Summary
So we’ve survived 2008 (just). Heading into 2009, it is now time to
worry about whether corporates are the new financials and how
easy it will be for companies to access primary markets. The outlook
is clearly for another volatile year, but overall we see value in credit
as an asset class and within that we see telcos as a (fairly) safe
place to hide at attractive spreads, faring well in terms of cyclicality
and liquidity – we recommend an Overweight in cash but would start
the year Neutral in CDS.

Fundamentally fine …
We think that European Telecoms compares favourably to other sectors with respect to both cyclicality
and liquidity and, despite the market’s concerns in Q4 2008, we are not overly worried by emerging
markets risk at this stage. Event risk is the sector’s main area of fundamental weakness in our view as we
see the prospects of M&A and new share buybacks as greater than for the rest of the corporate universe.
However, on balance we expect Telecoms to have a better 2009 than most other sectors.
Cyclical, but not that cyclical: Very few business models are unaffected by the economy, and the telco
sector will face challenges in a recession just like any other. We expect to witness earnings downgrades
and profits warnings in 2009, but expect these to be much less severe than for most other sectors and
overall believe that the cash flow generation capacity of the telecom sector will remain pretty impressive
– we estimate an aggregate FCF of EUR48bn in 2009 before dividends and EUR19bn after. Moreover,
we believe the operators all have significant potential to preserve cash flows by reducing shareholder
returns should conditions deteriorate more aggressively than we expect.
Ample liquidity: Although the telecoms sector has high bond redemptions – EUR21bn in 2009 – in
many cases operators could afford to repay these out of cash flows should they wish to. For the operators
where this isn’t the case, abundant credit lines leave us comfortable from a funding perspective, at least
until the end of 2009.
Emerging Markets: In Q4 2008 investor attention turned to global credit-crunch contagion and how the
EMs will fare in 2009. The outlook has clearly deteriorated and as such the market has once again started
to price in higher-risk premiums to EM exposed names (across both credit and equity). However, we do
not see EM as a major risk factor for telecom bondholders at this point and while we believe that this
factor could help correct relative value discrepancies between operators, we do not see it as a driver of the
sector overall.

Event risk: We are by no means looking for transformational releveraging in 2009, but many telcos
retain the financial flexibility to take advantage of low equity valuations via either M&A or share
buybacks next year. Moreover, while we believe that certain operators have the potential to scale back
dividends and or capex to preserve cash flows, we do not expect this to be widespread and think
sacrificing shareholder value to protect balance sheets will be more prevalent in other areas of the
corporate universe.
If only it was that simple
Overall we see telecoms as strongly positioned from a fundamental perspective, but clearly this is not the
only factor driving credit spreads at present (although we think fundamentals are at long last growing in
importance). Our strategy view is that credit offers value as an asset class, particularly in cash, but that
investors will need to take a medium-term view on investments as technicals will continue to drive
spreads in the near term.
We expect continued unwind pain: Many structured credit products have been unwound over the past
18 months (both market-value based product and also some loss-based ones) and our view is that
deleveraging in this space is unlikely to be completed anytime soon. We expect this to disproportionately
hurt telcos which have generally been heavily included in CDOs.
We forecast EUR25bn equivalent of supply: Although the telcos could theoretically rely on cash flows
and bank lines to cover funding needs in 2009, in practice we do not expect this to be the case. Our view
is that the bond markets will be open for business in 2009, although admittedly not at the pricing levels
that they have been in recent years, and we forecast EUR25bn equivalent of European Telecom supply for
the year across euros (cEUR18.5bn), sterling (cGBP1.2bn) and dollars (cUSD6.1bn).
Overweight in euros, sterling and dollars: Clearly EUR25bn is not an insignificant amount of bond
issuance, but this burden is not particularly high compared with previous years’ issuance from telcos and
to other sectors. Moreover, we do not expect a concentration of supply by issuer, and most of the names
with high requirements are the usual suspects (which are well known and relatively well liked by bond
investors). We therefore think that telecom new issuance will generally be well received and will offer
some of the best value in cash next year. In secondary markets we see the best value in the short end.
There has been a propensity to sell shorter-dated assets in recent months as investors looking to raise cash
have sold those bonds trading closer to par, leaving short-dated paper trading cheaply. We can’t rule out
more near-term pressure, but believe that further into 2009 curves should begin to normalise again.
Neutral CDS: We think technicals in CDS are much too strong to justify an Overweight in Telecoms
however. As the most CDO-exposed corporate sector, we expect telcos to be disproportionately hurt by
deleveraging and would start the year neutral. We also expect issuers with high bank debt burdens to
continue trading wide to peers, as loan desks (whose propensity is to buy protection) now make up a
greater portion of the single-name CDS market than previously.
For more details on our Credit Strategy view please refer to our Credit strategy outlook 2009 – Cheap but not yet cheerful, report
published on 3 December 2008.

Names we like and names we don’t
Given how illiquid the markets are at present we believe bond investments should be carried out on a buy
and hold basis and so our recommendations all have a longer horizon than usual – in general we have
taken a twelve-month view. We have also deliberately focused on the cash markets, where we see better
value than in CDS.
Names we like …:
􀀗 We like very juicy spreads – Telecom Italia: TI is a strategically challenged credit and we believe its
spreads are likely to remain extremely volatile through 2009, so this is not an investment for the faint
hearted. Nonetheless we see current trading levels as very good value, especially short-dated paper.
􀀗 We like boring – KPN: We have nothing very interesting to say about KPN, which as a bondholder
is reassuring. We see it well positioned operationally, it has a sensible financial policy, we do not
expect it to issue in H1 and think that spreads are attractive.
􀀗 We like cheap and cheerful – BT: We believe that BT will face significant challenges in 2009 but,
should its prospects deteriorate, this could be offset by a dividend cut in our view, protecting cash
flows to some extent. Despite its challenges, we see BT as good value at current spreads across euros,
sterling and dollars, where we believe levels already reflect operational concerns.
􀀗 We like wide for no good reason – OTE: We expect OTE to continue to apply cash flows to debt
reduction through 2009, and although the group’s exposure to emerging markets creates volatility
potential, we see the name as offering some of the best value in both the euro and CDS markets,
particularly in comparison with other EM-exposed names such as Telenor and TeliaSonera.
… And names we don’t:
􀀗 We don’t like liquidity issues – Portugal Telecom: We believe that PT is a consensus
Underweight, but with good reason. If it does not secure financing by April its liquidity position will
be stretched, and if it comes to market before then we expect it to be very cheap, significantly repricing
secondaries.
􀀗 We don’t like negative FCF – Telenor: Telenor’s expansion into India will hurt cash flows through
2009 and beyond, and whether or not the rights issue goes ahead this name still trades too tightly in
our view.
􀀗 We don’t like risky and tight – Telekom Austria: We were a non-consensus (and fairly boring)
Neutral on TKA through 2008, as although we have long had fundamental concerns on this credit we
struggled to see a catalyst for widening. Going into 2009 we believe that EM risk, supply and
potential M&A could all lead to re-pricing.
We outline full details of our recommendations across euros, sterling, dollars and CDS on page 38.

目录

Telecoms in 2009 5
What could change the
positive fundamental picture? 15
Potential 2009 M&A 20
Liquidity & supply 29
Relative value 35
Credit Profiles 43
Belgacom SA 44
BT Group plc 46
Deutsche Telekom AG 48
France Telecom SA 50
Hellenic Telecommunications (OTE) 52
Koninklijke KPN NV 54
Portugal Telecom SGPS SA 56
Société Francaise du Radiotéléphone SA (SFR) 58
Telecom Corporation of New Zealand Ltd (TCNZ) 60
Telecom Italia SpA 62
Telefonica SA 64
Telekom Austria AG 66
Telenor ASA 68
TeliaSonera AB 70
Telstra Corporation Ltd 72

Vivendi SA 74
Vodafone Group plc 76
Appendix: European Telecom
Statistics 78
European fixed-line markets 80
Western European mobile markets 84
Eastern European mobile markets 85
Brazilian mobile market 86
Asian mobile markets 86
European mobile markets 89
European telecom M&A: acquisitions 91
European telecom M&A: disposals 92
European Telecom M&A 93
Coupon step language 95
Disclosure appendix 99
Disclaimer 104

Telecoms in 2009
􀀗 We expect the European telcos to face various cyclical challenges
in 2009, but on balance do not foresee a major deterioration
􀀗 The sector retains its impressive cash generation capacity, and
most balance sheets have capacity for M&A and buybacks
􀀗 If these do not transpire we could see leverage upside, while the
weaker issuers could easily protect bondholders via dividend cuts

Telecoms in 2009
We expect telecoms to face cyclical challenges in
2009 just like any other sector: our main concerns
are the ICT segment, pre-paid mobile and access
revenues in certain markets. However, despite
these pressures we expect the group to be less
affected than most other corners of the corporate
universe next year.
Overall we expect sector revenues and EBITDA
to continue growing in 2009, albeit slowly, with
EM exposed operators still most strongly placed
in our view. We expect to witness a very mixed
capex picture by operator, but on a sector basis
expect investment to come in roughly flat for
2009. As a result free cash flows look set to
remain strong, and we therefore see leverage as
stable to improving next year in the absence of
major M&A.
How cyclical are telcos?
Structural factors have long been the dominant
concern for telecom investors – technological
change, capex requirements, growth prospects,
regulation – and while we still think these are the

most important sectors drivers, in the current market
clearly we also have to consider cyclicality.
Very few business models are unaffected by the
economy, and the telco sector is likely to face
challenges in a downturn just like any other
segment. Ultimately our view is that it will be less
affected than most other corners of the corporate
universe, but in the early 1990s mobile and
internet services were in their infancy, and even in
the smaller-scale downturn of 2000/01 penetration
levels were still much lower than they are now, so
that the telecoms sector as we know it today has
never been properly tested in a downturn.
Consequently we cannot be completely sure how
it will fare, and clearly some names are likely to
be more impacted than others.
Over recent months we have seen evidence of
consumers economising/trading down across both
traditionally cyclical sectors and supposedly
“recession-proof” areas of the corporate universe.
Despite many telco CEOs’ protests that their
products are viewed as essential, in telecoms we
are beginning to feel the impact of the weaker
economic climate and it seems reasonable to
assume that we will see greater repercussions as

the downturn develops. However, at this stage it is
difficult to know what form this will take.
Fixed versus mobile: We have long been
concerned about consumers going mobile-only,
and believe that tighter household budgets could
be the catalyst to prompt many users to cut the
cord with their fixed line provider.
Subscriptions: Intuitively the subscription
elements of the sector look set to be the most
resilient (at least initially), especially in markets
with longer contract lengths. Moreover, customers
on voice bundles (both fixed and mobile) have
less scope to cut back spending.
Voice versus non-voice: Growth in high-end
services looks likely to be most at risk, leaving us
most concerned about prospects for data revenues
in mobile and TV services in fixed.
It might not all be bad news: Many unbundlers,
altnets and cable operators – who are mostly noninvestment
grade – are feeling the impact of the
weaker credit markets much more acutely than the
incumbents, which could restrict their ability to
compete as aggressively in future.
Fixed
The fixed line segment is already a delicate
balancing act – good growth in broadband offsets
significant declines in access & traffic, leaving
revenues slowly falling overall. We are concerned
that it would not take much to upset this balance
and leave the sector facing aggressive fixed
declines once again. Accelerating line losses,
slowing broadband growth, or a little bit of both
could easily upset the status quo, and these are all
clearly a possibility in a weaker macro backdrop.

Is cyclicality a catalyst to cut the cord? We are
concerned that households looking to economise
may disconnect fixed lines and rely purely on
mobile services. This is a particular risk in
markets where mobile broadband is readily
available as a cheap alternative (we found it
interesting that Carphone Warehouse blamed its
slowing broadband growth in the UK on strong
take-up of mobile broadband services).
Clearly the European markets most at risk are
those with a lower percentage of mobile-only
households (ie, markets with more fixed lines
with potential to be cut) and weaker economic
outlooks – it is therefore unsurprising that the UK
and Spain have both shown the most significant
deterioration in access line trends through 2008
(see page 82).

Heavy subscription element
Revenues within the traditional fixed-line sector
are much more heavily weighted to access (rather
than traffic) than they were in previous downturns
– most fixed packages now include bundles of
minutes, so that consumers on a budget have only
limited scope to cut back traffic expenditure. As a
result, where consumers retain access lines we see
limited potential for ARPU declines.
Similarly, broadband subscribers now massively
outweigh narrowband so that the bulk of internet
revenues are subscription based, and in most cases
this is also true of TV.

High end services untested in a downturn
Demand for internet services is completely
untested in a downturn, and therefore whether
they are seen as a luxury by consumers is unclear
at this stage. So far this year European broadband
stats have held up well (see data on page 82), but
if we look at the US this was not the case, with
subscribers dropping off in Q2 and Q3.

Should consumers look to economise on broadband
services we could either witness a trading down in
terms of speed, or higher churn as customers deflect
to lower cost competitors (ie, growing price
sensitivity could support ULL operators).
At this stage we do not expect to witness declines
in the total number of broadband subscribers,
although we do expect growth to slow in many
markets. On an individual operator basis, we
could see significantly higher pressure however,
particularly in markets with high levels of lowprice
competition from aggressive unbundlers.

TV revenues at risk: At present TV still
represents a small proportion of telco segment
revenues, but has in many cases been key to
defending access lines. As an indication as to how
this segment may perform in a recession we again
look at the US (a more mature TV market than
Europe). As illustrated below, pay-TV subscriber
numbers only fell slightly during the early 1990s
downturn, although this does not give any
indication as to whether consumers traded down
to lower-end packages. Market research by
Continental Research (October 2008) found that
25% of Sky and Virgin customers in the UK were
planning to reduce spending on pay-TV services,
which clearly does not bode well for the high end
of this segment. However, telco IP-TV offerings
tend to target the lower end of the pay-TV space,
so may either be more insulated than the rest of
the segment, or even benefit from down trading in
our view.

It might not all be bad news: Many unbundlers,
altnets and cable operators – who are mostly noninvestment
grade – are feeling the impact of the
weaker credit markets much more acutely than the
incumbents, which could restrict their ability to
compete as aggressively in future.
Competitors are most under pressure in Spain and
the Netherlands, while we see the financial
position of players in Italy, France and the UK as
fairly sound.
Mobile
Mobile still stronger than fixed: Ultimately our
belief is that mobile customer numbers will not
change significantly in a downturn. We do not
expect to witness cost-conscious consumers
cutting off mobile contracts in favour of fixed,
and as discussed previously see a much greater
likelihood of the reverse.
So far this has held true, with mobile subscriber
growth remaining positive across all European
markets through 2008. However, given that most
developed markets are fully penetrated, reported
subscriber increases are largely derived from
consumers owning and using multiple handsets.
This growth is very likely to fall (Nokia predicts a
5% fall in the global handset market next year),
and we also believe that some consumers will
scale back to single handsets/SIMs. We therefore

believe that on a reported basis subscriber
numbers in some mobile markets may show
modest declines (with Italy being the most at risk
due to its high proportion of pre-pay subscribers).
Within mobile markets we believe that the major
risk to operators is subscribers cutting off
contracts and moving to pre-pay, and within preppay
the risk is that consumers move to value
brands. This is more of a risk in markets with
short contract lengths & more aggressive MVNO
competition, such as the UK and Netherlands.
Subscriptions versus pre-pay: Most mobile
customers are charged on a usage-based pre-pay
system, which intuitively would suggest that the
segment is more exposed to a downturn than the
fixed line space. The market has been closely
monitoring Vodafone for evidence on the fate of
the sector, and although the operator has generally
held up better than expected, its performance has
unsurprisingly been weakest where the economic
backdrop is toughest and specifically within the
pre-pay space. As illustrated below, spending on
pre-pay services has deteriorated markedly in its
weakest markets (Spain and the UK) this year.

However, since pre-pay ARPUs are relatively
low, most of the industry’s revenues actually
derive from contracts (c75% on average), where
fees cover the bulk of bills. In this space there is
less scope for customers to reduce spending,

especially in markets such as Germany where
contract lengths are often two years and beyond.
As illustrated below, the notable exception to this
rule is Italy, leaving this the most vulnerable
mobile market in our view.

Data most at risk: Being on a subscription provides
a short-term protection, but clearly customers are not
locked into contracts forever and there is still scope
for consumers to trade down or switch off services at
some stage. In our view the non-voice element
appears the most obvious place to scale back.
However, so far most operators report that growth in
data revenues remains very high, even in the UK and
Spain. Moreover, we see developments at the high
end of the handset market as positive for data
services in 2009.
ICT
Likely to be the sector’s weakest link: ICT
services (IT and network consulting, systems
integration, outsourcing) have proved to be a
growth driver for several European operators over
recent years, growing at an average 5-6%1 but in
our view this is likely to be by far the most
sensitive element of telco sector revenues to the
deteriorating macro backdrop. We see new
projects as very likely to come under pressure
from budget cuts taking place across the corporate
and financial sectors, and various players in this

space reported a marked deterioration in
conditions in H2 2008.
However the ICT business model operates on a
contract basis, with large IT service contracts
typically lasting for five years or longer.
Therefore while we expect new contract wins to
decline significantly, sector revenues will not dry
up completely.
Not too negative for cash flows however:
Moreover, projects tend to be low margin at the
beginning, with profitability highest in the second
half of a contract’s life. As contracts reach maturity
cash flows are therefore higher, and overall margins
will stop being diluted by new projects.
BT is by far the most exposed to this sector and
has already announced a profits warning in its
Global Services division, although it cited cost
issues rather than demand weakness. We believe
Belgacom, KPN and, to some extent, DT are also
vulnerable to a potential ICT slowdown.
Growth still low single digit
On balance, we see the telecom sector’s already
fairly weak growth profile as likely to weaken
further in 2009, but to remain positive on average.
Despite recent concerns over slowing emerging
market economies we expect EM exposure to
remain supportive to growth profiles overall (we
discuss EM risk in more detail on page 15),
leaving Telefonica, Telenor and TeliaSonera still
most strongly placed from a revenue perspective,
while we expect fixed line focused and ICT
exposed names to suffer from the weakest revenue
outlook (BT, TI, KPN).

Credit outlook fairly stable
􀀗 EBITDA: still growing, albeit slowly
􀀗 A mixed capex picture by operator, but
roughly flat on balance for 2009
􀀗 Free cash flows are still strong and stable
􀀗 We see leverage as stable to improving next
year in the absence of major M&A
􀀗 2009 ratings bias is to the downside, but
only slightly
EBITDA still growing
Overall we expect Western European organic
EBITDA growth to remain positive, albeit at a
low level, mirroring the revenue picture. Many
operators are already carrying out cost-saving
programmes, which we expect to continue
supporting sector margins overall, but the ability
of many operators to implement workforce
reductions remains restricted by politics, so thattelcos cannot be as nimble as companies in some
other sectors in cutting costs in a downturn.
Moreover, the benefits of any new programmes
announced in 2009 will likely be felt in the
medium rather than near term.

We believe BT is the main name to watch in 2009
from a margin perspective due to dilution from its
deteriorating Global Services division, and we will
be closely monitoring TI’s success in implementing
its recently announced efficiency initiatives.
Capex will depend on fibre and 4G
Across the corporate universe we have witnessed
numerous companies scaling back capex plans to
preserve cash in light of both the credit market
backdrop and economic outlook. However, at this
stage we do not see pressure on the telcos to
significantly reduce investment, even if funding
conditions show no signs of improvement. For the
weakest names we believe that the possibility of
reducing shareholder returns provides an ample
cushion for cash flows (although in the majority
of cases we do not believe that even this will
be necessary).
Over the past five years the sector average
capex/sales ratio has been fairly constant at
around 13-14%, although the ratio varies
materially between operators. The highest capex

burdens tend to be in emerging markets as
operators roll-out networks from scratch, and in
2009 this will be the case for Telenor (which
guides for high twenties capex to sales due to its
Indian expansion) while TCNZ will also invest
heavily as it simultaneously rolls out fibre and
upgrades its mobile network
Fibre plans
Fibre strategies will be the major driver of capex
changes in Western Europe going forward, although
at this stage most incumbent roll-out plans are either
unclear or are spread over several years, and so
should not impact 2009 figures materially.

Spectrum auctions
Spectrum auctions are set to take place throughout
Europe over the next few years, with German,
French, Dutch, Belgian and UK auctions expected
to begin in 2009 – HSBC Equity Research
estimates the European spectrum costs to issuers
in our universe at cEUR20bn over 2009-11.
As with the 3G auctions, the most expensive
spectrum is likely to be in the UK and Germany,
meaning that Vodafone, DT and Telefonica are
set to be the biggest spenders. Of these, Vodafone
and KPN are set to see the largest credit profile
impact – the former due to its presence across
many European mobile markets and the latter due
to its presence in Germany but relatively small
size. Overall, however, we believe that these costs
are manageable for all the major telcos within
their current financial policies and credit ratings.