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On Sep 18, 2013, we downgraded our recommendation on Orange (ORAN - Analyst Report) to Underperform from Neutral rating due to its subdued performance during the first half of 2013.

Why the Downgrade?

Decelerating mobile service revenues in France and lower Enterprise segment revenues resulted in annualised decline in the top and the bottom line. Stiff competition, regulatory concerns and wireless switch also remain detrimental to the company’s performance. The Paris-based company currently carries a Zacks Rank #5 (Strong Sell).

Detailed Analysis

Cutthroat competition within the French telecom market is forcing Orange to reduce its average revenue per user (ARPU). Rollout of attractive 3G plans by broadband service provider, Iliad SA has resulted in continued revenue erosion. In an attempt to remain competitive, the company slashed its service rates. Orange expects ARPU to decrease around 12% in 2013 and in turn impact its performance.

Regulatory issues in certain European markets remain concerns for the company. Reduction in mobile termination rates in key markets such as the U.K. and Spain continues to impact the company’s revenues from these markets. Additionally, in Belgium, mobile tariffs have been decreased by the fixed line carriers to bring in new customers while triple play rates in the country are one of the highest in Europe. This is impacting the competitive balance in the country.

The ongoing wireless substitution trend has affected Orange’s fixed line telephone business as the company continues to face access line losses. To compensate for access line loss the company is jointly implementing the FTTH (Fiber to the Home) network in Spain with Vodafone Group Plc. (VOD - Analyst Report) at a cost of around $ 3 billion. This can, however, constrain Orange’s balance sheet.

Slowdown in economic growth in the emerging markets could hurt the company’s expected return on investment, minimizing shareholder rewards. Additionally, the company recently issued $1.95 billion (€1.5 billion) worth of debt, which could enhance its leverage position and affect margins. Based on these risks, we have a negative stance on the company.

Other Stocks

Other stocks that are worth mentioning within the same sector are Cellcom Israel Ltd (CEL - Snapshot Report) and Telefonica (TEF - Analyst Report). CEL currently has a Zacks Rank #1 (Strong Buy) while TEF carries a Zacks Rank #2 (Buy).

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