12/01/2004

Telecom Italia
The Telecom Italia groups structure recently changed significantly as a result of the takeover bid launched by Olivetti on Telecom Italia, and the subsequent merger between the two into the new Telecom Italia, which led to a shortening of the groups chain of control. Following the merger, Olimpias share in Telecom Italia was diluted from 28% to around 11%, and then increased again to 17% through a capital increase, completed recently. In 3Q03, the group disinvested on the internet and media business unit via the partial spin-off of Seat Pagine Gialle SpA. The directories, directory assistance and business information activities were transferred to the beneficiary company New Seat Pagine Gialle, while the spun-off company (which took the name of Telecom Italia Media) kept its TV, internet and office products and services business areas. A 61.5% stake in New Seat Pagine Gialle was then sold to a private equity consortium, which slashed Telecom Italias net debt by EUR 3,681m in total. According to 9M03 figures, the groups profitability is high, with EBITDA and EBIT margins at 46.9% and 22.9% respectively, vs. 45.3% and 20.2% in 9M02. This profitability is mainly due to high margins from the wireline and mobile business units. After the merger with Olivetti, Telecom Italias net debt stood at EUR 34,253m, only slightly higher than the former Olivettis consolidated net debt (EUR 33,399m in FY02), but almost double that of the old Telecom Italia (EUR 18,118 m in FY02). Telecom Italias different reactions which rated the BBB+ (S&P) and merger into Olivetti triggered from international rating agencies, new entity Baa2 (Moodys), A- (Fitch).

Table of contents

page 2 groups structure page 3 financial profile page 8 peer analysis page 9 conclusions

Credit Analyst

Federica Viola ++8789 Federica.viola@ubm.it Alejandra Diez ++2319 alejandra.diez@ubm.it

Credit Note

www.ubm.it
Groups structure The Telecom Italia groups structure recently changed significantly as a result of the takeover bid launched by Olivetti on Telecom Italia, and the subsequent merger between the two into the new Telecom Italia, which led to a shortening of the groups chain of control. Following the merger, Olimpias share in Telecom Italia was diluted from 28% to around 11%, then increased again to 17.029% through a capital increase1, completed recently. The post-merger Telecom Italia shares were listed on the Milan stock exchange on 04/08/03, with market capitalisation of EUR 26,497m at 09/01/2004.
Figure 1: Telecom Italias post-merger structure

Cam Finan.

23.70%

Ass.Generali

Rcs Media Ed.Holding

4.41% 3.93%

Allianz

Mediobanca

Floating

51.19%

Premafin

Pirelli

50.40%

Intesa

Olimpia

17.02%

Holinvest

Unicredito

Ed.Holding

16.80%

Banca d'Italia

Floating TIM

TI Media

77.49%

Source: UBM from company data
In 3Q03, the group disinvested on the internet and media business unit via the partial spin-off of Seat Pagine Gialle SpA. The directories, directory assistance and business information activities were transferred to the beneficiary company New Seat Pagine Gialle, while the spun-off company (which took the name of Telecom Italia Media) kept its TV, internet and office products and services business areas. Telecom Italia purchased the Seat Pagine Gialle shares related to the JP Morgan put option early, for a total price of EUR 2,255m, and New Seat Pagine Gialle was listed on the Milan Stock Exchange on 4th August 2003. A 61.5% stake in New Seat Pagine Gialle was then sold to a private equity consortium2 for EUR 3,033m. The operation slashed Telecom Italias net debt by EUR

The first part of Olimpias capital increase (totalling EUR 700 m) was completed some weeks ago, and was used to purchase 295.75 million Telecom Italia ordinary shares at EUR 2.37 per share. The second tranche (totalling EUR 70m) was completed at the end of December, and was used to pay for Olimpias 19.9% subscription in a EUR 342.7m capital increase by Holinvest.
3,681m if we also take into account the deconsolidation of Seat Pagine Gialles debts of EUR 648m. Financial profile Operating results Owing to foreign exchange fluctuations and changes in the consolidation area, TIs consolidated revenues decreased by 2.2% in 9M03. Stripping out these two factors, however, they would have increased by 4.6%. The groups profitability is high, with EBITDA and EBIT margins at 46.9% and 22.9% respectively, vs. 45.3% and 20.2% in 9M02. This profitability is mainly due to high margins from the wireline and mobile business units. Profitability has also been helped by a ruling by the European Court of Justice, which declared the telecommunications licence fee introduced by Italys 1999 budget law3 to be illegal. The abolition of the licence has an impact at two different levels. At EBIT level it saves EUR 214m in the first nine months of 2003, which would otherwise be accounted as costs, while at extraordinary level it means the group can reverse EUR 1,465m of provisions for 2000-20024. The strategic guidelines disclosed by the group in February 2003 announced a forecast CAGR for EBITDA and EBIT of 5-5.5% and 8-8.5% respectively for 20032005: this is higher than the expected 4-4.5% CAGR for revenues thanks to efficiency gains.
Table 1: Operating results
Eur m Sales EBIT EBIT/Sales EBITDA EBITDA/Sales 31/12/00* 30,116 5,371 17.83% 13,182 43.77% 30/06/01* 16,189 2,812 17.37% 7,130 44.04% 31/12/01* 30/06/02* 30/09/02* 31/12/02* 30/09/03 Chg yoy 32,016 5,338 16.67% 13,737 42.91% 15,543 2,993 19.26% 6,902 44.41% 23,203 4,694 20.23% 10,521 45.34% 31,408 6,016 19.15% 14,061 44.77% 22,682 5,214 22.99% 10,648 46.94% 1.21% -2.25% 11.08%
(*) Data refer to former Olivetti Consolidated

The deal was completed on 8th August 2003, and the acquiring consortium (named Silver SpA) comprised BC Partners, CVC Capital partners, Permira and Investitori Associati. New Seat Pagine Gialle was then merged by incorporation into Silver and, immediately thereafter, Silver was incorporated into Spyglass. The merger became effective on 23th December; Spyglass was then renamed Seat Pagine Gialle and listed on the Milan stock exchange. Law 448/1998 (the budget law for 1999) introduced a licence fee proportional to revenues for telecommunications operators. Albacom and Infostrada appealed against this law. Telecom Italia paid around EUR 600 m in 1999, and then also appealed: the fees for 20002003 were therefore never actually paid, but were accounted as provisions. In September 2003, the European Court of Justice declared the fee to be illegal.
Once corrected by taxes of EUR 562m this sum totals EUR 903m.
Operating results by main business unit and geographical distribution Wireline and mobile telephony remain Telecom Italias main operating activities, and increased their contribution in 2003 thanks to the spin-off of New Seat Pagine Gialle, and to the exit of some companies from the groups consolidation base5. As a result, in 9M03 the wireline and mobile business units accounted for respectively 55.4% and 38.1%6 of the groups total EBITDA (vs. 54.7% and 36.6% in 9M02).
Figure 2: Revenues and EBITDA breakdown by business unit
Revenues breakdown by business unit (3Q03)
Wireline Internet & Media Olivetti-Tecnost Mobile IT (market) South-America IT (group)
EBITDA breakdown by business unit

4.5% 2.1%

2.8% 1.8%

0.4%0.4% 0.2% 2.7% 2.9%

From a geographical perspective, 80.3% of the groups revenues are generated on the domestic market, while international activity is mainly focused in Latin America, which represents 7.9% of total revenues. Telecoms international expansion is especially in Brazil. In the wireline domestic market, although it also continental Europe (chiefly France and Wireline
Table 2: Wireline profitability
W ireline (m ) Sales and services revenues Ebitda Ebit Ebitda m argin Ebit m argin Jun-02 8,406 3,901 2,396 46.4% 28.5% set-02 12,537 5,822 3,517 46.4% 28.1% dic-02 Jun-03 Chg YoY 17,047 8,552 1.7% 7,951 3,982 2.1% 4,677 2,441 1.9% 46.6% 46.6% 27.4% 28.5% set-03 12,687 6,047 3,724 47.7% 29.4% Chg YoY 1.2% 3.9% 5.9%
particularly active in the wireless segment, business, the group focuses mainly on the operates in the Mediterranean basin and Germany).
In the first nine months of the year, the wireline business unit posted revenues growth of 1.2% YoY, while EBITDA went up by 3.9%. Growth of 3.3% YoY in data services revenues and a 17.4% increase in internet revenues, both due to broadband, more than offset the 2% decline in voice traffic revenues.

Telespazio was deconsolidated in October 2002. Before adjustments for elisions and other activities.
Profitability in the business unit also rosewith the EBITDA margin rising from 46.4% in 9M02 to 47.7% in 9M03thanks to efficiency gains on raw materials, personnel and external services costs, as well as to the abolition of the telecoms licence fee7. Mobile
Table 3: Mobile profitability
M obile (m ) Sales and services revenues Ebitda Ebit Ebitda m argin Ebit m argin Jun-02 set-02 dic-02 Jun-03 Chg YoY set-03 5,185 8,010 10,867 5,534 6.7% 8,635 2,488 3,903 5,039 2,624 5.5% 4,157 1,684 2,713 3,358 1,826 8.4% 2,944 48.0% 48.7% 46.4% 47.4% 48.1% 32.5% 33.9% 30.9% 33.0% 34.1% Chg YoY 7.8% 6.5% 8.5%
Revenues from the mobile business unit increased by 7.8% YoY in 9M03, despite the negative exchange rate effect8. This result was due to a good performance from existing activities on both the domestic and Brazilian markets. Domestic market revenues, which represent more than 80% of total mobile revenues, rose by 6.7% YoY. Voice revenues posted a 4.4% increase, while VAS revenues shot up 40.2% to EUR 743m, with a positive contribution coming from both traditional (SMS) and innovative services (info services, ringtones and MMS). As profitability has been affected by GSM start-up costs in Brazil, the total EBITDA margin for the mobile business unit dropped to 48.1%, from 48.7% in 9M039. However, looking solely at domestic activities, in the first nine months of the year the mobile businesss profit margin was in line with that of the previous period: 54% vs. 54.5% in 9M02. South America
Table 4: South America profitability
South Am erica (m ) Sales and services revenues Ebitda Ebit Ebitda m argin Ebit m argin Jun-02 set-02 dic-02 Jun-03 Chg YoY set-1,036 1,-22.8% 190 -22.8% 61 -28.2% 101 33.7% 33.4% 31.9% 33.7% 34.7% 11.6% 11.2% 10.4% 10.8% 12.0% Chg YoY -18.5% -15.3% -12.9%
According to 9M03 results, revenues in the South American business unit dropped by 18.5%, owing mainly to foreign exchange fluctuations10.

Overall, operating costs in the wireline business declined by 1.1% YoY. Excluding the foreign exchange effect, revenues increased by 13.5% YoY.
TIM Brazils EBITDA fell to EUR 111m in 3Q03, from EUR 264m in 3Q02, because of foreign exchange losses and the launch of the GSM business in October 2002.
Stripping out the exchange rate effect, the South American unit would have posted a 2.8% increase in revenues thanks to growth in the Chilean market (+1.6% in local currency).
Although the foreign exchange effect also caused EBITDA to fall by 12.9% YoY, profitability showed an improvement, with the EBITDA margin rising from 33.4% in 9M02 to 34.7% in 9M03. Internet & Media
Table 5: Internet and media profitability
Internet and Media (m ) Sales and services revenues Ebitda Ebit Ebitda m argin Ebit m argin Jun-02 set-02 dic-02 Jun-03 Chg YoY set-1,379 1,-0.9% 1,246 17.7% 80 321.1% 90 24.0% 29.1% 29.8% 28.5% 27.7% 2.2% 9.2% 11.7% 9.3% 8.0% Chg YoY -18.7% -22.4% -29.1%
Revenues from the internet and media business unit were hit by the deconsolidation of some assets11. However, considering just the activities that were not sold in the first nine months of the year, the unit posted a 24% YoY increase. Debt After the merger with Olivetti, Telecom Italias net debt stood at EUR 34,253m, only 2.25% higher than the former Olivettis consolidated net debt (EUR 33,399m in FY02). This almost stable figure was due to the groups strategy of cutting debt through asset disposals (Seat PG), and higher cash flow generation thanks to efficiency gains and a curb on investment. However, in comparison with the EUR 18,118m12 debt of the former Telecom Italia (which did not include Olivettis EUR 15.3 bn net debt), the new entitys net debt was up substantially, by 89%.

Figure 3: Net debt

The Pagine Gialle spin-off, effective from 8th August 2003, and the sale of IS Products SpA and Production Srl. FY02.
At September 2003, the group stated EUR 43.3m of gross financial debt in its balance sheet13. Around a third of this (EUR 14 bn) matures in the short term, including the EUR 3.8bn credit facility raised for the public tender offer and EUR 5,585m of bonds maturing in 2004. To refinance its short- and long-term debt, in October 2003 Telecom Italia issued USD 4bn of bonds, split into three tranches with maturities of five, ten and thirty years. Assuming this issue was aimed at refinancing the tender offer credit facility, bonds now account for around 88%14 of gross debt. The recently-authorised EUR 10bn EMTN programme is in line with the managements objective of refinancing maturing debt by optimising costs and diversifying the investor base.
Figure 4: Bonds maturity profile

7 ,,,,,,,2 ,,,,,,,,,,,5

. be yo n d
Source: UBM from Bloomberg
In 9M03, the new entitys gearing stood at 67.1%, compared with the former Olivettis 65.07%, and the old Telecom Italias 55.9%. 9M03 debt coverage remained fairly stable compared to the consolidated figure of the former Olivetti: net debt/EBITDA was 3.22x (vs. 3.23x in 9M02). On the other hand interest coverage showed an improvement: EBITDA/net interest was 6.32x (vs. 5.58x in 9M02). Again, however, when the new entity is compared with the former Telecom Italia, debt and interest coverage deteriorates substantially: 3.22x net debt/EBITDA for new Telecom Italia (vs.1.69x for old Telecom in 9M02) and 6.32x EBITDA/net interest (vs. 8.39x in 9M02).
13 In addition, S&P estimates off-balance sheet commitments of EUR 6bn, which include the net present value of lease obligations, asset-backed securities, vendor finance obligations, pension and severance liabilities and certain contingent liabilities. 14

Of which 9.1% is in USD.

Table 6: Financial results
Eur m Net Debt Financial Debt Equity Indebtedness Ratio Fin. Debt / (Fin. Debt + Equity) Net Debt / Equity Short-Term Fin. Debt Medium-Long Term Fin. Debt Net Debt/EBITDA Fin.Debt / EBITDA Interest Coverage (EBITDA on net interest) (EBITDA on gross interest) 31/12/00* 30/06/01* 31/12/01* 30/06/02* 30/09/02* 31/12/02* 30/09/03 (37,525) 45,087 31,366 58.97% 119.64% 39.04% 60.96% 2.85x 3.42x 14.39x 4.99x (41,911) 54,778 28,912.0 65.45% 144.96% 30.60% 69.40% 5.88x 7.68x 6.07x 3.95x (38,362) 47,708 26,353 64.42% 145.57% 22.16% 79.12% 2.79x 3.47x 4.76x 3.17x (37,094) 44,685 23,296 65.73% 159.23% 20.69% 79.31% 5.37x 6.47x 5.27x 3.48x (33,959) 42,479 22,805 65.07% 149% 17.59% 51.64% 3.23x 4.04x 5.58x n.a (33,399) 41,788 20,624 66.96% 161.94% 19.11% 80.89% 2.38x 2.97x 6.25x 3.68x (34,253) 43,331 21,177 67.17% 161.75% 32.43% 67.57% 3.22x 4.07x 6.32x n.a. Chg yoy 0.87% 2.01% -7.14%

Peer analysis

Telecom Italias merger into Olivetti triggered different reactions from rating agencies, which rated the new entity Baa2 (Moodys), BBB+ (S&P) and A- (Fitch)15. The post-merger Telecom Italia still has a lower debt burden16 than its lower-rated peers FT and DT, and consequently slightly better debt coverage ratios. However, it still lags behind peers such as Telefonica, which have lower debt and higher ratings. On the other hand, a comparison with other European incumbent operators shows TIs outstanding EBITDA margin of 46%, which puts the group in line with its higherrated peers and confirms its strength in terms of operating performance.

Table 7: Peer analysis, 1H03 (annualised)

M y's ood

TI TI (pre-m erger FY02) O livetti consolidated FY02 FT D T KPN TEF Baa2/Stable Baa1/Stable Baa2/Stable Baa3/+credit w atch Baa3/+credit w atch Baa3/+credit w atch Baa1/Stable

S P &

BBB+ /Positive A-/Stable BBB/Positive A-/Stable BBB/Stable BBB/Stable BBB/Positive BBB/Positive BBB+ /Stable BBB+ /Positive BBB+ /Stable BBB+ /Positive BBB+ /Positive
EB A/ N D / Total D t / Total D t / EB A/ N ITD et ebt eb eb ITD et Sales EB A ITD EB A ITD Total Capital Fin Exp
46% 46% 45% 37% 35% 47% 44% 2.71x 1.30x 2.38x 2.91x 2.76x 1.64x 1.71x 3.34x 1.46x 2.97x 3.47x 3.21x 1.90x 2.11x 70% 61% 67% 80% 64% 68% 53% 5.78x 9.43x 6.25x 3.57x 4.90x 7.22x n.m.
Source: UBM from company and Bloomberg data
Moodys confirmed Olivettis rating of Baa2 and downgraded Telecom Italia from Baa1 to Baa2; S&P upgraded Olivetti to BBB+ from BBB, and held Telecom Italia at BBB+; Fitch upgraded Olivetti to A- from BBB, bringing its rating into line with that of Telecom Italia, which was confirmed at A-. Once Olivetti and Telecom Italias ratings had been brought in line, Olivettis rating was then withdrawn by all the international rating agencies. The groups management plans to reduce net debt to below EUR 30bn by 2004.
Conclusions The new Telecom Italia is Italys leading fixed-line and mobile telecommunications operator, boasting strong operating cash flow capacity and a solid competitive position. The groups new structure is the result of Telecom Italias merger into Olivetti. We therefore carried out our analysis by comparing the new Telecom Italia with the former Olivettis consolidated results (which included the old Telecom Italia). On the negative side, the merger operation added EUR 5.3bn in debt to the former Olivettis consolidated net debt, giving the new Telecom Italia weaker debt protection ratios than those of the former Olivetti, which have been partially mitigated by Seat PG and other asset disposal. On the positive side, the merger reduced the amount of minorities in the equity of the new company, thus avoiding the significant dividend leakage that plagued the old company and increasing the new Telecom Italias financial flexibility. The 9M03 results and peer analysis show the new Telecom Italias operating strength, and more generally, its leading position in terms of profitability. After the merger, Telecom Italias net debt stood at EUR 34,253m, only slightly higher than the former Olivettis consolidated net debt (EUR 33,399m in FY02), but almost double that of the old Telecom Italia (EUR 18,118m in FY02). International rating agencies reacted differently to the change, either by adjusting the rating of the new Telecom Italia to that of the former Olivetti (Moodys) or by keeping it in line with that of the old Telecom Italia (S&P and Fitch). The new Telecom Italia is currently rated Baa2 by Moodys, BBB+ by S&P and A- by Fitch. Future ratings will clearly depend on the groups ability to cut its debt, which in turn will depend on its ability to generate further efficiency gains; on the groups international expansion strategy; on the groups dividend policy; and on the effects of any further simplification of the control chain.

UBM Research Marco Annunziata - Head Ph: +39-02-8862.8001 M: marco.annunziata@ubm.it
Credit Research Unit Federica Viola Ph: +39-02-8862.8789 M: federica.viola@ubm.it
Alejandra Diez Ph: +39-02-8862.2319 M: alejandra.diez@ubm.it
This document (the "Document") has been prepared by UniCredit Banca Mobiliare SpA (UBM). As a company of the UniCredito Italiano Group (the Group), UBM is involved in several businesses that may relate to Telecom Italia SpA (the "Company"). The Group holds a position in the share capital of Olimpia SpA. A director of UBM is also member of the Board of Directors of the Company. Certain directors of UniCredito Italiano Spa are members of the Boards of Directors of Olimpia SpA and Pirelli & C S.p.A. UBM has, over the last year, acted as Joint Bookrunner in the placing of a bond issued by the Company. Moreover, UBM has acted as Underwriter in the underwriting syndicates for the increase of the Olivetti SpA share capital and also as Joint Bookrunner for the placing of two bonds issued by Olivetti. UBM, has acted as Lead Mandate Arranger of the banking syndicate involved in the Oli-Tel merger plan. UBM is currently acting as Joint Lead Manager and Bookrunner for the placing of a bond issued by the Company. UBM, as well as its parents or affiliates, is a market maker in financial instruments related to the Company. UBM performs investment services such as repurchase agreements and stock lending involving the securities issued by the Company. The Group issues Covered Warrants and other financial instruments on the stock of the Company. Information, which is not reflected in the Document, may therefore be available to persons connected with UBM. The Document is for information purposes only and is not intended as an offer or solicitation of an offer to sell or to buy any financial instrument. The Document is being distributed by electronic and ordinary mail to professional investors and may not be redistributed, reproduced or published in whole or in part. Information, opinions, estimates and forecasts contained herein have been obtained from, or are based upon, sources believed by UBM to be reliable, but no representation of warranty, express or implied, is made and no responsibility or liability is accepted by UBM as to their accuracy or completeness. The Document has been approved for distribution in UK by UBM London, regulated by the FSA for the conduct of Investment Business in the UK. It has not been approved for distribution to, or for the use of, private customers as defined by the rules of the FSA. The Document may not be distributed in USA, Canada, Japan or Australia.