Italy Market Overview

BMI View: A mobile penetration rate of over 142% is testament to the maturity of the Italian mobile market. However, operators have become over-reliant on simplistic low-cost service offerings to retain customers. In consequence, profit margins are slim and operating costs are being scrutinised closely with respect to return on investment. Market forces are once again driving consolidation, with WIND set to be acquired by 3 Italia in the near future. We believe newcomer Iliad’s low-value strategy will prevent the Italian market from pursuing new competitive dynamics.

Italy ranks 14th out of 20 Western European telecommunications markets surveyed in BMI’s proprietary Risk/Reward Index, scoring 56.7 points out of a potential 100 and slightly below the regional average score of 57.2. With regards to Industry Rewards, which measures the attractiveness of the market in terms of future subscriber and revenue growth, Italy scores just 45 points. This does not bode well for the newcomer, Iliad, as well as its MNO and MVNO peers.

Iliad will procure some spectrum and network assets from WIND and 3 and is expected to invest over $500mn in procuring towers and 35MHz of paired spectrum. Iliad may be looking to replicate the disruptive market strategy it successfully employed in France but we are of the opinion that competition is already very high in the Italian market with operators giving lucrative incentives and low tariffs to lure clients. Network sharing between operators already exists and incumbent TIM has already hived-off its tower business as a standalone operation (INWIT), but cost-reduction needs to go further and deeper if investments are to be monetised.

In recent quarters, the overall mobile subscriber base has contracted, declining by 3.5% y-o-y to 20.36mn by September 2016. Operators are shedding retail subscribers as MVNOs take root with low-cost ‘no frills’ services; at the same time, they are also closing inactive accounts in a more timely manner, the aim being to raise reported ARPUs and reassure investors. Although some progress has been made with regards to migrating customers to postpaid multi-service plans, that progress has been quite limited, highlighting the entrenched expectation of low-cost ‘good enough’ services amongst consumers. Iliad’s arrival will not, therefore, change the market’s overall direction.

As the incumbent public telecommunications operator, TIM bears a heavy infrastructure maintenance burden, having to attend to not only expanding its high-cost 3G/4G mobile voice and data networks but also managing the decline of its ageing nationwide copper access network. The latter is a huge drain on its finances and, although performance-enhancing technologies such as VDSL and vectoring can (and are) being used to extend its commercial lifespan, it will increasingly fall short of the market’s needs. A sell-off of TIM’s infrastructure business has been mooted and the creation of a standalone towers unit, INWIT, has been a positive first step in that direction.

Besides hosting its parent’s mobile networks, INWIT also supports WIND, 3 and Vodafone, either operating some towers on behalf of these companies or allowing them to be tenants on its sites. INWIT reported revenue growth of 56.7% YOY to €248.8mn in the first nine months of 2016 as third-party income improved to €57.4mn. Inwit reported a 56:44 TIM/other licensed operator (OLO) client ratio as of September 2016, while its co-tenancy ratio has improved to 1.70x, improving its monetisation of capital intensive towers in its portfolio. Increasing tenancy ratios by adding third parties to traditionally operator-specific sites is the main way in which tower companies can improve monetisation of passive infrastructure than would otherwise be possible under an operator-owned model, but opportunities for organic growth in this field are limited by the high cost of tower acquisition and operators’ reluctance to forego ownership of infrastructure.

Even after it sells excess towers to Iliad, future infrastructure consolidation and rationalisation will likely see the enlarged 3 Italia look to dispose of further assets, and INWIT will be well-placed to acquire these. Furthermore, we believe the high integration costs and disparities between WIND’s and 3’s customer bases will weigh on the enlarged entity’s profit margins and the disposal of all or most of its towers might well take place within the next three years. Meanwhile, Iliad will be unlikely to want to own and manage all the towers it will acquire from the merged operators, posing additional expansion opportunities for INWIT. A listing of INWIT may well, therefore, be inevitable if the company wishes to exploit these opportunities.

The enlarged 3/WIND will become the market leader, having a greater share (approx. 37%) than TIM (35%). However, it is Vodafone (28%) that has suffered the most from price competition brought by WIND and 3, and will continue to be weak in the short term, being the third out of four operators once Iliad launches.

BMI believes that the merged operator should look to improve its services to end-users, leveraging its newly-acquired economies of scale and synergies. This will not necessarily mean higher prices, but more innovative offers, such as the content-led deals recently offered by Telecom Italia and Vodafone, following partnerships with Mediaset and Netflix.

Price competition has driven the overall reduction of ARPU in Italy, already low by European standards due to the dominance of prepaid connections. 3 traditionally reported the highest ARPU, with WIND the lowest, and we believe the merger will lead to a further dilution. A better subscription mix, underpinned by new services, should see an increase, but we believe this will remain limited, as competition will remain strong and consumers will not accept large price hikes for their subscriptions. Operators will be able to cut costs through synergies, the end of unprofitable plans to gain market shares, and greater stability through a higher post-paid share, but not by increasing the prices of current services.

The need for stability is apparent after a period of strong competition, and this is seen in reported churn rates, which have improved in recent quarters. Operators will improve their profitability thanks to new services, but those can be developed more easily with a settled customer base, as overall investments remain heavy. LTE is such an example as, despite TIM’s focus on the technology, it still represents under 10% of its customer base. Migrating customers to new technologies and new services, and improving stability through post-paid and converged plans has seen success in other European markets, but Italy is starting later than its peers, and with fewer assets, because of the predominant prepaid market and the fragmentation (fixed, mobile, TV) of the different telecoms services that can be offered to customers.

Although INWIT is recording particularly strong improvements resulting from expansion of its co-tenancy business, its move into small cells and the Internet of Things (IoT) bears watching. Similarly, although telecoms accounts for just 15% of its local rival EI Towers’ revenues, the latter’s partnership with Sigfox network operator Nettrotter will provide a valuable source of additional income in the future. There has been muted interest in the European towers market so far, but the proliferation of IoT platforms and services over low-power wireless broadband solutions such as Sigfox will provide the revenue diversification that will make this market more appealing.

Mediaset-owned EI Towers is working with Netrotter to build a Sigfox-based wireless broadband network spanning 24 countries and covering more than a billion people. Services are already live in six countries but EI Towers’ Italian footprint covers 500 operational base stations and 70% of the population in 85% of cities. By early 2017, almost 1,000 base stations will be operational, essentially providing nationwide coverage. EI Towers will be able to monetise a broad range of off-the-shelf IoT solutions for companies in the utilities, infrastructure and consumer markets, including its water metering (Telenet Water), smart lighting (SULnet), asset management (SmartCooler) and pet tracking (ontrack pet) services.

Besides building new towers and growing its backhauling capabilities, INWIT is investing small cell technology and services, also with a view to gaining a first-mover advantage in the nascent IoT market. As of September 2016, INWIT claimed to be hosting around 200 IoT tenants on its network and is looking to be in a position to host 4,000 remote small cells by the end of 2018. Small cells represent 25% of its current order book for investment projects.

EI Towers’ less dynamic 4.3% YOY revenue growth, to EUR87.9mn, is due to its disproportionate focus on the relatively staid broadcasting market in Italy and the fact that its revenue diversification drive is still at a very early stage of development. The company has been linked with a putative takeover of INWIT as a means of defending its Italian business from foreign rivals such as Cellnex and Crown Castle, but this is yet to materialise. Telecom Italia is said to be mulling offers for INWIT, which would help the debt-laden operator focus on service-orientated investment opportunities; Spain-based Cellnex has previously indicated its interest in INWIT, but the Telefónica-owned Telxius could also turn to Italy as part of its expansion drive.

EI Towers does not necessarily need to bid for INWIT to remain relevant to the domestic mobile market. Vodafone, WIND and 3 still own most of their own towers and could put these assets on sale following the merger of WIND and 3. However, it does need to diversify away from broadcasting and, if tower purchases are too investment-heavy, it should continue to tap the emerging market for low power wide area broadband services and IoT connected devices for easily sustainable expansion.