Bleak outlook and price war warrant Hold recommendation

– We confirm our Hold recommendation, while lowering our target price from EUR 10.7 to EUR 10.0. We reduce our EPS estimate for 2010e by 3.7% and for 2011e by 4.3%, after including the impact of the domestic fixed and mobile merger.

– We expect only a slow recovery this year and therefore view the revenue target of EUR 4.7bn as unreachable. Domestic business continues to suffer from aggressive mobile and fixed-line prices, while the CEE subsidiaries are still under macroeconomic pressure. 2011 should show a stabilization. We expect TKA to see meaningful revenue growth only from 2012.

– Telekom Austria expects a EUR 80mn negative cash flow impact in 2010, break-even in 2013 and a EUR 100mn positive cash flow impact from 2014. Cross-selling should support revenues already from 2010 onwards. Merger costs should negatively affect 2010 and 2011 EBITDA, while cost synergies should boost EBITDA from 2014.

– The fixed and mobile market in Austria is experiencing continuous price competition. In 4Q09-1Q10, all mobile operators offered a 50% discount on monthly fees for the whole contract period. This offer has now been replaced by free monthly fees until year-end (A1 Smart), a 6-month free monthly fee (T-Mobile Surf) and a EUR 50 bonus when changing networks (orange all tariffs). In the fixed-line business, Kombi Paket retained its low Christmas prices. The latest promotion is free TV for new IPTV customers of Telekom Austria. We therefore do not expect the domestic business to post revenue growth before 2012.

– The 2Q10 results preview shows that a recovery has not taken place. After profit growth in 1Q10, we estimate Telekom Austria will post a 2.5% y/y profit decline in 2Q10. Major CEE operations still suffered from the recession, while the domestic operation faced stiff competition.