This article first appeared in The Edge Financial Daily, on November 25, 2015.

LONDON/MADRID: Telecom Italia’s home-market challenges and high debt might struggle to elicit a buy rating even from Pangloss, Voltaire’s eternal optimist. But French billionaires Vincent Bollore and Xavier Niel seem to see something worth having. Their purchases have driven up the share price. It could go 50% further, albeit only in the best of all possible worlds.

The optimist’s case for buying Telecom Italia (TI) stock relies on a shake-up in its two markets of Brazil and Italy. TI owns 67% of TIM Brasil, which could be a good match with domestic rivals such as Oi, Telefonica Brasil or America Movil. Barclays estimates a merger with Oi could generate as much as 25 billion reais (RM28.4 billion) in synergies, on a net present value basis. If TIM can be sold outright at five times earnings before interest, taxes, depreciation and amortisation (Ebitda) on which the sector trades and extract a premium worth half the value of the synergies, Telecom Italia’s stake could be worth €5.5 billion (RM24.8 billion).

That would give TI scope to invest more in high-speed broadband back in Italy, and so help command a higher valuation for its core business. Assume the TI domestic division deserves a multiple close to European peers of about seven times 2016 Ebitda, and it would have an enterprise value of €47 billion, suggesting its equity is worth €28 billion. That would imply a value per share of €1.4, compared with the current share price of €1.15.

The Frenchmen may have bigger hopes. Orange has talked about the potential for pan-European consolidation. Bake in a 20% premium if the whole thing gets taken over, and the new TI could go for €1.7 a share.

The best of all possible worlds may not happen, or be a long time coming. Brazilian consolidation has been talked about for years without much action. The Italian market may remain depressed. Niel’s purchases have caused TI shares to rise by 12% since mid-October. Much more than that requires a Panglossian disposition. — Reuters