TI Telecom Italia S.P.A. New

We are reiterating our long-term Neutral recommendation on France Telecom (FTE), the largest telecom carrier in Paris.

France Telecom remains significantly challenged by weak economic conditions and unfavorable regulatory measures across its key European markets that continue to weigh on its top line.

The company is facing tough competition from Bouygues, Telecom Italia spA (TI) and Vodafone Group Plc. (VOD) in its domestic market, which contributes more than half of its revenue and profit. Competition will intensify further next year, when the fourth mobile operator, Iliad SA's makes its entry into the market. 

In January 2011, the French government increased value added tax (VAT) on triple-play services from 5.5% to 19.6%. We believe the higher VAT might have an adverse effect on France Telecom’s profitability if the company is unable to pass the increased cost to customers.

The Spanish telecom regulator will continue to reduce termination rates by 40% to 50% through 2012. The last rate cut was implemented in October 2009. We believe the reduction in mobile termination rates (fees operators charge each other to connect calls) in key markets such as UK and Spain remains one of the key reasons for revenue decline across these markets.

In the recently concluded first quarter, the company reported strength in mobile subscriptions across all major regions but lackluster results on both top and bottom lines. On an annualized basis, revenue fell 1.4% due to strong adoption of smartphones and segmented offers. Adjusted EBITDA dropped 11.5% owing to increased commercial expenses as well as high VAT.

However, France Telecom continues to see customer growth in both wireless and ADSL broadband Internet businesses in France. At March 31, 2011, France Telecom had 215.9 million total subscribers across its operating territories, reflecting a 7% year-over-year increase.

The mobile customer base climbed 10.1% year over year to 156.7 million, primarily driven by a 25% growth in Africa and the Middle East to 65.5 million customers.

The company is on the right track with its new business plan -- Conquests 2015 (revealed in early July 2010). This plan is expected to boost the company’s growth in both domestic and international markets.

Orange, which has become the key growth driver for the company, continues to maintain a stable wireless market share in France driven by sustained contract customer growth backed by the success of the quadruple play offer, “Open,” and strong adoption of smartphones.

Internationally, the company is rolling its brands in Tunisia, establishing itself in Morocco, acquiring an interest in Meditel and improving its relationship with Egypt. France Telecom expects its sales to double over the next five years in emerging markets.

As part of the ongoing Conquests 2015 plan, the company has set a five-year (2011–2015) strategy to bring the company back to profitability. In addition, the possible divestiture of minority holdings, expansion of networks, various alliances, deleveraging balance sheet and healthy dividend payoutmake the stock attractive.

The company is mulling to sell its European (Austria, Belgium, Portugal and Switzerland) assets worth more than €1 billion due to unfavorable regulatory measures, which have adversely affected the company’s revenues. Moreover, France Telecom is also trying to strike deals with companies such as Google Inc. (GOOG) and Apple Inc. (AAPL) to lower costs of deploying upgraded networks in France.

Given the pros and cons, we prefer remain on the sidelines at present. The company also retains a Zacks #3 Rank (Hold) rating.

 
APPLE INC (AAPL): Free Stock Analysis Report
 
FRANCE TELE-ADR (FTE): Free Stock Analysis Report
 
GOOGLE INC-CL A (GOOG): Free Stock Analysis Report
 
TELECOM ITA-ADR (TI): Free Stock Analysis Report
 
VODAFONE GP PLC (VOD): Free Stock Analysis Report
 
Zacks Investment Research