Telecom Italia Breakup of Fixed Lines Seen as Bellwether

Telecom Italia’s Breakup of Fixed Lines Seen as Bellwether
Telecom Italia SpA board will probably decide next month whether to proceed with what would be an unprecedented move for a former government-owned phone company in Europe. Photographer: Alessia Pierdomenico/Bloomberg

Europe’s former phone monopolies, built on copper wires linking virtually every home and business in the region, are reeling from overwhelming debt, strict oversight, and slowing sales as consumers switch to mobile.

Telecom Italia SpA, which owes creditors 30 billion euros ($38 billion) -- more than double its market value -- is considering a way out of that conundrum: Spin off the fixed-line network into a separate company.

Chief Executive Officer Franco Bernabe said Nov. 9. Telecom Italia’s board will probably decide next month whether to proceed with what would be an unprecedented move for a former government-owned phone company in Europe.

A split would soften regulatory scrutiny of the Milan-based carrier and let it focus on faster-growing services such as data and wireless. Though Telecom Italia hasn’t given many details of the plan apart from saying it wants to maintain control of the new company, it has said it’s in talks to bring in external investors. Egyptian billionaire Naguib Sawiris has expressed interest in buying new shares in Telecom Italia, the carrier said today. Proceeds from any sale could help pay down debt and fund a faster fiber network.

“There is no similar experience in Europe,” said Pietro Candela, a partner at Booz & Co. in Milan. “It would become a case history to watch for both incumbents and regulators.”

Telecom Italia in 2008 created Open Access, a division that manages the grid and offers access to competitors. That move came about two years after BT Group Plc established a similar, fully-owned unit called Openreach.

BT Lesson

Other former phone monopolies such as Telefonica SA, facing slumping domestic economies and seeking to avoid a cut in their debt rating, are likely to monitor developments in Italy, said James Britton, an analyst at Nomura Holdings Inc.

“If TI achieved the spinoff and investors were supportive of the structure, driving up its market value, then it is possible that other management teams would review whether it could make sense,” Britton said.

The fixed-line network is worth 13 billion euros to 15 billion euros, said Marco Fossati, whose family’s Findim Group SA is Telecom Italia’s second-biggest shareholder, with a 5 percent stake. In a September interview, Fossati urged Telecom Italia to do a spinoff.

Telecom Italia rose 4.2 percent to 72 cents in Milan, paring the stock’s decline this year to 13 percent. On Nov. 9, the company posted its second straight quarter of falling sales and a 13 percent decline in profit.

Regulatory Constraints

As owner of the underlying network, Telecom Italia faces greater oversight than upstart rivals. The company must inform Italy’s communications authority at least 30 days ahead of any fixed-line phone and Internet offer so the watchdog can assess whether rivals can replicate the offering. Changes in wholesale prices can take more than two months.

Spinning off the network would ease that regulatory burden since Telecom Italia would be a legally separate company that buys capacity and offers service to subscribers, just as other carriers do today.

In a similar move meant to reduce regulatory pressure and costs, U.S. carrier AT&T Inc. is investing $14 billion to move customers over to wireless and fiber from its legacy network. AT&T said it plans to eventually decommission the technology carrying voice calls on its circuit-switched system in favor of faster Internet-based standards.

State Backing

CEO Bernabe said in September that Telecom Italia was in discussions with state-owned lender Cassa Depositi e Prestiti SpA about an investment in the grid.

“Telecom Italia’s problem is that with its debt and deteriorating domestic market, it cannot afford to invest without a partner,” said Robin Bienenstock, an analyst at Sanford C. Bernstein in London.

Italy had roughly 22 fixed-broadband connections per 100 people in January, versus the EU average of 28, according to the European Commission. Telecom Italia provided 53 percent of those connections, 10 percentage points higher than the EU average for incumbent carriers. The market’s No. 2, Wind Telecomunicazioni SpA, had about 16 percent.

A spinoff risks market-share losses for that business, which in the first nine months generated almost twice as much revenue for the company as domestic mobile did despite dropping 4 percent, to 9.6 billion euros. In wireless, where there’s more competition, Telecom Italia was No. 2 in Italy at the end of 2011, with 35 percent of the market versus 36 percent for the Italian unit of Vodafone Group Plc, according to the communications regulator.

Cash Flow

“Most telcos are very protective about their network and would not want to go this route,” said Will Draper, an analyst with Espirito Santo Investment Bank in London. “The network is the basis for the entire cash flow of the retail and wholesale revenue.”

By acting now, Telecom Italia could close a deal while the network retains significant value, according to Massimiliano Trovato, a fellow at the Bruno Leoni Institute and author of a paper called “The scrapping of the network.” Even as subscribers move to newer technologies such as wireless and fiber, the network will generate solid revenues until the transition is complete, which could take years.

“Telecom Italia is seeking to cash in on an asset, the copper network, which is set to become obsolete,” Trovato said. “It would achieve lower regulatory pressure and raise cash to cut debt today, and control of the strategic fiber network tomorrow.”

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