A lot of companies do debt financing to fund their operations or expansion but some of them are struggling to pay their debt obligations when it’s due. An example of this is Telecom Italia, the largest telecommunications company in Italy, which has been grappling with a prolonged debt issue and intends to solve and enhance its capital structuring by selling off some of its assets. In today’s FA Alpha, let’s assess Telecom Italia using Uniform Accounting to gauge its true risk and if its proposed liquidation of assets can help its debt issue.
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Some companies are taking on massive debt and have difficulties when the maturities come.
Telecom Italia has been dealing with debt problems for a very long time. Now, it wants to get rid of these issues and clean up its capital structure.
The company found a way to do that by selling its grid assets.
These assets, including the company’s landline network and submarine cable unit, are expected to bring somewhere between 20 to 25 billion Euros to the company.
The well-regarded U.S. based private equity firm KKR (KKR) has already made a proposal to acquire these assets for 20 billion Euros.
If completed, this transaction would significantly help the company to pay down its debt pile and reshape its capital structure.
Let’s have a look at the company’s current capital structure by leveraging Credit Cash Flow Prime (“CCFP”) to understand the company’s obligations matched against its cash and cash flows.
In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
The CCFP chart clearly shows that Telecom Italia’s cash flows are not sufficient to cover its obligations going forward.
CCFP chart indicates that the company has significant debt maturities in the next few years and its operating obligations make it challenging to handle them.
The company’s current capital structure is not sustainable and it clearly shows why Telecom Italia has been pushing to sell its grid assets.
In light of this, let’s take a look at the company’s adjusted CCFP to understand how its capital structure might change if the transaction is successfully completed.
We’re not expecting that the company will use all of the proceeds from the transaction to pay off its debt maturities.
But if it did, that could clean up its entire capital structure and look much safer and healthier.
The adjusted CCFP clearly shows that the company would have no significant debt maturities remaining and its cash flows would be more than enough to serve its obligations going forward.
Hence, it could achieve its goal of a healthier balance sheet and have a chance to reshape its capital structure.
That is why this transaction is highly critical to the company’s future and it has the potential to make or break Italy’s largest telecom operator.
It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.
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SUMMARY and Telecom Italia S.p.A. (TIT:ITA) Tearsheet
As the Uniform Accounting tearsheet for Telecom Italia S.p.A. (TIT:ITA) highlights, the Uniform P/E trades at 52.3x, which is above the global corporate average of 18.4x and its historical P/E of 36.9x.
High P/Es require high EPS growth to sustain them. In the case of Telecom Italia, the company has recently shown a 808% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Telecom Italia’s Wall Street analyst-driven forecast is for a -100% EPS decline in 2022 and an immaterial EPS growth in 2023.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Telecom Italia’s €0.31 stock price. These are often referred to as market embedded expectations.
Furthermore, the company’s earning power in 2021 was below the long-run corporate average. Moreover, cash flows and cash on hand are below its total obligations—including debt maturities and capex maintenance. The company also has an intrinsic credit risk that is 150bps above the risk-free rate.
Overall, this signals a moderate credit risk.
Lastly, Telecom Italia’s Uniform earnings growth is below its peer averages and is trading above its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research