Telecom Italia SpA (TIT), the company created from a merger of Italy’s disparate phone operators two decades ago, risks a downgrade to junk-bond status after rejecting calls for a stock sale and failing to win capital from overseas investors.
The cost of insuring Telecom Italia’s debt using credit-default swaps rose for a third day, taking the increase since the company’s Aug. 2 earnings report to 60 basis points to an 11-month high of 402 basis points at 9:15 a.m. in London, data compiled by Bloomberg showed. The swaps imply a B2 rating, five steps below investment grade, according to Moody’s Analytics.
After Fitch Ratings’ one-step cut yesterday, all three major credit companies rank the debt at one step above junk. A cut to non-investment grade would be the first since ratings started last decade on Telecom Italia’s debt -- which at 28.8 billion euros ($38 billion) on an adjusted net basis is triple its market value -- and would put the Milan-based carrier in the same league as Portugal Telecom SGPS SA and Greece’s Hellenic Telecommunications Organization SA. (HTO)
“In the absence of a rights issue, a cut to junk looks highly likely and would just be a matter of time,” said Roger Appleyard, head of global credit research at RBC Capital Markets in London, who advises selling the company’s bonds and puts the chances of a downgrade by Moody’s at more than 90 percent. “Telecom Italia is not a good story.”
Representatives for Moody’s and S&P declined to comment on a potential rating cut. Moody’s outlook on Telecom Italia’s debt is negative, while S&P’s is stable.
Chief Executive Officer Franco Bernabe said last week, after reporting a first-half net loss because of a 2.2 billion-euro goodwill writedown, that a downgrade is “one of the possible risks that the company must face.”
The yield investors demand to hold Telecom Italia’s 1 billion-euro 4 percent bond due January 2020 rose 43 basis points to a record 5.5 percent yesterday and was little changed at 5.45 percent today, according to data compiled by Bloomberg.
Telecom Italia’s bonds yield an average 5.1 percent, 2.4 percentage points more than the 2.7 percent yield on BBB rated company debt in Bank of America Merrill Lynch’s BBB Euro Corporate Index. The company’s borrowing costs compare with an average 2.7 percent for Telefonica SA (TEF) and 2.3 percent for Royal KPN NV (KPN), the data show.
Non-financial high-yield bonds yield 5.7 percent on average, the data show. Investors demand 4.3 percent in yield to hold Italian carmaker Fiat SpA’s speculative-grade securities, according to the data.
Telecom Italia is among European carriers hurt most by the region’s debt crisis as consumers cut spending. While Vodafone Group Plc (VOD) has businesses in the U.S. and emerging markets such as India to offset revenue declines in southern Europe, and as Telefonica operates in the U.K. and Germany, Telecom Italia generates almost 60 percent of its sales from its home market.
Last week, the carrier said revenue in Italy, where it competes with Vodafone and VimpelCom Ltd. (VIP:US)’s Wind unit, slumped 10 percent as earnings before interest, taxes, depreciation and amortization fell 13 percent. Telecom Italia is relying on growth in Brazil and Argentina to offset the decline.
Last December, Telecom Italia turned down an offer from Egyptian billionaire Naguib Sawiris to invest in the carrier. Telecom Italia then revived discussions with tycoon Li Ka-shing’s Hutchison Whampoa Ltd. (13) about a combination of their Italian wireless assets. Those talks, which could have resulted in fresh capital from Hong Kong-based Hutchison, collapsed because of differences in valuation and concern about Telecom Italia’s debt.
Speaking to analysts last week, Chief Financial Officer Piergiorgio Peluso said there is a risk of repayment of loans Telecom Italia owes to the European Investment Bank in the event of a downgrade and if the carrier can’t reach an agreement on additional guarantees or a revision of the price.
Telecom Italia’s stock is headed for its ninth consecutive annual decline. Down 30 percent this year through yesterday, it is the worst performer on the 24-company Bloomberg Europe Telecommunication Services Index, which gained 9.4 percent.
Today, the shares fell as much as 1.3 percent and were down 0.7 percent to 47.7 euro cents as of 10:19 a.m. in Milan.
To be sure, a debt downgrade may not be imminent.
Madeleine King, a credit sector strategist for the telecommunications industry at Credit Suisse Group AG in London, said Telecom Italia may hold off a rights issue until after investors such as Mediobanca SpA (MB) sell their holdings.
Mediobanca, Assicurazioni Generali SpA (G), Intesa Sanpaolo SpA (ISP) and Telefonica together own almost 22.5 percent of Telecom Italia through holding company Telco SpA. The partners, which agreed in February 2012 to renew their agreement for three years with an exit option in September 2013 and August 2014, may use the first window in September to revoke that accord, a person with knowledge of the matter has said. Last week, Generali CEO Mario Greco said the insurer would sell its stake under the right conditions.
Bernabe told analysts last week that its shareholders would make “a rational and orderly decision” about their holdings. He also ruled out a capital increase by Telecom Italia.
“Even though Telecom Italia is poised to face some tough comments from S&P and Moody’s in the coming days, the chances of a downgrade to junk are higher late this year or early next year rather than now,” King said.
In contrast to Telefonica, Telecom Italia doesn’t have many assets to sell in order to shore up its balance sheet, King said.
Last year, Telefonica suspended dividend payments and started selling assets including a stake in its German business, part of its investment in China Unicom (Hong Kong) Ltd. (762), and its call-center unit Atento. The disposals continued this year with sales such as the treasury stock, a stake in its Central American assets and the Irish unit.
“Telecom Italia’s leverage ratio isn’t escalating rapidly, but the trend of the company’s debt ratings is clearly downward as it struggles operationally,” said David Novosel, a senior analyst at independent researcher Gimme Credit LLC in Chicago.
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