10 December 2008
Sector outlook 2009
A defensive sector for
defensive times
Robert Grindle
Research Analyst
(44) 20 754 51065
robert.grindle@db.com
David-A Wright
Research Analyst
(44) 20 754 58490
david-a.wright@db.com
Matthew Bloxham, CFA
Research Analyst
(44) 20 754 58163
matthew.bloxham@db.com
Carola Bardelli
Research Analyst
(39) 02 86 37 97 08
carola.bardelli@db.com
Remain overweight, buy defensive large-caps
Telecoms is less exposed to the macro-economic slow-down than the market as a
whole. Secular growth, contracted sales, and an improvement in price deflation
(while the market sees a deterioration), sees top lines more defensive. Opex and
capex can be cut significantly to maintain strong cash flows and dividends.
Deutsche Bank AG/London
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http://gm.db.com/IndependentResearch or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE
LOCATED IN APPENDIX 1.
Industry Strategy
Top picks
Telefonica (TEF.MC),EUR16.09 Buy
Vodafone Group Plc (VOD.L),GBP135.45 Buy
Telecom Italia (TLIT.MI),EUR1.08 Buy
KPN (KPN.AS),EUR11.11 Buy
Swisscom (SCMN.VX),CHF358.50 Buy
Sector relative to market
80
90
100
110
120
130
9.12.07
9.1.08
9.2.08
9.3.08
9.4.08
9.5.08
9.6.08
9.7.08
9.8.08
9.9.08
9.10.08
9.11.08
Table of contents
Executive summary ............................................ Page 4
Outlook for 2009 ................................................ Page 8
Macro risk lower for telcos .............................. Page 23
Levers to sustain cash flow.............................. Page 32
Credit crunch .................................................... Page 41
Pan-European Telecoms Team
Carola Bardelli carola.bardelli@db.com
39 0286379-708
Matthew Bloxham matthew.bloxham@db.com
44 20 754 58163
Robert Grindle robert.grindle@db.com
44 20 754 51065
Benjamin Kohnke benjamin.kohnke@db.com
49 69 910 31943
Maurizio Pandolfi maurizio.pandolfi@db.com
39 028 6379 709
Jussi Uskola jussi.uskola@db.com
358 9 2525 2551
David Wright david-a.wrighte@db.com
44 20 754 58490
Sales Contact
Audrey Wiggin audrey.wiggin@db.com
+44 20 754 50707
Jonathan Smith jonathan-d.smith@db.com
+44 20 754 74383
Global Markets Research Company
Preparing for the year ahead
After a strong year end for Telcos in 2008 we publish our views ahead of 2009 on
the threat of economic slowdown, sustainability of strong free cash generation
and shareholder returns, and impact of the credit crunch.
Economic impact hits harder elsewhere
Telecoms has long been deflationary such that we expect limited impact from the
slide in inflationary expectations for the wider market which sees telcos half as
exposed to nominal GDP declines. A high proportion of contracted sales, secular
growth and lower price competition should further cap top line weakness.
Surprisingly, we discover there is little difference between operators exposure to
the economic downturn. TI looks least exposed however and DT the worst.
Cost and capex levers should sustain cash generation and dividend
Whilst telco top lines have been deflationary, costs have been significantly
inflationary and we see benefits here. Higher than appreciated variable costs
alongside cost cutting can do much do sustain high margins which are defensive
relative to other sectors. Capex can be cut quickly if growth fails. On our
estimates, cuts to maintenance levels would see a 50% boost to sector FCF, an
increment that would more than cover the sector’s 7% dividend yield.
The silver lining we see to the credit crunch
The quoted telcos in general have low re-financing risk (although PT seems worse
positioned) but smaller players are increasingly squeezed by lower pricing and
high leverage. The credit crunch may yet facilitate in-market consolidation,
improving fundamentals for the larger players.
Sector valuation looks appealing
The sector trades in line with the market on PE (DB CROCI), and at historically low
absolute levels. We believe the rating should be higher due to defensiveness of
earnings and the sustainability of premium dividends. In these current economic
conditions we prefer high yielding, large-caps which have less sensitivity to
earnings if business conditions deteriorate. Our top picks are TEF,VOD, TI, KPN,
SCMN, and C&W.
Valuation and risk
We use DCF and SOTP valuation methodology to reach our target prices. A wider
market rally could see defensive telco names lag. TEF and TI are also exposed to a
re-rotation to financials. FY09 guidance could also read bearishly as management
hedge themselves against GDP slowdown and little historic evidence to spending
patterns.

Table of Contents
Executive summary ................................................................................... 4
Outlook For 2009....................................................................................... 8
Lessons from 2008 ...................................................................................................................8
Drivers for 2009 ......................................................................................................................12
What is valuation telling us?....................................................................................................14
Our stock picks .......................................................................................................................15
Key risks.................................................................................................................................19
Macro risk lower for telcos ........................................................................ 23
Telecoms hasn’t kept up with nominal GDP...........................................................................23
Deflationary not inflationary….................................................................................................24
…but deflationary trends improving… ....................................................................................25
…more revenues are contracted….........................................................................................26
…and secular growth continues .............................................................................................27
Sector less exposed to economic slowdown .........................................................................28
Economy winners and losers: TI better, DT worse .................................................................30
Levers to sustain cash flow ........................................................................ 32
Greater focus by companies on FCF.......................................................................................32
Leveraging variable cost structure ..........................................................................................33
Capex – highly discretionary with mobile, much less so on fixed...........................................36
Credit crunch issues................................................................................. 41
Summary................................................................................................................................41
EUR21bn of bond refinancing due in 2009 .............................................................................41
The costs of refinancing at higher spreads .............................................................................43
Oligopoly reinforced through consolidation/capital constraints ..............................................45
Pension risks..........................................................................................................................46
Company pages ...................................................................................... 49