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Edited Transcript of TIT.MI earnings conference call or presentation 2-Aug-19 11:00am GMT

Q2 2019 Telecom Italia SpA Earnings Call

Rome Aug 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Telecom Italia SpA earnings conference call or presentation Friday, August 2, 2019 at 11:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Carola Bardelli

Telecom Italia S.p.A. - Head of IR

* Giovanni Ronca

Telecom Italia S.p.A. - CFO

* Lorenzo Forina

Telecom Italia S.p.A. - Chief Revenue Officer

* Luigi Gubitosi

Telecom Italia S.p.A. - CEO, General Manager & Executive Director

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Conference Call Participants

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* Andrew J. Lee

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Domenico Ghilotti

Equita SIM S.p.A., Research Division - Co-Head of Research

* Fabio Pavan

Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst

* Georgios Ierodiaconou

Citigroup Inc, Research Division - Director

* James Edmund Ratzer

New Street Research LLP - Europe Team Head of Communications Services & Analyst

* Jeremy A. Dellis

Jefferies LLC, Research Division - MD & Senior Telecommunications Analyst

* Mandeep Singh

Redburn (Europe) Limited, Research Division - TMT Specialist Sales

* Roman Arbuzov

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Carola Bardelli, Telecom Italia S.p.A. - Head of IR [1]

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Ladies and gentlemen, good afternoon. This is Carola Bardelli, Head of Investor Relations. I'm pleased to welcome all of you to our second quarter 2019 results presentation. I'm here with our CEO, Luigi Gubitosi; and our CFO, Giovanni Ronca. Luigi will provide you an update on the plan execution and on the main strategic initiatives, and Giovanni will present the second quarter results. A Q&A session will follow.

Pointing you to our safe harbor disclaimer on Page 1. Let me remind you that our comments are based on IFRS 9/15 standards comparable to last year's results and that we are also showing an after lease view on which we are basing our guidance in line with most of our peers.

So Luigi, the floor is all yours.

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [2]

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Thank you, Carola. Hello to everybody. It's again a pleasure for me to be here with you and to tell you that we have started the execution of our plan and things are proceeding smoothly. And as we mentioned to you in some of the meetings we had in the roadshow, we are sure that with the right drive and direction, things do happen.

And in fact, if I can meet -- if I can start immediately with Slide #3. As you can see, our execution is at full speed. So let me tell you what happened in Q2. We have signed another important agreement with the unions just this morning that we call Expansion Contract because it allows for recruitment on new staff, at the same time solidarietà like savings. And this -- TIM is the first company to use this law. As we discussed in the previous call, we were expecting over 200 people to leave the company in June. And in fact, there were 1,266, as you can see. And our reskilling and reengagement work is proceeding. It's less evident. It's not numeric, but it will pay off as we move along. As I said, we already had 1,600 exit, including those that were -- left before June. And so we confirm that we have secured 37% of the targeted cost cutting by 2021.

Last month, we launched our 5G commercial offering. We have won, again, a prize for the best mobile network in Italy. And with 5G, we assure that we'll be able to open a gap with our competitors. We have delivered on one of the toughest promise that we made, we stabilized the ARPU in mobile. We said it would happen this quarter; indeed, it happened. And we are delivering a number of initiative that we call fix the fixed to improve the wireline KPIs. And we told you there will be a couple of difficult quarter, Q1 and Q2 in terms of KPI on fixed. You will start seeing improvement from next quarter.

In Brazil, we're posting positive results despite macro headwinds. We have signed an MOU with Vivo to share mobile networks on the back of our positive experience in Italy. And we had very good news on past excess tax payment. So it was -- we were awarded a decision by a Brazilian court, which decided we have an overall tax credit worth EUR 3.4 billion, which we booked to a large extent in Q2 and for about EUR 300 million -- EUR 300-plus million is going to be in Q4 -- in Q3, sorry. This is worth about 4% of Telecom Italia market cap, obviously on after-tax basis and so on so forth.

On the deleverage side of our plan, we are also more than on track with acceleration of net debt reduction to EUR 349 million in Q2, which brings debt down EUR 539 million versus 2018. We're very comfortable with our deleveraging plan. Importantly, we generated almost EUR 800 million equity free cash flow in the first half, which is a good start on the way to our EUR 3.5 billion targeted by 2021.

If we move to the next slide, #4, I'll give you some updates. Well, I don't think we'll go match into the so-called Vodafone transaction, INWIT transaction, simply because we had the call last week. But obviously, we'd be happy to answer to any question you might have on the both, any additional questions. You might recall, we gave you a range of EUR 100 million to EUR 150 million of synergies. We believe we are top end of that range.

And the other important thing is that when this transaction will go through, through debt consolidation, a special dividend and potential reduction in the stake we own -- we will own in the merged company, we should be able to reduce our debt by over EUR 1.4 billion. So on top of the EUR 3.5 billion, we have identified almost EUR 1.4 billion -- actually, more than EUR 1.4 billion, so we're almost at EUR 6 billion, if one includes other strategic initiatives that we identified, including the finance company and so on. So it's obviously still something that has to happen, but we are on the right way to get there.

On the consumer -- sorry, on Open Fiber, we have a work in progress which is protected by NDA. So I'll have to limit myself to say that we did present our option to the Board, and the Board does confirm a mandate to continue negotiation with Open Fiber shareholders, and happy to report that this is a very constructive climate.

Consumer credit partnership, it's moving along. We have defined a short list of 3, and we expect to select the partner by October. And also, this is something we had not mentioned to you before, but you can see the full box, which is somewhat a surprise in the sense that we have been debating our strategy on content and concentrating on -- and we want to concentrate on patent aggregation. Basically, TIM used to be present in production of contents, but without the critical mass. And seeing the evolution of the content market, we believe that it's much more beneficial for us to do content aggregation of contents produced by others and to use it to start bundling and playing on convergence. We believe convergence. It's going to be an important work going forward.

We settled a long time dispute that we have with Sky, which will allow TIMvision to bundle with NOW TV, which, as you know, is the Sky online platform, which includes basically several sports, most important of which is going to be the football, Serie A TIM matches. This come along other distribution agreements that we have closed with Amazon, Discovery, Mediaset, Netflix, and we'll see others along the way. And this without any significant impact on our accounts in a sense that this is to say we are an aggregator, and therefore, we take a cut on what we sell rather than risk our own money to produce it.

If we move on the main trends on Page 6, please. The bottom line of this slide is that we have reduced the debt more than EUR 0.5 billion, in fact, a historical low level for Telecom Italia debt. And we have generated an equity free cash flow that is 3x previous years and very much in line with our 3-year plan. So basically, this is probably the area in which we are most advanced, and that's why you keep hearing me say that I'm comfortable with the leveraging.

Operating results show service revenue, that excluding Sparkle, down 1.2% year-on-year and EBITDA reduction at 2.6% year-on-year. So this is more than offset by lower CapEx, and it is leading us to a slightly positive EBITDA minus CapEx.

So now let's dive in the details. And on Page 7, you see the mobile. The very good news in this quarter is that we posted a quarterly growth in ARPU as a consequence of the more rational approach on pricing, which we discussed in the past couple of calls as well as some smart upselling and repricing actions, segmented repricing action.

Also, I think on the bottom left part of this chart, you can see that the churn rate is declining, still not where we would like to be, but becoming -- is the best over the last year. And that the MNP market, the mobile number portability, it's basically in turn at the lowest.

So we see that in mobile competition is somewhat moderating and it's a better market, it's definitely a much better market than it was a year ago. As usual, that will take some time, but we see this trend so far continuing. It will take some time before we see a significant improvement. As usual, we are paying -- still paying for the excesses of 2018, but the effect is moderating and we are now moderately optimistic about the future. The market is still quite competitive at the low end of the segment and less so on the more valuable part of the customer base.

If we could move to Page 8, you will see that basically 5G shall give us an opportunity to continue to stabilize the market and upsell it somehow. And we see it as an opportunity to improve our performance, also in terms of return on invested capital. From a customer point of view, there would be better services, new services for both corporates and consumer. Importantly for us, it will be at higher price than the current one.

And we already started setting the bar with prices 50% to 150% higher than the current ones, which, by the way, as you know, we're already in an upward trend. We don't see 5G as 4G plus 1, but it's a real game changer with opportunity for us to grow in volume and value. At the same time, we are optimizing the rollout, and our partnership with Vodafone enables us to reach total coverage by 2025 and to save CapEx and OpEx through active and passive sharing. So 5G in the long term will help us improve our revenues and network sharing. Partnership will boost our margins while optimizing invested capital.

I will not comment specifically Page 9 unless there's questions because this is something that, as I said, we commented extensively last week. You always heard us enthusiastic about this partnership. As we're moving on, we're even more enthusiastic we are at the beginnings. So we do see that as a significant improvement for TIM and a dramatic game changer for INWIT, which will obviously benefit enormously from this transaction.

Moving on Page 10. We see that fixed service revenue is still in positive territory, if you exclude the Sparkle impact. Retail is helped by a positive trend in the Business segment. And ICT, that is continuing its double-digit growth at 17%. However, in the Consumer segment, the ARPU growth this quarter is not entirely offsetting line losses. In domestic wholesale, 11.4% growth is driven by a move from ULL, which is at EUR 8.6 per month to VULA which is at EUR 13 per month. Non-regulated business is growing nicely, very nicely I would say. And wholesale price is fixed by AGCOM, which, at this time, let's say, we think were quite fair, and we expect wholesale to remain in positive territory for every quarter in 2019, although probably not at the same pace than Q2.

On Sparkle, we explained earlier on in the year that there would have been a material decrease in revenues, which, as you can see, are down, yet EBITDA has improved up to 18%, thanks to the new strategy. So we have repositioned it from basically no-margin business into positive margin activities. So there is some good evolution in terms of EBITDA for Sparkle and will continue throughout the year.

On Page 11, you can see that the fiber lines continue to grow. We've now reached 6.3 million lines in terms -- with an increase of 6% over previous quarter and 45% year-over-year. We are back on growth on broadband lines, thanks a number of actions, including push or migrating voice-only customer to ADSL. Overall, Retail line losses were 346 (sic) [346k] lines due to anticipated increase in cleanup of the customer base in Q2, which is finished with Q2. And as I said before, you will see better number in Q3 and Q4. We expect these line losses to improve also as a consequence of the action that I will describe shortly.

The ARPU continues to grow quarter-on-quarter, a marked increase of 8.3%, with Broadband ARPU benefiting also from upselling services beyond connectivity. This is also an effect of the cancellation of lines obviously that were basically mute and therefore are not paying us anything. As I mentioned before, this effect, it's completed with this quarter. So in the next quarter, basically, we tell you about internal plan that's called Fix the fixed. In fact, as some of you have pointed out, this is the main area of attention we should have in terms of stabilizing our market position. So what are we doing?

Basically, it's a new offering, which we have renamed TIM SUPER, premium positioning, the best technology at the maximum speed. We're going to have a modular offering with valuable adds-on: Security and cybersecurity is now very much felt among consumers increasingly. So that's something that you need as well as entertainment, smart home, assistance, voice and so on. The first year, some promotion. In the second year, there is an embedded price increase. ARPU from the second year is between 14% and 17% versus the previous offering. So on top on that we are benefiting from an improvement, the regulatory framework, that enables our technical staff to upsell to our customer base. We are also deploying a geo-marketing approach with local promos and specific offering for second homes in areas now reached by fiber, we'll be providing a renewed FWA. FWA is a very powerful technology which we had not utilized as much as we could in the past, and we are trying to make up for lost time. Also because with 5G, FWA will become, from a powerful instrument, an extremely powerful instrument. We are improving technical and commercial processes. And in general, this entire organization is focusing on Fixing the fixed, as I say.

One of the things that we think is going to be important, as I said, is going to be convergence, not only in terms of double play, but also in terms of triple play and quadruple play, where applicable.

We have had an old issue. In fact if you look in our financials, we discussed an old litigation with Sky. We did settle this litigation, and we believe we made -- we transformed a problem into an opportunity. So we achieved a deal that is allowing us to use some -- that we consider it some cost -- [sunk] cost to offer a sport kit on our TIMvision. That includes all the NOW sports, soccer and so not only Serie A TIM, but also Championships League, Premier League, Europa League, to other sports like Formula One, tennis and so on. And this together with other agreement that we'll close shortly will become the most rich offer in the market or at least at par with anybody else. And as many of you know, sports tends to be the killer application typically to attract customers to this platform.

On top of that, we have already secured agreement with Netflix, with Amazon Prime, with Eurosport, with CHILI, with Mediaset and others that are being signed, so I cannot disclose at the moment. So we expect this to increase the stickiness of our fixed line bases and become an interesting opportunity to enrich our offer and differentiate from our competitors.

With this, I would pass the microphone to Giovanni Ronca, who will continue with the cost and the numbers.

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Giovanni Ronca, Telecom Italia S.p.A. - CFO [3]

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Thank you, Luigi, and good afternoon to everyone. I'll start on Slide 14 saying that we are satisfied with our OpEx reduction, minus 6% year-on-year on a P&L view and minus 9% on a cash view excluding the effect of cost deferral from past years.

Focusing on the cash costs which better show the result of management actions, sales-driven costs are down significantly more than the relative sales. For example, interconnection are down as a consequence of Sparkle repositioning on higher-margin contracts. And Sparkle EBITDA was indeed up 17% year-on-year in the quarter, with a much higher client quality portfolio.

Likewise, equipment costs were down more than equipment sales as a result of our new portfolio policy aimed at improving margins on devices, margins that are significantly improved resulting in a EUR 30 million plus saving. We could say that we are effectively addressing also the unaddressable costs.

Moving to the addressable costs. Let's start from commercial costs that are significantly down. For instance, commissioning fees fell more than 30% year-on-year on a cash basis. G&A are down, thanks to optimization in different areas. On labor, this quarter was affected by the impact on the year-on-year comparison related to the one-off release of provision for unused previous year's holidays in 2018. I remind you that most of the 1,600 early retirements Luigi mentioned previously occurred on July 1, so the effect has still to come.

On industrial costs, the lower energy consumption, down almost 4% in the first half of this year, was offset by an effective hedging policy implemented last year, accounting for a EUR 15 million additional cost versus Q2 2018. Lastly, other includes rebates and liability reversal recorded in 2018, implying an approximately EUR 35 million drag in the year-on-year comparison. In fact, this one-off significantly affected domestic EBITDA performance. So as I said, removing all nonlinear items, you would get an even higher cost reduction.

Moving on Slide 15, we start talking about Brazil. Considering that Brazil already reported yesterday, I'll just -- I'm just flying over this slide focusing on the key points. Reappointing Pietro already brought results. Revenue growth is accelerating, thanks to strong growth in fixed and in mobile postpaid. And most importantly, the EBITDA growth topped 6% year-on-year, and EBITDA minus CapEx was up 25% year-on-year. Additionally, in this quarter, we had the very positive news to announce, as you can see on Slide 16.

Further to a final Brazilian Supreme Court decision, in Q2, TIM Brasil booked a BRL 2.9 billion tax credit related to the litigation on double taxation. Overall, TIM Brasil at year-end will have a BRL 3.4 billion tax asset. That will reduce TIM debt by EUR 800 million in 3 or 4 years, gross of taxes. This tax asset is obviously accounted for below the organic EBITDA, and it is booked in net working capital. Hence, it will gradually deflate net working capital in the next 3, 4 years, therefore, reducing net debt.

Moving to Slide 17. You see that net debt at the end of June fell to an historical low of EUR 24.7 million, down EUR 539 million versus December 2018, accelerating the fall in this quarter to EUR 349 million. The very positive cash generation is all related to an improving operating free cash flow, all organic, with lower CapEx and better working capital dynamics compared to previous year, as we show in the next slide, #18.

CapEx, thanks to the improved efficiency, is down year-on-year 6% or EUR 56 million, with our domestic CapEx in line, similarly to Q1, with announced target of EUR 200 million CapEx fall on a full year basis. And also, working capital has improved. As I said, net working capital included the booking of the Brazilian tax asset in Q2, which was partially offset by one -- by a capital one-off provisions in Italy and Brazil. Net of these one-off effects, net working capital strongly improved year-on-year. It was EUR 600 million better in the first 6 months, showing first evidence of actions taken to reduce working capital outflow. I will stress the point that cash cost saving realized in Q2 will translate in lower cash outflows in coming quarters.

Moving to Slide 19. You can see that, in Q2, the cost of debt was further reduced after the already significant fall recorded in Q1. The average cost is now 3.7%, which is down 10 basis points quarter-on-quarter and 30 basis points year-to-date. As we anticipated in our last roadshow, the 2019 funding plan is fundamentally completed, and we have a sound liquidity margin and an improved coverage ratio of the next 24 months debt maturities.

In Slide 20, we see how in this quarter, the nonrecurring items are contributing positively to our profits. They are related to the mentioned Brazilian tax asset, partially offset by domestic provision for potential regulatory and litigations and by Brazilian provision, mainly due to supply and personnel. This leads to a reported EBITDA of EUR 2.3 billion, plus 17% year-on-year, and a net income 20% higher. Taxes and minorities obviously included the Brazilian one-off.

Slide 21. Looking at our results with the after lease view on which we provided our guidance, we see that EBITDA shows better performance year-on-year versus the IFRS 9/15, both at group level from 2.6% to minus -- sorry, from minus 2.6% to minus 1.3% and domestic from minus 4.4% to minus 3.3%.

Let me now hand back to Luigi for the closing remarks. Thank you.

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [4]

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Thanks, Giovanni. So in summary, we are delivering on time and we are delivering fast. Return on invested capital remains our key priority. Organic action will remain focused on revenue stabilization, cost cutting, including risk, stopping net working capital outflows, invested capital optimization. As you saw from the first deal announced, we are committed to provide additional upside through more inorganic action. Guidance remains unchanged.

We are now ready to take your questions. Thank you very much for your attention.

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Questions and Answers

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Operator [1]

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(Operator Instructions) First question comes from Mr. Singh Mandeep from Redburn.

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Mandeep Singh, Redburn (Europe) Limited, Research Division - TMT Specialist Sales [2]

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(technical difficulty) visible stringent cleanup policy, but could you talk to us a little bit about mobile substitution? How much mobile substitution you're seeing? And if you are seeing, how you can choose to address that? That will be the first question. And on the second question, I know you've been authorized to continue the negotiations with the shareholders of Open Fiber. Could you just update us how you still, from a personal standpoint, much more in favor of full combination for maximum synergies? Or can you sort of tell us perhaps, of the different options that have been presented, which one seems to be the more popular ones and the least popular ones.

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [3]

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Okay. I will ask Lorenzo Forina, our Chief Revenue Officer, to answer your first question. I'll take the second one.

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Lorenzo Forina, Telecom Italia S.p.A. - Chief Revenue Officer [4]

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Well, as we discussed in our last call, the gigabyte war of last year provided us somehow significant gigabyte allowance in the market. So we experienced in the first half slightly more fixed to mobile substitution than previous year. Well, the good news is that given that the industry raised the price with quite of a rational approach in the mobile market, the effect, and we are already experiencing, is improving over time. So I'm not saying it's no effect, but we clearly see that the fixed to mobile substitution that reached the peak in the first half is somehow slowing down.

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [5]

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With regards to your second question, and I appreciate it, obviously, you would want to have a lot of color. But as I said, we have established good working relationship with our counterparts. And there is, I think, a positive attitude. We're working well together. So I would find inappropriate to discuss publicly what we're discussing separately because, obviously, you should imagine that we are discussing also options in terms of structures and so on so forth. So I also know at the same time that you obviously have expressed interest and sometimes concern, and by you, I mean not only yourself, but in general the analysts as a group, concern about what the impact of a deal, if any, might create on the company. And please be advised that your concerns are mine as well in the sense that my objective is not to do a deal per se. A deal is not an end. It's a mean to achieve something. So I reiterate that we wouldn't do anything that will jeopardize our deleveraging plan or that would have excess dilution or that would create any other issue to our ultimate goal, it's to create value for TIM shareholders. And in fact, I have to say -- I mean I think something I could say is that yesterday, we had unanimous support from the Board in doing what we're doing. So hopefully, you're going to be able to know more relatively soon. But this sort of things take some time to materialize. And also, as I said, it's not going to be me who's going to breach confidentiality. Sorry, but I have a commitment. And a lot of this is also based on personal and trust relationship with my counterparts. I hope you understand my point.

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Operator [6]

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Next question comes from Mr. James Ratzer from New Street Research.

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Carola Bardelli, Telecom Italia S.p.A. - Head of IR [7]

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James? Let's move to the...

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James Edmund Ratzer, New Street Research LLP - Europe Team Head of Communications Services & Analyst [8]

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Yes. Sorry, I think I was on mute. Sorry. Yes. 2 questions, please. So the first one was just going back to your wireline cleanup that you've been doing. Could you please just help to quantify what the impact was of the cleanup in the second quarter and just remind us again what that was in the first quarter? And also, did that have any impact on your broadband numbers? So I was wondering if the 60,000 you reported is actually even higher than that when you include the cleanup.

And then second question if you could help us how to think about how the retail service revenues in wireline will likely develop over the second half of the year because I mean we saw slippage of around 200 basis point between Q1 and Q2. Should we expect that to recover going forward? Or has it become a little bit harder given some of the pricing trends in the market?

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [9]

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Sorry. The line was not particularly clear, but I think I understood 2 questions. One, you were asking how much was the cleanup. And if I recall correctly, it was somewhat north of 70,000 or so. And Lorenzo is nodding, so yes, I recall correctly probably. And your second question was, again, if we understood correctly, what's going to happen to revenues in the second half of the year, in fixed wireline revenues. Have I understood correctly?

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James Edmund Ratzer, New Street Research LLP - Europe Team Head of Communications Services & Analyst [10]

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Yes. In particular, on the retail services side and also just to confirm, did that cleanup affect your broadband subscriber trend at all?

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [11]

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Yes. I guess, obviously, we had some of that. I think some was voice, but some was broadband. I wouldn't be able to tell you now what was the breakdown. But with regards to the revenues, you should recall that last year, we had 3 repricing, which I think was something that spooked our customers, which we're not planning at the moment. In fact, one of the reasons why we think there's going to be some stabilization in line losses will -- the line losses is because some of our competitors are going to do repricing in July and August, so -- and also, you see that there is a number of actions that we're going to implement. So we expect that to become a positive factor. With regards to your specific question on revenues on domestic, I think the comparison with the previous year, given the fact that we're not increasing prices and there is a lower customer base, logically should be unflattering.

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James Edmund Ratzer, New Street Research LLP - Europe Team Head of Communications Services & Analyst [12]

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Okay. But now it sounds like that your intention into the second half of the year is to aim to be a little bit more price competitive in the market than you have been in the past.

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [13]

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You see we're going to be -- I apologize for not -- yes. Yes. Absolutely. Now we definitely -- as I said before, and you also -- you can infer it from the space that we are giving to fixed in this presentation. Management focus and attention beside the usual one that is given by Lorenzo Forina and his team is now very much focused on fixed. And in fact, we have also developed a number of IT instruments to follow that more closely. More in general, I mean, as I said before, in what we are doing, there is a number of things that we're quite happy with. Deleverage is coming up fast, and we're happy with that.

On the fixed line, I think we can do better, and we should be better. So we'll be more competitive on a number of things, but obviously, we are happy where the price -- our prices are now, and we're seeing our competitors coming closer to us. So I don't envisage that we're going to lower prices. I see them going up. So the gap is closing, and this is what we see on the market. But not because we're going down. It's because they're going up. And I think this is healthy. Thank you.

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Operator [14]

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Next question comes from Mr. Fabio Pavan from Mediobanca.

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Fabio Pavan, Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst [15]

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The first one is on the free cash flow generation. I was wondering, if you will, argue, it's fair to say, in the first half, it came out ahead of expectations. So my question is, what we should expect for the second part of the year? And the second question is on the strategy for contents, which we've seen make a lot of sense in the context of price inflation and content. Could you just tell us how this strategy will work? Are you going to share -- what is the business model? Are you going to share the costs with the counterpart for marketing? Are you going to cash in just a portion of the agreement? How can you integrate in a bundle offer these contents?

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [16]

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Okay. On the first one, and obviously, we didn't give a guidance about net financial position at year-end because, in fact, free cash flow was also a bit ahead of our expectation indeed. And in fact, I'll tell you an internal item. We have a guidance also for the Board, which is the budget. We raised our budget. We were expecting to reduce debt by EUR 750 million this year. We have increased it to EUR 1 billion. We expect to reduce our net financial position. So basically, if you consider that it went down by EUR 539 million, that tells you that we more or less expect a similar reduction in the second half. And my colleagues are all looking at me like, what did you say because I just raised the bar in this respect. But that's what we expect. So on this part, as I said, we think we will now have a good control of the operating machine and on the flows.

Your second question, what sort of business model we're going to have, the strategy for content. Okay. As I said before, the strategy that TIM had was in -- to do content production. And I think was, honestly, a waste of money because it was not enough to the critical mass. And with the Disney, the Netflix, the Vivendi, the Comcast of this world, A&T, and maybe Apple at some point, in order to be significant in production, you need to spend a lot. We can do that. Even at the Italian level, we should spend much more than we want to. So our strategy is to aggregate.

What are we? We are a connection between these platforms and the customers. We reach the customers' houses. We reach most customers' houses. And ideally, we reach even more. And therefore, our strategy is to do basically a strategy of reseller effectively, revenue sharing, the type of activity where we don't give guarantees or we don't take risks basically. We want to have a very good customer experience. We want to have the best providers. And we don't want to have, however, impact on our margins. So whatever comes up, it's something on top. Having said that, I do believe that we have not used convergence enough. And this -- if we look at the stickiness of the customers [over] this type of thing, the kind of TIMvision customers, they tend to be much stickier than the regular customers. So the more we can use this, it becomes also a way to reduce churn in turn. I hope I answered your question, but definitely, it will not impact our margins.

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Operator [17]

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Next question comes from Andrew Lee from Goldman Sachs.

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Andrew J. Lee, Goldman Sachs Group Inc., Research Division - Equity Analyst [18]

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I had 2 on your self-help opportunity. Just firstly on debt. Your debt guidance in 2021 is obviously pretty dynamic. It obviously doesn't include [in a way] stake sale. You can't do anything more -- much more [than what you have] because you've already done that. But I wondered what are the other blue-sky opportunities to reduce debt on the inorganic sides, potential for data center, use data centers? Color on this and the size of the opportunity will be good.

And then secondly, just on cost cutting. It looks like it's going very well. Is the overall opportunity for cost cutting bigger than you thought? Is it mainly digitalization driving this? And are you finding, for example, unions are more amenable to the need for this?

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [19]

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Okay. First of all, so our debt guidance -- you said INWIT. I think I mentioned already what we can do there, so 1 -- let's say EUR 1.4 billion. Then we mentioned, I think, that there's a finance company that we're working on. The impact of the 2 would be another EUR 2 billion -- sorry, including that. We have the EUR 1.4 billion, let's say, plus another EUR 500 million to EUR 600 million, so the combination of the 2 will be EUR 2 billion. Then I think we have identified at least another EUR 1 billion, but we're not ready to disclose out yet.

When we come up with something that we tell you, we like to follow through with execution. So until we are ready with execution -- probably before year-end maybe, we'll tell you. Or in the next 3 to 6 months -- after 6 months, we might discuss further this matter. But at the moment, let's say, we're comfortable with the fact that we should be able to achieve this situation.

Now I think you mentioned data centers, and this is part of our discussion. But please be -- we do not intend to sell and exit data center business where we are leading in Italy. However, the complete strategy around that part of the business, data center, cloud, [Mac], which is something we're working on, is going to be something that we will disclose later on in the year.

So just to summarize the answer to your question. The EUR 3.5 billion that we gave as a target, as of today, it seems achievable. In fact, we are ahead of schedule, but I'm not prepared to raise guidance until we get more evidence. So we did raise the guidance with our Board for this year in terms of cash flow.

We also -- we are not expecting Brazil honestly. There was one of those call that you get from -- Labriola called me on Saturday night, and I said, "Okay. What's going on in Brazil? Any big issue?" And then it was good news fortunately. You get an unexpected call late in -- on a weekend that you always assume the worst and instead, it was the best. So that was not contemplated in the plan, and it's not -- but it will make our expectation definitely stronger. So as I said, I prefer to say that I'm comfortable to the EUR 3.5 billion rather than say we can do better. We'll try to do better, but we need to [move].

Cost cutting is probably bigger than we thought initially. We can do more. But again, as we present the new plan, we'll do something. At the moment, we have a feeling, as I say, that on the debt side, we are on the right track and we can do better. Now we're focusing also on -- as I said, on the business side, on the fixed in particular, and we'll try to do better in that.

Inorganic, there is plenty of opportunity that we're looking at. As we're ready to come open on that, we'll tell you. But let's say -- we did say that this will be our plan, and our objective is to delever the company, and I'm very comfortable we'll do that.

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Carola Bardelli, Telecom Italia S.p.A. - Head of IR [20]

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Thank you, Andrew.

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Operator [21]

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Next question comes from Mr. Domenico Ghilotti from Equita.

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Domenico Ghilotti, Equita SIM S.p.A., Research Division - Co-Head of Research [22]

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My first question is on the cost side. Because if I look at the P&L contribution, so apart from the interconnection and equipment that you were mentioning before, the trend has not been as supportive as I expected. And so I'm trying to understand how and when we will see really the key components of the cost side going down.

Second question is on the free cash flow generation. In particular, I'm wondering if you can elaborate on the INWIT deal impact on your free cash flow. So do you see the deal as accretive in the free cash flow generation that you can generate once INWIT is deconsolidated? And when we will see the CapEx savings that you were mentioning in terms of synergies?

Last question is on the savings conversion. Current price is slightly above the 6-month average. So I wonder if you see an opportunity -- window of opportunity for conversion or if you are looking at different metrics, different conditions.

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Giovanni Ronca, Telecom Italia S.p.A. - CFO [23]

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Okay. Let's start from the first question about cost. What you see in the quarter is that a portion of the cost reduction is obviously related to lower volumes in terms of revenues, but there is an over-contribution of the cost reduction compared to the pure effect of revenue decline. So I think that we are able to work both on the unaddressable and addressable costs at the same way. All of it takes time. It takes time also in the translation of cost from -- into cash because there is a working capital payment cycle that will, I mean, make -- materialize in the cost -- the cash cost saving in the following quarter even if realized, from a technical standpoint, this quarter.

The points on which we are working harder and were not as clear as it were today, in particular, things like the cost of energy. Cost of energy is something that is not related to -- I mean something not understood, but managed incorrectly in the past in terms of hedging strategy. This can bring EUR 15 million of savings going forward if managed differently, and we are acting in that side.

Labor, labor is something that in terms of actual exits of people, of early retirements is taking place in the third quarter. If you think about the number of actual exits in the first half, we are talking about 340 people. The big chunk of exits is in July. We are talking about 1,600 people. This -- what will be the effect? The effect will be to decrease something that is totally in our control like the cost of labor progressively in the coming quarters.

Then in this quarter, on a comparison -- from a comparison standpoint versus the same quarter last year, there is a single one-off release of provision of unused holidays. That is something that is related to a well -- a good way of managing the labor cost. Last year, we decided to cancel these holidays never utilized for the last 2 years. One-off? Yes. Unhealthy way of managing things? Yes as well.

You see that -- on the chart on Page 14, that you have in the line Other what we defined the liability reversal and rebates. What does it mean? It means that, in the previous quarters, we were using rebates as a sort of decreasing cost of services equipment, something that we are utilizing much less or progressively, it's fading going forward in this respect.

So the cost structure is changing. The cost management becomes more effective. Results will come in the coming quarter as in every industry. Luigi?

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [24]

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Yes. You made 2 more questions. One was about the impact of the network sharing partnership with Vodafone, what will it do to our guidance. And I believe it will enhance equity free cash flow target once the dividend of the new INWIT is included in line with Vodafone and European peers' definition. So we don't expect a negative impact in summary.

You also asked what's going to happen on savings shares. Well, I can tell you nothing in August. But going forward, you know that my position with the Board, the major shareholders is to -- all major shareholders is to -- when they're at the right terms and condition, is to execute the conversion -- or propose the conversion rather. I think that's the right word.

So we will see how things develop. We obviously -- it will be inappropriate that we say in advance that this would be a material, well, nonpublic information which we make public. I think we will be ready to do that, but I think I've made, in a number of occasion, the comment that I think this is something that comes from the past that, at some point, should be converted. So the sooner, the better. But I don't have a firm date yet. Thank you.

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Carola Bardelli, Telecom Italia S.p.A. - Head of IR [25]

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Thank you, Domenico.

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Operator [26]

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(Operator Instructions) The next question is from Roman Arbuzov from JPMorgan.

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Roman Arbuzov, JP Morgan Chase & Co, Research Division - Analyst [27]

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The first one is on financials and about the EUR 3.5 billion equity free cash flow guidance that you have for the medium term. And it looks to me, I guess, the guidance is conservative given the strong start and the strong free cash flow generation that you've had in the first half and also the strong deleveraging that you expect in the second half. I guess that means that you will end up with comfortably more than EUR 1 billion in equity free cash flow this year. And given the growth that you expect in 2020 and '21, so the EUR 3.5 billion is conservative. Can you just provide us comments on how conservative you think that might be?

And then also, on the free cash flow, can you, within that, comment on the working capital, please? Because that's been one of the key drivers in the strength of the equity free cash flow. And if we go back to the presentation that you've made for the full year 2018 results, your initial expectations were for the working capital to be broadly flattish 2019 versus 2018, and you're developing much faster. So perhaps you can give us an update on what is a realistic trajectory that you expect for working capital for the coming years.

And then can I ask another question on Open Fiber, please? And sorry to come back to this sensitive topic, but I was wondering if you could give us a sense of how you approach the situation as opposed to anything specific -- any specific scenarios that you're currently discussing with your partners? But in terms of your velocity in your approach, can you perhaps share some thoughts on how pragmatically you're approaching this? And is there a strategic element at all in your thinking?

So what I mean by that is, are you fully focused on deriving the synergies and driving deleveraging as a key result that you're looking forward from this transaction? Or do you also think about what the transaction is going to do to your business on a 5-year view? And sort of how much does the longer part of your thinking influence your decision-making in this respect?

And if I may add that the Enel CEO yesterday on their results conference call seemed to imply -- at least, that was my interpretation of it. He seemed to imply that the current discussions are more in its very pragmatic realm, that you're approaching it from the perspective of deriving synergies and deleveraging as opposed to anything else. So if you can comment, that will be very much appreciated. And if you can't, that's fully understood because you've made it very clear as good presenters.

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [28]

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Okay. About guidance and whether that's conservative, well, as I said, we have raised a bit some -- our expectations or the Board expectations about debt reduction. We are up to a promising start. But before we call it a trend, we would like to see a bit more, honestly. I'd rather keep conservative and make it than make you a lot of promises and then don't do it. So we stick with our guidance for the time being.

As I said to you, today, we are quite comfortable. But 3 years is a long time. We've only done the first 6 months. In terms of deleveraging, these first 6 months have done well. Let me -- allow me to [sell] it myself. Hopefully, we'll be able -- at some point, we'll be able to discuss whether we should raise guidance. But today, I'm not ready to do that yet, not because I know anything that might derail, but simply, we want to have more -- we are very comfortable with what we're telling you now. The EUR 3.5 billion is doable. Before telling you that we can do more, we want to make sure that we have more elements.

In this respect, I will ask Giovanni to go on the question on working capital you were asking.

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Giovanni Ronca, Telecom Italia S.p.A. - CFO [29]

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Yes. Let me make a point restating the starting point for 2018 after the change in accounting principle because this is important than to comment on the target. The old sort of guidance, in fact, was then on previous IAS principles. The number that you have in mind was EUR 1.372 billion, is going to be EUR 1.250 billion under IFRS. So more or less, EUR 100 million better than the old [principal] closing actual of 2018. What we do expect for full year 2019 is to get closer to the EUR 1 billion, so having a further reduction in the range of EUR 200 million of working capital absorption.

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Roman Arbuzov, JP Morgan Chase & Co, Research Division - Analyst [30]

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Okay. And from there on, would you expect to reach sort of around EUR 600 million on a 3-year view? Is that still the case?

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Giovanni Ronca, Telecom Italia S.p.A. - CFO [31]

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You mean by 2021?

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Roman Arbuzov, JP Morgan Chase & Co, Research Division - Analyst [32]

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Yes.

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Giovanni Ronca, Telecom Italia S.p.A. - CFO [33]

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Yes. This further improvement is absolutely in line with our projections.

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [34]

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So then you were asking about Open Fiber and how do I approach the situation. Well, my philosophy of deals is that you try to understand the objectives of your counterpart. And in this respect, I consider myself a pragmatic and I try to build bridges. So there is a lot of focus on my part on this deal.

And I think you are making an unusual question. "Do you look at the short term or the long term?" I never -- I pride myself of never trying to fix a quarter and then who cares about the future as I plan to stay more than your -- in Italy, now one of the jokes is that there are 2 seasonal jobs, ski instructor and Telecom Italia CEO. I heard that. So I plan to stay more, so it's not my point to fix a quarter or 2 quarters and see what the result in the short term is. And then -- so anyone who knows my managerial history knows that I look at 5 years. It's -- I mean I look at long term. I don't know that long term is 5 years, 3 years or 10 years. I look at the health of the companies I manage.

Having said that, long term is made by a lot of short terms as well. So it's not like we can -- we cannot ignore issues like dilution and so on. I think, as I said, the approach that we're having is pragmatic. And okay, how do we best achieve? And I underwrite what Francesco Starace said. I think the fact that also -- it's business, not personal, but the fact that I think there is reciprocal respect from -- with both (inaudible) Starace and myself. So I think we're all pragmatic people. We're trying to see if we can find a win-win solution for everybody. And knowing that -- I'm actually quite comfortable in knowing that my counterparts are experienced and smart people, so I'm sure we'll find a way.

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Carola Bardelli, Telecom Italia S.p.A. - Head of IR [35]

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Thank you, Roman.

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Operator [36]

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Next question comes from Mr. Georgios Ierodiaconou from Citi.

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Georgios Ierodiaconou, Citigroup Inc, Research Division - Director [37]

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I have 2 -- actually, 2 follow-ups. The first one is around the cost savings on Page 14, and I appreciate you gave us a bit of color about the discontinuities you had in the second quarter of '18. My question -- and also the labor savings you are expecting in the second half of the year. My question is whether there will be other discontinuities, either positive or negative, that you experienced last year or you expect to see in the second half of this year that we should be aware of. And also, regarding the other line items apart from labor, whether it's something -- your initiatives will pay off already in the second half of this year or whether it's something where we will see the benefits more as we head into 2020.

And then my second follow-up. I think, earlier, you were asked about strategic options and maybe selling data centers. I was curious. You did not mention Sparkle, and I know you never mentioned it in the past. But before your time, there were occasions where Sparkle was being rumored or speculated as being an asset that maybe Telecom Italia could dispose. Is it something you consider core? Is it a matter of turning it around and then you see what the options are? I'd be curious to hear how you think about Sparkle from here.

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [38]

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Yes. Let me take first the question about Sparkle, and then I'll pass to Giovanni for commenting on the other questions you made. Look, as we said in the recent past, Sparkle is recovering from, I think, a period of under-management. And in fact, its EBITDA is up significantly over last year, notwithstanding the fact that it has eliminated a number of unprofitable contracts. So we're happy what's happening in Sparkle. I think it will come again under the -- in the radar scree,n, but not quite yet. So I think you won't hear anything in 2019 about Sparkle, barring any -- something I might not know at the moment. But let's say, no, there are no plans to discuss Sparkle involvement in extraordinary transaction. And if I understood correctly, that was your question, right?

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Georgios Ierodiaconou, Citigroup Inc, Research Division - Director [39]

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Correct.

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [40]

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Okay. So Giovanni, will you answer the other question, please?

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Giovanni Ronca, Telecom Italia S.p.A. - CFO [41]

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Yes. So going back to the guidance, what you -- what is clear is that 2019, we expect the low to mid-single-digit decrease in terms of EBITDA. Going forward, 2021, we confirm the indication that we will have, so from 2020, a low single-digit growth. This is the result on the cost side of the effect of the labor maneuver we are doing. Last year was the year of Solidarity for -- by definition. This year is the year in which there is the kick in of the early retirements, and that will produce their effects going forward.

Then in my experience, the -- when you have then materializing the early retirement -- the retirement effect, you understand that many things can be optimized in terms of processes in automation. So further savings are enabled by the fact that the FTEs are reduced inside the company and you work differently and more effectively on many topics. So I do expect to have a cost structure -- in 2020, 2021, a cost structure that will be materially different also from this standpoint. So the change -- the transformation has just started in that respect.

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Georgios Ierodiaconou, Citigroup Inc, Research Division - Director [42]

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Any discontinuities -- if I could follow up. Are there any discontinuities in the second half we should be aware of?

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Giovanni Ronca, Telecom Italia S.p.A. - CFO [43]

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Sorry. Say it again?

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Georgios Ierodiaconou, Citigroup Inc, Research Division - Director [44]

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Are there any discontinuities on the OpEx side we should be aware of that may impact the second half of this year or impacted the second half of last year?

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Giovanni Ronca, Telecom Italia S.p.A. - CFO [45]

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The only point I mentioned is Solidarity. Apart from that, there is no other extraordinary effect on costs. Be always conscious to the fact that a portion of the costs are noncash, related to deferred cost of previous years. So this is smoothing our ability to translate cost into cash in the very short term. It will happen in the longer term. The fact is that the actions we are putting in place today are key to then deliver going forward. There is nothing extraordinary we plan to do going forward.

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Carola Bardelli, Telecom Italia S.p.A. - Head of IR [46]

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Thank you, Georgios.

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Operator [47]

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Last question is from Jeremy Dellis from Jefferies.

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Jeremy A. Dellis, Jefferies LLC, Research Division - MD & Senior Telecommunications Analyst [48]

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I had a question on organic EBITDA actually in the domestic business, declining around 4% year-on-year both in the first quarter and in the second. And that's broadly consistent with, I suppose, your full year guidance, but I wondered if we should expect an improvement in the second half given what you've been saying about cost and head count reductions kicking in from the 1st of July.

But I asked the question because there's also a potential sort of tailwind unwinding, which is that, I suppose, from the third quarter, you lose the EBITDA tailwind from the EUR 1.95 price increase applied to 8 million broadband customers last July, and that could be a sort of EUR 40 million or 3 percentage point tailwind dropping out. So really just to ask whether we can expect an improvement, really, in the organic domestic EBITDA trend in the third quarter.

And my second question has to do with retail broadband adds. You reported a stronger number, obviously, this quarter. Is that a basis that we should think of in terms of further improvement that will then in itself drive improvement in access line loss as well? And can we expect you to be on top of selling broadband into voice-only, seeing more benefit from the TIM SUPER initiative from June and also from the new Sky initiative? How to think about that, please?

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Luigi Gubitosi, Telecom Italia S.p.A. - CEO, General Manager & Executive Director [49]

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Okay. Lorenzo will take this question about the broadband. But with regards to the -- I'll answer your question about EBITDA and tailwinds or headwinds. I think we have both, basically, at the moment, and we have some headwinds which are made -- mostly made by the fact that we have not been raising prices this -- now in this quarter and -- as we did last year. So as we have a smaller customer base, that's going to prove an unflattering comparison. On the other end, there's a number of cost initiatives. So all in all, we are happy with our guidance for the year. And we definitely see that by year-end, you'll see improvements.

With regards to the specific part on the fixed line, I'll ask Lorenzo Forina to take your question.

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Lorenzo Forina, Telecom Italia S.p.A. - Chief Revenue Officer [50]

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Well, just to let you know that what the CEO said is currently ongoing, namely Fix the fixed plan. And we're experiencing already quite some very good signals in terms of recovering of health and structural performance on wireline. Namely, we've been working a lot during the first and second quarter on reducing the activation -- the deactivation, and we already see signals of reducing the deactivation of 1/3, which is a big number.

And on the other hand, 3 things make me quite positive on line loss on the third and fourth quarter. First is the agreement on content that we discussed; second, the new offering on second of -- secondary houses or mobile-only, the so-called TIM flexi that we didn't mention but is somehow getting very good traction in the market. And last that we mentioned in the presentation, we will launch the FWA offering in the third quarter that make us target very, very new segments we've never been present.

What we did on broadband -- on broadband, yes, we have been upselling broadband to our voice-only customer base. And we are building up a more future-proof customer base because they can then be upselling to fiber or we can -- and we are selling the modem to them, and we are selling more service. Just it's an initial path that is showing good results that will go on as well in the third and fourth quarter.

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Carola Bardelli, Telecom Italia S.p.A. - Head of IR [51]

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Thank you very much, Jerry. Thanks a lot to all of you. I think we are now ready for holidays or at least for the weekend. And if there is any follow-up question, Investor Relations is obviously available for any question you may have. And see you in the autumn.

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Operator [52]

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The conference call is over. Thank you for calling.