturity on 4 billion euros of loans by three years, people with knowledge of the situation said last month. The people declined to be identified because the deal is private.

Telecom Italia proposed on March 29 to cut its ordinary dividend by 26 percent to 4.3 cents per share as part of efforts to reduce debt and maintain its Baa2 rating at Moody’s Investors Service and equivalent BBB grade at Standard & Poor’s. The company previously forecast annual dividend growth of 15 percent through 2013.

Dividend Cuts

Telecom Italia and other former phone monopolies in Europe, such as Spain’s Telefonica SA, are suffering in their home markets because of weak economies amid the sovereign debt crisis. Telefonica and Telekom Austria AG cut dividends in December while France Telecom SA did the same on Feb. 22.

“While the dividend cuts are credit positive, they do not completely offset companies’ difficulties in deleveraging or in sustaining cash flow through organic growth,” Carlos Winzer, an analyst at Moody’s in Madrid, wrote in a March 20 report.

Moody’s cut its outlook on Telecom Italia to “negative” in September, citing the “effects on consumer spending from slow economic growth and government austerity measures.”

When Franco Bernabe became chief executive officer in 2007 he announced plans to cut debt, which almost equaled the phone operator’s market value.

Goodwill Writedown

The Italian company’s 2011 net loss was caused by a 7.3 billion-euro writedown of goodwill related partly to its merger with Olivetti SpA in 1999, Telecom Italia said in its 2011 earnings statement on March 29. Excluding writedowns, net income was 2.6 billion euros, a 19 percent decline from 2010.

Revenue increased 8.7 percent to 30 billion euros, boosted by growth in its Latin American businesses that included the expansion of its Tim Participacoes SA unit in Rio de Janeiro to beat billionaire Carlos Slim’s America Movil to be Brazil’s second-largest wireless operator. Telecom Italia also has a 22.7 percent stake in Telecom Argentina SA, the country’s No.2 phone company.

The cost to insure Telecom Italia’s debt using credit-default swaps has dropped 31 percent this year to 335 basis points, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

That compares with a 28 percent decline in contracts on France Telecom and a 16 percent drop for Telefonica. A fall in the price of the swaps indicates an improvement in perceptions of creditworthiness.

“The market is very positive on Telecom Italia’s debt reduction plan,” said Alexander Wisch, an analyst at S&P Capital IQ Equity Research in London who has a “hold” recommendation on the stock. “It’s partly based on progress in Brazil and Argentina where the outlook is very good.”

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