17 November 2015 Country Update Tide turns as recovery starts At the macro inflection point: 11.8% unemployment. Jobs Act bearing fruit August data showed Italy broke through the 12% floor on the unemployment rate after three years, falling 1pp below the end-2014 peak. New perm contracts are 1.33m ytd vs 991k in the same 2014 period (+340k, or +34%), with 307k temp contracts converted to perm vs 261k last year (+46k, or +18%). Perm hires are running 31% above the pre-jobs Act quarterly average, whilst terminations are 5% below, which means Italy finally managed to create net new perm jobs of 77k in Q1 and 32k in Q2. Separating wheat from chaff: tax cuts, not higher productivity, driving hiring INPS data say 70% of new perm contracts are due to tax cuts, not necessarily to macrodriven new job creation. The monthly path is volatile and trending down: new perm contracts spiked in March (+95k) and April (+103k), but lost steam in May (-13% mom) and June (-9% mom), before posting a meagre 39k in August. After slowing hiring in 2H14 awaiting the Jobs Act, corporates caught up and rushed to cash in the tax cuts, slowing down hiring afterward. Perm hires as a percent of the total started to rise in January, when tax cuts were introduced, and peaked in March at 43% (from 30% at end 2014). They are now back to the mid-30% region. Moreover, >90% of net new perm jobs are in less productive Southern/Central regions. Indeed, Veneto, Emilia, Piedmont and Lombardy, i.e. 50% of GDP, only account for 4% of net new perm jobs in 2015. The rollover of tax cuts into 2016 is crucial to keep up momentum Perm contracts will exceed the government estimate this year. The Stability Law will extend tax cuts to new perm hires next year, even though they will be 60% lower (from 8,060 to 3,250) and for two years only. This should fuel new perm hires next year, while buying time for the reform to raise productivity mid-term. MB Jobs Act survey: 89% of respondents view the labour reform as positive We surveyed the HRs of 47 Italian corporates. Consensus (76%) said the Jobs Act makes new hiring easier, but only 15% have increased their workforce accordingly. Almost 68% expect new hiring will be mostly of young people. The picture is of a positive-but-slow reaction to the reform, due to macro uncertainty, scepticism on productivity gains, and tax cuts being a one-off. Since August though, when we ran the survey, we have seen GDP upgrades and tax cuts extended to 2016, which is why we expect an acceleration in net new perm hiring next year. Tax Credit Certificates (TCCs) Our proposal to policy-makers to boost demand Following a similar solution Germany adopted in 1933 (MEFO bills), Italy could issue TCCs, i.e. claims with the right to pay the government for taxes. TCCs are not debt (no reimbursement in euros) or currency (no legal tender). Thus, they might not be in breach of EU treaties. We estimate two years deferral on such quasi (fiscal) money would activate a 1.2x Keynesian multiplier, i.e. the demand shock needed to complement the supply-side focus of the Jobs Act. Our macro simulation points to doubling GDP growth in 2016-17 to 3%, surplus at 0.8% in 2017 (vs 1.1% deficit) and debt/gdp at 112% in 2019 vs the current 120% estimate. 77bn higher GDP in 2017 would not jeopardise tax revenues, which would be 16bn higher after accepting the TCCs due to mature. TCCs could also support public works via CDP. Tax cuts are 3% accretive in our coverage if fully exploiting the age pyramid We estimate 2% of the workforce in Italy is eligible for early retirement, i.e. 14% of people older than 50/55 years. Replacing them with new, cheaper hires would boost EPS by 3% pa, so that the one-off solidarity fund cost would be covered in five-six years. RCS (+27%), L Espresso (+15%) and Mondadori (+13%) lead the EPS accretion rank on the rhs table, with TI and MS (+6%/+7%) confirming the high TMT gearing. Finmeccanica (+8%) and Italcementi (+5%) as cyclicals, BP (+5%), UBI and BPM (c.+3%) among banks, Hera (+8%) and among utilities complete the winners. Antonio Guglielmi Equity Analyst +44 203 0369 570 antonio.guglielmi@mediobanca.com Javier Suarez Equity Analyst +39 02 8829 036 Nicolo Pessina/Sara Piccinini/Carlo Signani We thank Marco Cattaneo for his contribution to the section on Tax Credit Certificates Italian Equity Team Alessandro Tortora +39 02 8829 673 Andrea Filtri +44 203 0369 571 Chiara Rotelli +39 02 8829 931 Fabio Pavan +39 02 8829 633 Gian Luca Ferrari +39 02 8829 482 Massimo Vecchio +39 02 8829 541 Niccolò Storer +39 02 8829 444 Riccardo Rovere +39 02 8829 604 Simonetta Chiriotti +39 02 8829 933 Simulation on tax cuts from new hiring, 2016 EPS Jobs Act, 3yrs annual avg (not in MBe) RCS Mediagroup 26.6% L'Espresso 15.4% Mondadori 13.0% Finmeccanica 8.0% Hera 7.9% Mediaset 7.1% Telecom Italia 6.0% Italcementi 5.5% A2A 5.4% Banco Popolare 5.2% Iren 4.7% AEFFE 4.6% Autogrill 4.5% Cairo Communication 3.7% UBI Banca 3.4% Banca Pop. Milano 3.4% Credem 2.6% Acea 2.6% Creval 2.5% Intesa Sanpaolo 2.0% Rai Way 1.9% Unicredit 1.7% EI Towers 1.5% Enel 1.2% Pirelli & C. 1.1% Snam 1.1% Cerved 1.1% Buzzi Unicem 0.9% Fincantieri 0.8% Geox 0.8% Atlantia 0.7% Prysmian 0.6% Generali 0.5% ENI 0.5% Tod's 0.4% Enel Green Power 0.4% Salini Impregilo 0.3% Banca Generali 0.2% Mediolanum 0.1% Source: Mediobanca Securities estimates IMPORTANT DISCLOSURE FOR U.S. INVESTORS: This document is prepared by Mediobanca Securities, the equity research department of Mediobanca S.p.A. (parent company of Mediobanca Securities USA LLC ( MBUSA )) and it is distributed in the United States by MBUSA which accepts responsibility for its content. The research analyst(s) named on this report are not registered / qualified as research analysts with Finra. Any US person receiving this document and wishing to effect transactions in any securities discussed herein should do so with MBUSA, not Mediobanca S.p.A.. Please refer to the last pages of this document for important disclaimers.
Contents Executive Summary - The Italian labour market is changing 3 Jobs Act the pillars of the labour reform 8 First effects of the Jobs Act 20 Jobs Act effect on MB coverage: 3% EPS accretion 30 The Mediobanca Jobs Act survey 41 Tax Credit Notes to complement the Jobs Act 49 17 November 2015 2
Executive summary The Italian labour market is changing Unemployment rate down to 11.8% signals an inflection point during the summer... Most recent ISTAT data suggest a potential inflection point in the Italian unemployment rate during the summer. Indeed, August data show that for the first time over the last three years, Italy broke through the 12% floor, bringing its unemployment rate 1pp under the peak observed at the end of 2014 at 11.9%. September confirmed such trend with 11.8% rate. The number of employed people reached 22.6mn, +0.3pp, or +69k mom in August, and +1.5pp, or +325k, yoy. The picture remains gloomy, however: almost 60% of unemployed people are not able to find a job for at least one year; only Greece, at 70%, has a higher rate. The main EU countries range between 30% and 50%. Similarly, discouraged as a percentage of inactive remains the highest in Europe, at 13%.... meaning the Jobs Act is already bearing fruit? The new labour reform introduced in March 2015 is built on three pillars: the new perm contract with increasing security according to tenure; the new rules on dismissal; and the tax deduction scheme for 2015 permanent activations applied on a three-year horizon for a maximum of 8,060 per annum. We looked in detail at the reform in our March report (see Job Done, 26 March 2015). Six months into the new framework, we aim to check if and how this is now working in order to understand how much of the recent positive newsflow can be attributed to the new labour market regulation. Net new perm contracts created six months after the Jobs Act The good news: perm hires are rising An accelerating trend on new perm hires seems clear. New perm contracts ytd amount to 1.33m vs. 991k the previous year (+340k, or +34%), with 307k temp contracts converted to perm vs. 261k last year (+46k, or +18%). Perm hires are thus running 31% above the pre-jobs Act quarterly average whilst terminations are 5% below, which means that Italy has, for the first time in the last few years, created net new perm jobs, specifically 77k in Q1 and 32k in Q2 (rhs chart below). The lhs chart below shows that 2015 data marked a change from the trend observed over the previous two years, when net activations were negative at more than 200k each year. Permanent contracts activated, terminated and net between the two, 000 1,100 600 100 Activated Net 1,010 991 Terminated 1,331 98 Permanent contracts; Activations, terminations and delta 1Q12-2Q15 (quarterly) 800,000 Activated Terminated 600,000 400,000 200,000 00-200,000 Net activation 76.9k 31,8k (400) (900) (1,400) (248) (216) (1,258) (1,207) (1,233) Jan - Sept 2013 Jan - Sept 2014 Jan - Sept 2015-400,000-600,000-800,000 Source: Mediobanca Securities on Ministero del Lavoro and INPS data 17 November 2015 3
The bad news: INPS tax cuts, more than macro or the new contract per se, explain the delta A less rosy picture emerges, however, when we break down the data. INPS figures in fact suggest 70% of the new perm activations are explained by the tax cuts and not necessarily by genuine new job creation due to the new contract per se. The monthly path is also volatile and trending down: perm activations spiked in March (+95k) and April (+103k), but lost steam in May (-13% mom) and June (-9% mom), before posting a meagre 39k units in August. This seems to reflect a sort of catch-up effect, i.e. companies suspended hiring in 2H14 in anticipation of the Jobs Act, cashed in the tax benefits at the beginning of the year, and slowed hiring again afterward. As a result, after an initial spike in net new perm activations in April (+49,851), the following months have seen a downward trend, leading to negative figures (lhs chart below). Permanent contracts as a percent of total contracts activated have increased their share since the introduction of the tax benefits in January 2015 (from 30% in December 2014 to a March 2015 peak of 43%), but are now back down to the mid-30% region. Net activations of permanent and temporary contracts 200,000 Permanent Temporary 144,074 150,000 147,830 94,519 100,000 70,668 49,851 50,000 271 47 31,370-9,768 0-50,000-100,000-115,188-150,000 Permanent contract as % of total contracts 50% 45% 40% 35% 30% 25% 34% 32% 31% 31% 31% 39% Tax deduction scheme available New perm. contract 43% 41% 39% 35% 33% 33% 31% 30% 30% 30% 29% 31% 30% 30% 28% 42% 38% 37% 35% 33% 34% Source: Mediobanca Securities on Ministero del Lavoro data We must also flag that >90% of the net new perm hires come from the less productive Southern/Central regions, with Lazio, Campania, Sicilia and Puglia alone accounting for 74% of the total. Put differently, Veneto, Emilia Romagna, Piedmont and Lombardy (i.e. nearly 50% of Italian GDP) only account for 4% of the net new perm jobs created in 2015, further suggesting that tax cuts, more than GDP growth, have driven the process so far. The pending Stability Law is a key positive, given the rollover of the tax incentives to 2016 Perm contracts activated through the tax cuts should exceed the 1mn government estimate this year. The 2016 Stability Law under approval will envisage a rollover of the tax deduction scheme to new perm hires activated next year. While for 2015, companies were entitled to 8,060 INPS (social security contributions) deductions for as long as three years, the new scheme envisages a 60% reduction, to 3,250, and a two-year timeframe for new perm hires in 2016. We consider this extremely positive, as it should help fuel the momentum on new perm activations via tax cuts while buying time for the labour reform to bear fruit in the medium term via higher productivity. 17 November 2015 4
% of EBITDA in Italy Italy Labour tax cuts are 3% accretive in our coverage universe Labour-intensive and Italy-focused companies are more geared into the Jobs Act Financials, utilities, real estate and TMT are the sectors best positioned to take advantage of the Jobs Act, given their above-average margin exposure to Italy (the new labour reform applies only to the Italian workforce) and their high labour intensity. Labour costs on total costs (%) vs. EBITDA in Italy (%), 2014 Source: Mediobanca Securities on companies data Our modelling assumes layoffs replaced by new perm hires In order to estimate the potential benefit of the Jobs Act, our modelling looks at the time needed to recoup the negative one-off cost of redundancies of the first year. As such, we look at the activation of the so-called Solidarity Fund that is required in order to reduce the workforce before introducing new entry-level employees. This way, we estimate the cost savings in the years following the activation of the Solidarity Fund, translating into higher EPS due to tax cuts on new hires. The age pyramid is the key constraint in our modelling in quantifying the room for layoffs available. 1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 Oil Utilities TMT Real Estate Infrastructure Consumers Pure Industrials Branded Goods Healthcare Financials 0 0.1 0.2 0.3 0.4 0.5 0.6 Labour costs on Total Costs in IT Our first conclusion is that roughly 2% of the workforce located in Italy is still eligible for early retirement, i.e. 14% of the employees older than 50/55 years. As a result, the 45 companies under our coverage included in our analysis face an average 15% negative EPS impact in year 1 from one-off costs related to early retirement, with TMT being the sector most impacted (c.-32%). Replacing older workers with new, cheaper hires would boost EPS by c.3% pa, with TMT leading the pack at +6%, followed by Utilities (+3%), Financials (+2.2%) and Pure Industrials (+2.0%). As a result, it will take, on average, between five and six years for a company to recoup the initial one-off cost generated by the Solidarity Fund. We estimate that an early retirement plan entirely recovered through new hiring would reduce the labour cost by c.200bps, on average, and the cost/income ratio by c.50bps. Companies that could benefit the most from the Jobs Act based on our methodology are RCS (+27%), L Espresso (+15%) and Mondadori (+13%) among TMT, Finmeccanica (+8%) and Italcementi (+5.5%) of cyclicals, Banco Popolare (c.+5%), UBI and Banca Popolare di Milano (c.+3%) among banks, and Hera (+8%) among utilities. Telecom Italia and Mediaset would also enjoy a mid-single-digit EPS benefit confirming the high gearing of the TMT sector to the labour reform. 17 November 2015 5
Mediobanca Jobs Act survey The Mediobanca Jobs Act survey Almost 89% of respondents view the labour reform as very positive... If our theoretical modelling suggests enough gearing to the labour reform in our coverage, how much are our companies really adjusting themselves to the new labour market framework in practice? We surveyed the HR departments of 47 Italian corporates that we cover and collected an overall constructive message, given that 89% of respondents viewed the labour reform as a positive step. Do you see the labour reform (Jobs Act) as positive? 33% Disagree 2% Neutral 8% Do you think that more labour flexibility and increased ease in making redundancies will result in an increase of employment? Agree 37% 9% disagree 9% Disagree 15% Agree 56% Neutral 30% Source: Mediobanca Securities... but only 15% have increased the workforce due to the Jobs Act... However, uncertainty on the macro impact remains, which is why corporates do not seem to have positioned themselves at full speed to take advantage of potential medium-term productivity gains and of short-term tax cuts benefits. Consensus (76%) emerges that the Jobs Act will make new hiring easier, but the same does not apply (only 35%) in regards to redundancies. The main negative we found was that only 46% of respondents believe the reform will increase employment, and this is mainly due to the persisting uncertainty about the potential link between flexibility and productivity (only 26% see a causal connection). It follows that only 15% of the sample confirms an increase in the workforce so far as a result of the Jobs Act, while 55% expect the reform to bear fruit only in the long run.... but not necessarily due to the tax incentives In what is surprising to us, corporates seem reluctant to admit their new hiring policy has been mainly driven by INPS tax incentives, as two-thirds disagree that tax cuts explain their new perm hiring and only 21% expect an acceleration in new perm hires before year end when 2015 tax incentives will terminate. Moreover, none of respondents intends to relocate its foreign activity back in Italy to take full advantage of the new labour reform. Flexecurity will reduce the powers of the unions Interestingly, in our view, there seems to be no consensus on whether increased flexibility has come at the expense of job security, as almost 36% disagree that employees feel less protected and another 28% have a neutral opinion. As far as unions are concerned, only 9% think the Jobs Act has complicated relations with unions, while 56% believe the relevance of unions is poised to decrease over time with individual negotiations gaining sway. Uncertainty on macro and on flexibility vs productivity say the best is yet to come in 2016 In summary, what emerges is a picture of a positive but slow reaction to the new labour reform due to persisting macro uncertainty, to scepticism on related productivity gains and to the one-off tax cuts attached to the reform. We collected these views in late summer. Two relevant things have happened since then: consistent GDP upgrades and rollover of the tax cuts into 2016. We think these two factors will help make Italian corporate more comfortable towards new hiring, which is why we expect 2016 to show an acceleration in the trend of net new perm hiring. 17 November 2015 6
Tax Credit Certificates - the demand shock Complementing the Jobs Act with a shock on the demand side a proposal to policy makers The recent government projections increased GDP growth rate to +0.9% in 2015 and 1.6% in 2016. We deem this as realistic but not good enough to tackle the unemployment rate at 11.9% and to recover the 10% output lost between 2008 and 2014. We believe the reforms implemented by the government, as long as positive, are mainly focused on the supply-side of the equation whereas we think demand-side policies would also be greatly needed to fight the current economic depression. Classic expansionary policy would increase public investments and/or lower taxes to increase output, lower unemployment and boost workers purchasing power. However, euro area regulations limit or rather forbid most of these actions, forcing Italy into austerity. Tax Credit Certificates: boosting growth via quasi (fiscal) money without breaching EU treaties We believe tax credit certificates (TCCs) would represent the shock needed on the demand side in order to boost growth without being at the same time in breach of the EU regulation. Following a similar solution adopted by Germany with the so-called MEFO bills in 1933, TCCs are claims that give the owner the right to pay for liabilities to the government for taxes, contributions, sanctions, etc. They are not to be considered debt as the government would never reimburse them in euro whereas it would accept them to reduce the tax burden. Equally they are not currency as they are not legal tender. This is why they could be considered as fiscal money or quasi money. Our macro simulation suggests a TCCs injection would double GDP growth in 2016-17... We simulate TCCs to be assigned for 20bn in 2016, 40bn in 2017 and 40bn in 2018. Two-thirds would be assigned to sustain demand, one third to improve competitiveness. All of them would have a deferral of two years so not to jeopardise the financial stability of the government and having enough time for TCCs to generate additional output via a 1.2x Keynesian multiplier. Our simulation indicates GDP growth would double in 2016 and 2017 to 3%, surplus would reach 0.8% in 2017 versus the 1.1% deficit assumed today, debt / GDP would land at 112% in 2019 versus current base case at 120%. In summary, injecting such a shock via an implicit tax cut achieved through TCCs deferred by two years, GDP would be 77bn higher in 2017.... without jeopardising tax revenues and before activating other players such as CDP Our modelling suggests 36bn higher tax revenues in year 2, which would decrease to 16bn after accepting 20bn of TCCs issued two years before and due to mature. Hence, the government would be left with double GDP growth on top of a positive 16bn delta on tax revenues. TCCs could be used in various ways, such as financing public works initiatives of the government or supporting expansionary projects via Cassa Depositi e Prestiti. Reconciling the numbers from no CCFs to CCFs issuance 2015 2016 2017 2018 2019 Base case GDP 1,679 1,735 1,793 1,849 Direct GDP increase from TCC: cumulative 24 48 48 48 Effect of higher inflation 15 21 25 29 Effect of compounded real growth 0 2 4 5 New GDP with TCCs 1,719 1,806 1,870 1,932 Inflation - without TCC 1.1% 1.7% 1.8% 1.8% Inflation - with TCCs 2.0% 2.0% 2.0% 2.0% Price index - without TCCs 100.00 101.07 102.80 104.67 106.55 Price index - with TCCs 100.00 102.00 104.04 106.12 108.24 Higher GDP 40 71 77 83 Tax rate % 47.8% 47.5% 47.4% 47.2% Higher gross government revenues 19 34 36 40 TCC utilised -20-40 Higher net government revenues 19 34 16 0 Source: Mediobanca Securities 17 November 2015 7
Jobs Act the pillars of the labour reform Most recent ISTAT data seem to suggest a potential inflection point in the Italian unemployment rate during the summer. Indeed, August data show that for the first time over the last three years Italy broke the 12% floor, bringing its unemployment rate 1p.p. below the peak observed at the end of 2014 at 11.9%. September data confirmed such positive trend with 11.8% unemployment rate. The number of employed people reached 22.6mn, +0.3p.p. or +69k mom in August and +1.5p.p. or +325k yoy. The picture remains gloomy though: almost 60% of unemployed people are not able to find a job for at least one year; only Greece has a higher rate, with more than 70%, while the main EU countries range between 30% and 50%. Similarly, the number of discouraged as a % of inactives remains the highest in Europe, at 13%. In this chapter, we summarise the pillars of the labour reform that we discussed at length in our note Job Done, 26 March 2015: the introduction of the new permanent contract with increasing security according to tenure; the new rules on dismissal; and the tax deduction scheme for 2015 permanent activations applied on a three-year horizon for a maximum of 8,060 per annum. In the rest of this research note we will focus on the initial effects of the Jobs Act in the six months since its introduction (Chapter 2), on its implications for our stock coverage both in terms of EPS impact from tax cuts (Chapter 3) and of companies expectations going forward, which we collected via survey (Chapter 4). We will conclude our work with a proposal to policy makers on how to complement the supply side intervention of the Jobs Act with demand side initiatives aimed at boosting growth via tax credit certificates, i.e. fiscal money (Chapter 5). Unemployment remains an issue Inflection point in August? The upward trend in the Italian unemployment rate over the last couple of years contrasts with the downward trajectory observed for the Eurozone as a whole and places the country at historical peak levels. Unemployment rate Italy and Euro area - Monthly (%) 13.5 Italy Euro area 13.0 13.0 12.7 12.8 12.7 12.6 12.8 12.5 12.5 12.6 12.4 12.4 12.0 11.9 11.7 11.8 11.5 11.5 11.5 11.2 11.1 Unemployment rate Italy Annual (%) 16 14 13.0% 12 11.3 10 8 6 6.4 6.1 9.7 13.0 11.0 4 Source: Mediobanca Securities on Eurostat data Source: Mediobanca Securities on ISTAT data However, the last available ISTAT data seem to suggest that a potential inflection point has been materialising during the summer. As shown below, the unemployment rate stood at 11.9% in August, down 0.1p.p. mom. Indeed, this was the first time in the last three years that Italy managed to break the 12% level, placing its unemployment rate 1p.p. below the peak observed at the end of 2014. As of September the unemployment rate stands at 11.8%. 17 November 2015 8
Italy: unemployment rate monthly data (Jan-2008 to Sep-2015, %) 14 13 12 11.8 13.0 11.9 11 11.8 10 9 7.7 8 6.7 7 6 Source: Mediobanca Securities, ISTAT As a result ISTAT data show the number of employed people reached 22.6 million as of August 2015. Employed monthly data (Jan-2008 to Sep-2015) 000 23,400 23,200 23,000 22,800 22,600 22,400 22,200 22,000 21,800 21,600 23,202 22,657 22,667 22,134 22,545 Source: Mediobanca Securities, ISTAT But unemployed people are staying unemployed longer... Italy keeps reporting one of the highest rates of long-term unemployment (12 months or more) as a % of total unemployment in Europe. Indeed almost 60% of unemployed are not able to find a job for a year or more. Only Greece has a higher rate, at more than 70%, while Italy s major peers range between 30-50%. Long-term unemployment (12 months or more) as a % of the total unemployment (%) 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 Belgium Ireland Spain Italy United Kingdom Germany Greece France Finland Source: Mediobanca Securities on Eurostat 17 November 2015 9
...up to the point that they stop even looking for a job... The Eurostat indicator of people available to work but not seeking reveals more than a 50% increase since 2005, having reached the alarming figure of 3.4mn. The rhs chart below shows that Italians are the most discouraged workers within Europe, ahead of countries such as Bulgaria, Portugal and Spain. Italy - People available to work but not seeking 2005-14 (m) 3.5 3.3 3.1 2.9 2.7 2.5 2.3 2.1 1.9 1.7 1.5 Source: Mediobanca Securities on Eurostat data...or just ask friends... Discouraged as a % of inactive (think no work is available) 2014 Italy Bulgaria Portugal Spain Finland Poland Euro area Netherlands Belgium Ireland France Sweden Greece Germany Luxembourg Switzerland Austria United Kingdom Denmark 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0.0 2.5 5.0 7.5 10.0 12.5 15.0 In Italy only 28.6% of the unemployed people try to find a job through the public unemployment offices whereas in Germany the rate is almost 80%. The Jobs Act includes a reform of these agencies, which through centralisation and enhancement is expected to provide better service. So far, though, Italians in almost 84% of cases prefer to try and find a job through friends and personal relationships. Job search: ask friends, relatives, trade unions (%) 2014 Greece Czech Rep Ireland Spain Italy Portugal Austria Euro area Poland Bulgaria Denmark France Netherlands Luxembourg UK Germany Finland Belgium Sweden Switzerland Norway 0.0 20.0 40.0 60.0 80.0 100.0 Job search: contact public employment office (%) 2014 Czech Rep Germany Austria Luxembourg Poland Sweden Belgium Greece France Norway UK Finland Euro area Denmark Bulgaria Netherlands Switzerland Portugal Ireland Italy Spain 0.0 20.0 40.0 60.0 80.0 100.0 Source: Mediobanca Securities on Eurostat data 17 November 2015 10
Youth pays the highest price Signs of change emerge on youth unemployment, whose rate stood at 40.5% as of September 2015, a decrease of -1.3p.p. yoy. Youth unemployment monthly data (Jan-2008 to Sep-2015, %) 48 43 43.7 38 33 29.1 38.2 40.5 28 29.3 23 18 21.5 Source: Mediobanca Securities, ISTAT Share of permanent employment in a downward trend for youth The number of employed people under permanent contract has been decreasing slowly over the last 14 years, from 89.9% to 86.4%. However, such decrease is much more pronounced among youth workers. If in 2003 those aged between 15-24 had a permanent contract in 72.6% of the cases, by 2014 their share had dropped to 44.0%. We note that the sharp drop in 2004 probably stems from the introduction of the Legge Biaggi the year before, which introduced new and more flexible labour contracts, including the co.co.pro, apprenticeship, occasional work and other forms of temporary work. At the time of the reform, youth unemployment stood at 20.6% whereas as of August 2015 such number had doubled to 40.7%. Share of permanent employment; 15-24yr and total (2000-2014, %) 100 15-24yr Share of permanent employment Total Share of permanent employment 90 89.9 90.2 90.1 90.1 88.2 87.8 86.9 86.8 86.7 87.6 87.3 86.7 86.2 86.8 86.4 80 70 73.4 74.7 72.9 72.6 60 50 65.5 63.1 59.1 57.8 56.6 55.5 53.2 50.0 40 46.8 47.3 44.0 Source: Mediobanca Securities on OECD data 17 November 2015 11
The Jobs Act The new permanent contract with increases in security related to tenure In Job Done (26 March 2015), we analysed in detail the new labour reform introduced this year in Italy. We summarise in the remaining sections of this chapter the key pillars of the reform. Effective as of 7 March 2015, the Jobs Act introduced a new form of permanent contract with increases in job security based on the seniority of the worker. This will apply only to the private sector. A reform of the public sector is expected later on. The government foresees the new regulation encouraging the use of this form of employment rather than the temporary one, in an attempt to reduce job insecurity, as well as to improve competitiveness and consequently lower unemployment through economic growth. The new permanent contract establishes increasing levels of security related to tenure. The standard protection in case of dismissal foresees two months salary compensation for each year of service with a minimum of four months and up to a maximum of 24 months for companies with more than 15 employees. Below the 15-employee threshold, compensation for dismissal amounts to one month s salary per year of tenure for a minimum of two and a maximum of six months. Three years of tax deduction on new perm contracts means up to 24,180 tax incentive... In order to facilitate the transition towards the new form of permanent contract, the 2015 Stability Law allows for tax deductions for as long as 36 months on new permanent hires and on contracts converted from temporary to permanent. This applies as a one-off tax relief only to new permanent contracts issued in 2015. Tax exemption is limited to 8,060 per year (or 24,180 in three years). In order to be eligible for such tax relief, the employee shall not have been employed under a permanent contract within the previous six months and shall not have been part of any other tax relief programme. Moreover, the tax benefit will apply only to contracts activated throughout 2015, and will be valid for INPS contributions only. No tax benefits are allowed for INAIL, TFR or solidarity fund. The 2016 Stability Law recently presented by the government intends to roll over such tax benefits to 2016 and 2017 permanent hires. Starting from 2015, companies will also be waived from paying the IRAP tax on employees with a permanent contract. This is expected to reduce the tax wedge in Italy, which, as we show below, is among the highest in OECD countries together with social security contributions. Tax wedge and social security contribution for low-income workers (assumes compensation of 67% of the average) 2014 60 Average tax wedge Average rate of employers's SSC 50 40 30 20 10 0 Source: Mediobanca Securities on OECD data... as detailed in the case studies below for INPS... The table below shows some examples of the amount of tax deductions that come with the 2015 Stability Law. We calculate the tax benefits for three different levels of seniority within the construction sector and covered by the national collective contract (CCNL, Contratto colletivo 17 November 2015 12
nazionale). The workers in the examples below also have different levels of INPS rate, which translate to different levels of INPS contributions. INPS tax deduction examples ( ), 2015 and 2015-17 For the worker with a lower INPS rate (28.98%), the tax benefit is as much as 5,680 annually and 17,040 for the three-year period. This means that his employer will not have to pay any INPS contribution. The 2015 Stability Law has implemented a further tax deduction based on which the IRAP tax (regional tax on production) will have the cost of permanent workers deducted from its calculation. This means about 992 of additional tax benefits on the permanent employee. The same is true for an employee with annual taxable income of up to 19,600 but an INPS rate of 30.88%: 100% deduction of the 6,052 INPS tax, 18,157 over the three-year period and a 992 IRAP benefit. For a worker with higher seniority and an annual taxable income of up to 28,000, the tax benefit reaches its annual maximum of 8,060, 24,180 over the three-year limit with an extra 1,496 from IRAP tax savings. Sector: Construction Medium Seniority CCNL High Seniority CCNL Annual taxable income (14 monthly salaries) 19,600 19,600 28,000 INPS rate (%) 28.98% 30.88% 30.88% Total INPS tax 5,680 6,052 8,646 Annual INPS deduction 5,680 6,052 8,060 3 year INPS deduction 17,040 18,157 24,180 Annual IRAP deduction 992 992 1,496 Source: Mediobanca Securities calculations, CCNL= Contratto colletivo nazionale National collective contract... and IRAP... The Legge di stabilitá 2015 (2015 Stability Law) introduced IRAP tax benefits for the cost of labour for workers with permanent contracts. IRAP savings on labour costs vary according to the region: in southern Italy the impact is larger than in the north-central areas, while in the south it reaches 2.5%, and in the north-centre it does not exceed 2.3% in the best-case scenario. For the southern regions, the tax benefits have a lower impact on employees with low wages, as those regions already benefitted from past tax deductions. The table below shows an annual tax benefit from IRAP deduction ranging from 408 to almost 1,500 depending on the geographic location and age of the employee. IRAP tax benefits on permanent contracts - 2015 North - Centre Before tax, wage of 30,000 Before tax, wage of 40,000 Older than 35 yrs Tax savings as a % of labour cost... at the expense of temporary contracts Younger than 35 yrs and Older than 35 yrs women as a % of as a % of Tax savings Tax savings labour cost labour cost Younger than 35 yrs and women as a % of Tax savings labour cost 1 to 5 employees 795 1.8 585 1.3 1,271 2.2 1,061 1.83 10 employees 828 1.9 618 1.4 1,303 2.2 1,093 1.88 50 employees 854 2.0 644 1.5 1,329 2.3 1,119 1.93 South 1 to 5 employees 673 1.6 408 0.9 1,402 2.4 1,137 2.0 10 employees 714 1.6 449 1.0 1,443 2.5 1,177 2.0 50 employees 746 1.7 481 1.1 1,475 2.5 1,210 2.1 Source: Mediobanca Securities on Italian government data In contrast, temporary contracts have been penalised in terms of IRAP as a mean of incentivising permanent employment. The table below shows that the additional IRAP costs of social security contributions on temporary contracts has increased by 1.40%. In the calculation below, we assume a 3.90% average IRAP tax rate for the North Centre and 4.82% for the South. On average, we 17 November 2015 13
calculate the more penalising IRAP provisions on temp contracts increase IRAP contributions by 21-25% depending on location and age of the worker. IRAP - Additional costs for temporary contracts - 2015 Before tax, wage of 30,000 Before tax, wage of 40,000 Costs as a % of labour cost Costs as a % of labour cost North - Centre IRAP 1,250 2.87 1,668 2.87 1.40% Social security increase 420 0.96 560 0.96 Total 1,671 3.84 2,228 3.84 South IRAP 1,546 3.55 2,061 3.55 1.40% Social security increase 420 0.96 560 0.96 Total 1,966 4.51 2,621 4.51 Source: Mediobanca Securities on Italian government data Controversial issues within the Jobs Act Cost of dismissal - Jobs Act vs former policy In the charts below, we attempt to contrast the cost of dismissal under the Jobs Act versus the former policy at companies with more (lhs) and less (rhs) than 15 employees. For the former policy, we take into account the individual dismissal with standard protection or the disciplinary dismissal as defined by the Legge Fornero, which implies an indemnity between 12-24 months salary to be decided by the judge according to the worker s seniority and the company s size. We base our simulations on the following assumptions: For companies with more than 15 employees (lhs chart) we assume for the old policy 12 months indemnity for two years of employment (minimum requirement), 16 for 5yrs, 20 for 10yrs and the maximum 24 for 15yrs. Under the Jobs Act, the indemnity assumption is two months per year of employment with a minimum of four and a maximum of 24. For companies with less than 15 employees (rhs chart) we assume for the old policy 2.5 months indemnity for two years of employment (minimum requirement), 3.5 for 5yrs, 4.5 for 10yrs and the maximum 6 for 15yrs. Under the Jobs Act, the indemnity assumption is two months per year of employment with a minimum of two and a maximum of six. The results below show that: for less than 15 employees cost neutrality between the two policies is at years 2 and 10. In between, we see that the cost of dismissal is higher with the Jobs Act. Conversely, as regards to companies with >15 employees, the cost of dismissal is cheaper under the Jobs Act than under the Legge Fornero, and the two policies converge only at the 10th year in our exercise. Companies with >15 employees; cost of dismissals Wage 1,500, 2015 40,000 Worker - Fomer policy Worker - Jobs Act 35,000 30,000 25,000 20,000 15,000 10,000 5,000 2 years 5 years 10 years 15 years Source: Mediobanca Securities on Italian government data Companies with <15 employees; cost of dismissals Wage 1,500, 2015 10,500 Worker - Fomer policy Worker - Jobs Act 9,500 8,500 7,500 6,500 5,500 4,500 3,500 2,500 2 years 5 years 10 years 15 years 17 November 2015 14
The new policy comes with a risk The tax deduction incentive is inevitably bringing an increase in new permanent contract activations this year. However, we must not confuse the one-off effect of the tax deductions that the government is implementing for this year alone with the new regulation on permanent contracts. Indeed, there is a considerable risk, in our view, that the Jobs Act could actually defeat its own purpose. As the government through the Poletti decree of May 2014 did not limit enough temporary contracts, there is the possibility that once the tax deduction expires, companies will jump back into the temporary contracts those of which have not been amended in their length and are still available for as long as three years. This is even more likely when considering that, as we show below, companies would be better off by hiring under a new permanent contract in 2015, cashing in today the tax benefit and leveraging tomorrow on the lower dismissal cost. This is why we consider extremely important the effort that the government is putting in to rolling over such tax cuts on permanent employment to the next two years. This should make the positive trends on permanent employment which we analyse in Chapter 2 more recurring in the medium term rather than just the result of a one-off step aimed at cashing in on the tax cuts in 2015. Hire, fire and make a profit after one year... The two following tables outline two simulations of costs and benefits of the new labour reform. In the first exercise, we analyse a newly hired worker with the permanent contract with increasing security according to tenure. We assume that this worker will be dismissed within one year and we apply this to an annual wage ranging from 12-25k. We assume an INPS rate of 31.78%, in line with the major business sectors, and calculate the tax benefits for the year. We add an estimate of the IRAP tax deductions, assuming the 3.9% base tax rate. We add the two and then deduct the dismissal costs calculated as two months per year of tenure. In our example, as we assume only one year of employment, we end up dismissing at the minimum required cost of four months. The result (in the last column) shows that the employer could exploit the tax cuts and then dismiss the worker at no extra cost or actually at a profit ranging between 282-587, i.e., 2.0-4.0% of his gross annual wage. Representative workers hired and dismissed a year later ( ), 2015 Annual IRAP monthly wage dismissal deduction (E) Annual wage (A) (B) (13 INPS rate (C) deduction (D= (tax rate instalments) A*C - Max 3.9%*) 8,060))... or 20%, after three years Annual total benefits (F= D+E) Dismissal indemnity (G=B*2 months per year) Difference between benefits and indemnity (H= F-G) 12,000 923 31.78% 3,813 468 4,281 4,000 282 15,000 1,154 31.78% 4,767 585 5,352 5,000 352 18,000 1,385 31.78% 5,720 702 6,422 6,000 422 22,000 1,692 31.78% 6,991 858 7,849 7,333 516 25,000 1,923 31.78% 7,945 975 8,920 8,333 587 Source: Mediobanca Securities estimates, *national base tax rate, additional regional tax not applied The second simulation follows the logic above, but it applies to a worker hired for three years, i.e., the maximum allowed INPS tax deduction period. The cost for dismissal is six months salary given two months per year of tenure applied to our simulation based on three years of employment. The results show that the employer is in an even better situation, offering a profit ranging between 6,845-14,260, i.e., roughly 20% of his cumulated gross wage for the three years. Representative workers hired and dismissed three years later, 2015-18 Annual wage (A) monthly wage (B) (13 instalments) INPS rate (C) Annual INPS deduction (D= A*C - Max 8,060)) IRAP deduction (E) (tax rate 3.9%*) Annual total benefits (F= D+E) 3 year total benefits (G= F*3) Dismissal indemnity (G=B*2 months per year) Difference between benefits and indemnity (H= F-G) 12,000 923 31.78% 3,814 468 4,282 12,844 6,000 6,845 15,000 1,154 31.78% 4,767 585 5,352 16,056 7,500 8,556 18,000 1,385 31.78% 5,720 702 6,422 19,267 9,000 10,267 22,000 1,692 31.78% 6,992 858 7,850 23,548 11,000 12,549 25,000 1,923 31.78% 7,945 975 8,920 26,760 12,500 14,260 Source: Mediobanca Securities estimates, *national base tax rate, additional regional tax not applied 17 November 2015 15
There is therefore the risk that, as soon as the tax benefits expire, employers will cash in the upside and go back to temporary contracts, which, in our view, the government has not limited enough. Temp contracts are still available for as long as 36 months, and they can be renewed as many as five times. In theory this means that the worker could be in a precarious state for as long as five years: three years under a temp contact and the first two under a perm contract that comes with a low pecuniary indemnity in case of dismissal (minimum four months wages versus 12-24 before), therefore incentivising companies to lay off people after the third year of perm employment. Moreover, companies will always be keen to offer the out-of-court procedure to dismissed staff, as it is basically half the regular indemnity (one month s salary for each year of service for a minimum of two and a maximum of 18); indeed, workers could be tempted to accept it as tax free indemnity and get paid right away with a cashier s check. The increase in permanent contracts will dictate the degree of success of the Jobs Act The effectiveness of the Jobs Act will be a function of whether the new permanent contract will be able to reduce temporary employment versus permanent. The chart below shows the mix of permanent versus temporary contracts for youth (15-24 yrs) and for the entire labour force in Italy, in both 2000 and 2013. It is clear that Italy witnessed a substantial decrease in the share of workers under a permanent contract in that period. The percentage of temp versus perm, which in 2000 stood at 9% vs 91%, decreased to 13% vs 87%; For youth employment, the trend towards temp has been more evident, with the share of temp contracts doubling, from 25% vs 75% in 2000 to 54% vs 48% in 2014. The new permanent contract with increasing security according to tenure could be the right compromise to match both the employers need for flexibility and the employees legitimate demand for job security. Indeed, the new contract can be considered a hybrid between the old permanent and temporary contracts. Italy - Permanent employment vs temporary, Youth vs Total; 2000 and 2014 (%) 100.0% 2000 2014 91.3% 86.9% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Source: Mediobanca Securities on OECD data Temporary employment contract categories Less and more expensive The Jobs Act aims to reduce the number of types of temporary contracts by reorganising the outlying types. The law eliminated the co.co.pro, (one type of temporary contract), associazione in partecipazione (joint venture with contribution of labour) and job sharing. Other forms of unstable employment remained in place: 25.4% 54.3% 8.7% 13.1% The government did not amend the 36-month limit on temporary contracts or the number of extensions allowed. The job on call will continue to be allowed. 74.6% 45.7% Temporary 15-24y Total Temporary Permanent 15-24y Total permanet 17 November 2015 16
The apprenticeship will go through a grouping of the first level (diploma and professional specialization) with the third level (higher education and research). In the event of corporate restructuring for objective, technical or production reasons, the employer is entitled to downgrade the employee to a lower level versus the one hired for. The pay downgrade must be followed by a training programme. The new regulation also allows individual agreements on amendments to salary, tasks and seniority. Fixed-term contract 32% more expensive In terms of fixed-term contracts, the Jobs Act is not introducing major changes as it wants to promote the new permanent contract. As such, the fixed-term contract will not benefit from any INPS deduction or the IRAP cut. Moreover, as shown earlier in our case study simulation, the INPS tax rate for temp contracts has been raised by 1.4%. On average, an employee on a fixed-term contract is expected to be around 30% more expensive than one on the new permanent contract, as the table below shows. Labour cost, Temporary vs Permanent contract 2015E Temporary employment The main characteristics of the fixed-term contracts are: Before Tax Wage Maximum duration of 36 months. In cases exceeding 36 months, the contract shall be converted to permanent. It can be renewed up to a maximum of five times within a three-year horizon. If exceeded, it automatically converts to a permanent contract. If the employee is hired back on a fixed-term contract within 10 days after the termination of a six-month contract (or 20 days after more than six-month contract), the second contract shall convert to a permanent one. If the employment lasts more than the 36-month term, the employer is bound to credit the employee with an additional contribution for each day thereafter, in the amount of 20% until the consecutive 10th day and 40% after each following day. If the employment lasts more than the 30th day of a contract shorter than six months, or beyond the 50th day in the other circumstances, the contract converts to a permanent one. Fixed-term contracts cannot exceed 20% of the total number of employees within the company. If such a 20% limit is exceeded, it converts into permanent and the employer shall be required to pay 20% of the salary for each month or fraction of month, if their number does not exceed one. If their number does exceed one, then the penalty rises to 50% of the salary, for each month or fraction of the month. In case of conversion of the fixed-term contract, the employer is bound to pay the employee a contribution that shall amount to between a 2.5 and 12 months salary. Apprenticeship contract Total tax rate Tax rate for worker INPS rate for employers Labour cost Industrial <15 employees 26,000 41.27% 9.19% 32.28% 34,393 - Industrial >50 employees 26,000 42.97% 9.49% 33.48% 34,705 - Permanent employment Labour cost post tax benefits Industrial <15 employees 26,000 40.07% 9.19% 30.88% 34,029 26,000 Industrial >50 employees 26,000 41.57% 9.49% 32.08% 34,341 26,281 Source: Mediobanca Securities The government has also implemented a dual system in which study and work are integrated in the form of apprenticeship. The main new features the Jobs Act is proposing are: 17 November 2015 17
Three categories of apprenticeship have been introduced: a) for a qualification, diploma and professional specialisation, applicable to those aged between 15-25 years; b) professionalise, applicable to those aged between 18-29 years; c) higher education and research, applicable to those aged between 18-29 years. The apprenticeship contract shall have a minimum duration of six months. Piece work is forbidden. Minor changes to the part-time contract regulation The Jobs Act brings just a few changes to the part-time contract. It can still be either permanent or temporary, and it must be drafted in written form indicating the length of the employment and the work schedule. Additional working hours. Only the horizontal part-time worker is allowed to work additional hours, upon agreement with the employer. National collective contracts establish the maximum number of additional working hours permitted and the consequences if these are exceeded. If national collective contracts do not have any regulation in the matter, the employer is entitled to ask the employee to work for no more than 15% of the weekly agreed hours. Overtime work is not allowed for the vertical and mixed part-time worker, in line with the previous law. Moreover, if there is no regulation within the national collective agreement, the employer can extend the working time by 25% of the agreed schedule. Wages. The salary shall not be lower than that of the full-time job, computed considering the working hours. In the vertical part time, contracts may have lower wages than the fulltime during a trial period or illness. Conversion. The decree allows for employees of both the public and the private sectors to convert to part-time if they are affected by oncologic pathologies or severe chronicdegenerative diseases, and then to convert back to full-time once they recover. Single parents of a child below 13 years or handicapped, as well as those affected by severe diseases, have priority in contract conversion. Staff leasing and casual labour The government deregulated the contract for staff leasing that is now applicable to every sector. However, the decree implements a limitation on the number of contracts, which must not exceed 10% of total employees, although there is always the potential for CCNL to amend it. Starting from 2015, pay for casual work will be limited to a total of 7,000 a year, calculated for the past 365 days, from 5,050 of 2014 and for as much as 2,000 for a single client. Abrogated contracts The government has revoked, with the art. 46, comma 1. Let. H, the job-sharing contract. Moreover, it has established that such contracts currently in use on projects will no longer be allowed although it will permit those outstanding to reach their expiry date. Also, it has abrogated the contract of associazione in partecipazione (joint venture with contribution of labour). Reduced protection in the new rules on dismissal A new out-of-court procedure The new framework for dismissal is probably the most important change introduced by the Jobs Act, specifically the amendment of Articolo 18 of the Workers Charter. The aim is to simplify layoffs by introducing clearer rules and giving guaranteed times on appealing/procedures. This is expected to stimulate hiring, as companies can now better assess the cost of activating new employment contracts and benefit from greater freedom and lower cost of dismissing employees. Moreover, the new regulation also applies to companies with less than 15 employees, though with some differences. As highlighted previously, the standard protection in case of dismissal is two months salary for each year of service with a minimum of four months and up to a maximum of 24 months for companies with more than 15 employees. Below the 15-employee threshold, compensation for 17 November 2015 18
dismissal amounts to one month s salary per year of tenure for a minimum of two months and a maximum of six months, as ruled by a judge. This is subject to tax treatment. A new alternative out-of-court procedure envisages that in the case of dismissal the employer can offer the employee a tax free pecuniary compensation that is not subject to social security contribution. For companies with more than 15 employees, the amount is equivalent to one month s salary for each year of employment for a minimum of two and a maximum of 18 months pay. The acceptance of the offer forestalls any further dispute by the worker, which means no longer having an appeal to the court. Below the 15-employee threshold, compensation amounts to half a month s salary per year of tenure for a minimum of one and a maximum of six months. This new regulation should ease the massive delays in Italian court enforcement, which is currently one of slowest in Europe, as the table below highlights. Indeed, this new procedure mirrors Germany s Hartz IV reform, which successfully reduced the number of court cases, as 60% of the disputes are now settled with monetary compensation. Days required to enforce a labour contract, 2013 1,650 1,450 1,250 1,050 850 650 450 250 50-150 576 1,185 Source: Mediobanca Securities on World Bank data 17 November 2015 19
First effects of the Jobs Act Six months since the implementation of the Jobs Act, data suggest mixed results. On the positive side we note a change in the trend of perm hires. New perm contracts YTD amount to 1.33m versus 991k the previous-year period (+340k, or +34%), with 307k temp contracts converted to perm versus 261k last year (+46k, or +18%). Perm hires are thus running 31% above the pre-jobs Act quarterly average whilst terminations are 5% below, which means that Italy has for the first time in the last few years created net new permanent jobs, specifically 77k in Q1 and 32k in Q2. However a less rosy picture emerges in breaking down the data. INPS figures in fact suggest 70% of the new perm activations are explained by the tax cuts rather than by genuine new job creations due to the new contract per se. This is why perm activations spiked in March (+95k) and April (+103k) but lost steam in May (-13% mom) and in June (-9% mom) before posting a meagre 39k units in August. This reflects a sort of catch-up effect, i.e., companies suspended hiring in 2H 2014 in anticipation of the more favourable conditions foreseen by the Jobs Act, cashed in on the tax benefits and slowed their hiring again afterward. As a result, after an initial spike in net new perm activations in April (+49,851), the following months have seen a downward trend, leading to negative figures. Permanent contracts as a % of total contracts activated increased their share since the introduction of the tax benefits (from 30% in December 2014 to a March 2015 peak of 43%) but are now back down to the mid-30%s. We also must flag that >90% of the net new perm hires come from the less productive Southern/Central regions, with Lazio, Campania, Sicilia and Puglia alone accounting for 74% of the total. Put differently, Veneto, Emilia Romagna, Piedmont and Lombardy (almost 50% of Italian GDP) only account for 4% of the net new permanent jobs created in 2015, further suggesting that tax cuts, more than GDP growth, have driven the process so far. Perm contracts activated through the tax cuts should exceed the 1mn government estimate. The 2016 Stability Law under approval will envisage a rollover of the tax deduction scheme to new perm hires activated next year. While for 2015 companies were entitled to 8,060 INPS (social security contributions) deductions for as long as three years, the new scheme envisages a 60% reduction to 3,250 and a two-year timeframe for new perm hires in 2016. We consider this extremely positive as it should help fuel the momentum on new perm activations via tax cuts while buying time for the labour reform to bear fruit in the medium term via higher productivity. The Jobs Act at work A mild but visible recovery six months after the Jobs Act implementation Six months after the introduction of the Jobs Act back in March, initial data on permanent contract activations are good but not great. Moreover, as expected, data seem to suggest the ongoing pickup is largely attributable to the tax deduction scheme rather than to the labour reform per se, which would naturally take a longer time to bear fruit. As of August 2015 ISTAT data show the number of new permanent contract activations is still quite flattish, even though above last year s levels. The glass half full New permanent contracts have increased with the Jobs Act... Our data collection suggests the following findings: New permanent contracts activated in the first two quarters of this year amount to 1.1m, almost equally split between the two quarters, as shown below; Permanent contracts; Activation, terminations and net between the two 1Q2012-2Q15 (quarterly) I 2013 II 2013 III 2013 IV 2013 I 2014 II 2014 III 2014 IV 2014 I 2015 II 2015 Activated 462,113 400,368 376,949 374,141 444,980 408,792 406,399 366,399 554,324 550,115 Terminated 489,821 499,306 487,367 567,151 484,613 466,067 487,649 589,805 477,401 518,279 Net Activated -27,708-98,938-110,418-193,010-39,633-57,275-81,250-223,406 76,923 31,836 Source: Mediobanca Securities on Ministero del Lavoro data 17 November 2015 20
This implies a quarterly run rate since the introduction of the Jobs Act of roughly 552k, which is 31% above the quarterly average of the previous three years; and This is particularly relevant considering that the quarterly average YTD in all other types (temporary, apprenticeship, etc.) is flat or below the quarterly average of the previous three years. As such, there seems to be a Jobs Act effect specifically on permanent job positions.... while perm terminations have declined Additionally the permanent contracts terminated in the previous two quarters of this year are 5% below the previous three years quarterly average, further signalling an acceleration in the creation of new permanent jobs; Quarterly trends of activations and terminations by type Activated Permanent Temporary Apprenticeship Contractor Other Total Quarterly average 2012-14 420,608 1,664,174 65,007 179,958 167,551 2,497,297 Quarterly average 2015 552,220 1,782,279 57,463 142,946 145,091 2,679,997 Difference 31.3% 7.1% -11.6% -20.6% -13.4% 7.3% Terminated Quarterly average 2012-14 522,204 1,578,384 47,720 189,322 177,679 2,515,309 Quarterly average 2015 497,840 1,413,759 42,155 146,788 136,314 2,236,855 Difference -4.7% -10.4% -11.7% -22.5% -23.3% -11.1% Source: Mediobanca Securities on Ministero del Lavoro data As a result of the above, for the first time in the last few years Italy has managed to create net new permanent jobs, specifically 77k in Q1 and 32k in Q2, as shown below. Permanent contracts; Activations, terminations and delta 1Q2012-2Q15 (quarterly) 800,000 600,000 400,000 200,000 00-200,000-400,000-600,000-800,000 Activated Terminated Net activation 76.9k 31,8k Source: Mediobanca Securities on Ministero del Lavoro data If we add the monthly data now available for July, August and September to the quarterly data above, we find total permanent activations reaching 1,331k units in contrast to 1,233k terminations. This brings the total net activations YTD to 98k. The chart below confirms once more that the 2015 data point to positive change from the trend observed over the previous two years, when net activations were negative at more than 200k each year. 17 November 2015 21
Permanent contracts activated, terminated and net between the two 000 Activated Terminated Net 1,100 600 1,010 991 1,331 100 98 (400) (900) (1,400) (248) (216) (1,258) (1,207) (1,233) Jan - Sept 2013 Jan - Sept 2014 Jan - Sept 2015 Source: Mediobanca Securities on INPS data Permanent contract activations showed a consistent downward trend until mid-2015, which resulted in Italy losing on average almost 400,000 permanent contracts a year, with the highest drop in 2013, when the net difference between activations and terminations of permanent contracts was 430,074. In contrast, the net temporary contracts have been positive over the last four years, with an average of around 330,000 per year. It follows that the success of the new permanent contract will depend on how well it can reverse this trend. This is why we consider 2015 data particularly encouraging in terms of net perm activations, as it shows a clear reversal of the trend of recent years. Permanent and Temporary contracts; Net between new activations and terminations 1Q2012-2Q15 (quarterly) 700,000 Permanent Temporary 500,000 300,000 100,000 76,923 31,836-100,000-300,000-500,000-700,000 Source: Mediobanca Securities on Ministero del Lavoro data The glass half empty New permanent jobs are largely explained by the tax deduction scheme However, things are not so straightforward as they seem. The negative flip side of the above coin lies in the INPS data, which show that a total of 906,044 permanent contracts have been activated (or converted) through the tax deduction scheme introduced last January. 17 November 2015 22
Employment contracts activated through the tax deduction scheme - 2015 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Total as of Sept. Permanent contract 65,203 70,511 94,645 103,002 89,672 81,871 75,078 38,727 85,181 703,890 Temporary converted into permanent 13,700 14,281 29,703 34,214 25,777 21,802 24,988 18,608 19,081 202,154 Total 78,903 84,792 124,348 137,216 115,449 103,673 100,066 57,335 104,262 906,044 Source: Mediobanca Securities, INPS It follows that roughly 70% of the new permanent activations described above can be explained by the tax cuts; Moreover, the monthly trend suggests permanent activations spiked in March and April, at 95k and 103k, respectively, as soon as the new contract went live. But the trend lost momentum immediately afterward and has slowed since May, at a -26% MoM at 90k followed by -9% MoM in June at 82k, until reaching a meagre 39k units in August. This monthly volatility could reflect a sort of catch-up effect, i.e., companies suspended hiring in 2H 2014 in anticipation of the more favourable conditions foreseen by the Jobs Act. This suggests that new 2015 hires are mainly the result of the one-off tax deduction that lasts for three years but applies only to new permanent hires in 2015. As such, the question is what will happen once the tax incentive expires. In the absence of a taxdeduction incentive, the risk is that companies will find it more convenient go back to temporary contracts. Conversions from temp to permanent explain 22% of the total perm activations YtD and make no exception to the slowdown observed during the summer. The 34k monthly peak observed in April more than halved in August. Monthly data confirm that permanent contracts decreased in the few months after the April spike. Indeed as we show below, in April 200k permanent activations contrasted with 150k terminations but in the following months this positive delta reversed (180k activations vs 180k terminations in May, 145k vs 155k in June and 138k vs 155k in July). Conversely, for temporary contracts, data show that after a deep fall in May, they started increasing steadily in succeeding months. Contracts activated 2015 Permanent Temporary Internship Contract work Other 1,000,000 900,000 800,000 700,000 600,000 500,000 400,000 300,000 200,000 100,000 00 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Contracts terminated - 2015 Permanent Temporary Internship Contract work Other Mar-15 Apr-15 May-15 Jun-15 Jul-15 00-100,000-200,000-300,000-400,000-500,000-600,000-700,000-800,000 Source: Mediobanca Securities on Ministero del Lavoro data The result is that the large majority of the total 110k net new activations recorded this year were achieved immediately after the introduction of the Jobs Act, then lost steam in the following months. As we show below, net new activations have turned flat or negative since May. On the other hand, due also to seasonal jobs during the summer, temporary contracts recorded an upward trend. 17 November 2015 23
Net activations increase (decrease) of permanent and temporary contracts ( July 2013 - September 2015) 200,000 Permanent Temporary 144,074 150,000 147,830 94,519 100,000 70,668 49,851 50,000 271 47 31,370-9,768 0-50,000-100,000-150,000-115,188 Source: Mediobanca Securities on Ministero del Lavoro data Permanent contracts decreased as share of total activations Another way of reading the link between new perm contracts and the tax deduction scheme is by looking at the weight of perm contracts on total activations, as we summarise in the following chart. In December 2014, just before introducing the tax cuts, new perm contracts accounted for 30% of the total contracts activated that month. As soon as the fiscal incentives went live in January 2015, the number increased to 40-45% in Q1 2015. Thereafter, once again we notice that after the initial spike, permanent contracts are now back to an approximately 30% share of total contracts activated in June. September data show an upward trend, at 37%. Permanent contract as % of total contracts activated/transformed during the period (July 2013 - September 2015) 50% 45% 40% 35% 30% 25% 31% 31% 34% 32% 31% 31% 39% 35% 33% 31% 30% 28% 33% 30% 30% 29% 30% 43% 39% 41% 30% Tax deduction scheme available 42% 38% 33% 35% New perm. contract 37% 34% Source: Mediobanca Securities on INPS data Southern Italy dominates new perm contract activations The regional breakdown of the new permanent activations confirms the tax cut-related origin rather than a genuine production boost underlying new jobs creation. It is otherwise difficult to explain why more than 90% of net new perm hires through August YTD come from the less productive Southern/Central regions, with Lazio, Campania, Sicilia and Puglia alone contributing 74% of the total. It is particularly surprising to see that Veneto, one of the richest and most industrialised Italian regions, still reports a negative number YTD. Put differently, Veneto, Emilia Romagna, Piedmont and Lombardy (almost 50% of Italian GDP) only account for 4% of the net new permanent jobs created in 2015. 17 November 2015 24
Net permanent contracts activated between Jan and Sept 2013, 2014 and 2015 (by region, 000) 30 Jan - Sept 2013 Jan - Sept 2014 Jan - Sept 2015 26.7 28.6 20 10 0-6.5-1.8-1.3-0.8-0.7 0.2 0.7 1.0 1.2 2.8 3.2 3.6 4.6 4.8 5.0 7.8 9.7 9.8-10 -20-30 Source: Mediobanca Securities on INPS data Making the picture even less rosy, the amount of occasional employment is skyrocketing. Data on vouchers sold, which show the trend in occasional employment ( contractless ), increased by c190% in the last two years. From 28.3n vouchers sold in 2013, the number rose to 81.4m in 2015, maintaining the same annual pace of +70% in 2015 in spite of the introduction of the labour reform. We consider this a negative sign that companies remain reluctant to offer stable job positions in spite of the tax incentives. Vouchers of 10 value sold (from January to September 2013, 2014 and 2015, m) 90.00 Islands 81.4 80.00 South 4.9 70.00 Centre North-East 9.8 60.00 North-West 14.6 48.1 50.00 2.6 5.4 40.00 28.3 8.4 28.0 30.00 1.5 20.00 2.8 4.7 18.1 10.00 0.00 11.4 7.9 13.6 24.1 2013 2014 2015 Source: Mediobanca Securities on INPS data Stability Law 2016: Extending tax cuts to 2016-17 is good news Tax revenue shortfall could be higher than forecasted by the government When it projected the costs of the tax deduction scheme, the government used 2013 numbers provided by INPS. In 2013, 636k permanent contracts were activated excluding people employed on a permanent contract within the prior six months (non eligible). Given the attractive tax incentives, the government assumed that 1mn contracts would be incentivised in 2015, 210k of which were expected to exploit the full deduction ( 8,060 per annum), and the remaining 790k assumed at an average tax cost of 4,215 per annum, due to 360k employees with limited incentive given an annual salary below 8,500. 17 November 2015 25
With new perm contract activations already running at 1.1m in August, it looks like the government is now victim of its own success and may fall short of what it budgeted. In the following chart we try to estimate the shortfall in tax collections stemming from the monthly trend of new perm activation keeping constant the proportion above estimated by the government. The implied result is a 2.9bn tax shortfall as of August. Estimate of the lower income due to the tax deduction scheme ( m) - 2015 3,500 3,000 2,500 2,000 1,500 1,000 500-394 388 518 Source: Mediobanca Securities estimates on MEF data 582 The table below shows the government projections on the tax incentives related to new perm contracts. The 2015 assumption suggests we are running roughly 1bn higher than forecast, signalling the need to cover such a higher than expected tax collection shortfall. Impact on Italian government revenues from tax deductions on permanent contracts ( m) 2015 2016 2017 2018 Total Less revenues expected (1,886) (4,885) (5,030) (2,902) (14,703) 383 2,922 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Total 300 245 111 Source: Mediobanca Securities, MEF Tax cuts and stimulus - headed in the right direction Our analysis of perm activations suggests the risk of a one-off impact related to the tax incentives rather than to genuine new jobs creation stemming from higher productivity. This problem has been well known since the introduction of the Jobs Act and has engendered a debate about what would happen when the tax cuts were terminated. This is why we consider very positive that the 2016 Stability Law under discussion envisages a rollover of the tax deduction scheme to new perm hires to be activated next year. If for 2015 companies were entitled to 8,060 INPS (social security contributions) deductions for as long as three years, the new scheme envisages a 60% reduction to 3,250 and a two-year timeframe for new perm hires in 2016. This should help fuel the momentum on new perm activations within the frame of a Stability Law dedicated to growth initiatives and several tax cuts measures listed below: TASI-IMU: abolition of tax on first home for a lower tax burden equal to 3.7bn; Farm IMU: removal of tax on farming fields leads to 405mn less taxes; Municipalities: they will be compensated by the government for the lower tax revenue; Municipalities: they will be allowed to allocate resources for as much as 1bn in 2016; IMU bolted : tax relief for 530mn on bolted machineries; IRAP agriculture and fishing: zero IRAP tax from 2016; Postponement of VAT and excise tax increase related to safeguarding clauses; Amortization: 140% tax deduction on capex amortisation (industrial machinery and equipment) both IRES and IRPEF tax; IRES: to be decreased by 3.5%, from 27.5% to 24.0% from 2017, for 3.8bn during the first year and 4.0bn in the following; the so called migrant clause will provide the necessary budgetary room; 17 November 2015 26
Italy Professionals and SMEs: Fixed tax rate eligibility threshold raised by 15k to 30k for professionals and by 10k for SMEs. As regards start-up companies, the tax rate decreases to 5% from 10% and is valid for as long as five years instead of three years. IRAP allowance raised to 13k from 10.5k; Construction: tax deduction on restructuring raised to 50% from 36% as well as for furnishing and large household electrical appliances; Decentralized contract negotiation: lower tax rate on employees bonuses and profit sharing schemes to 10% which equals to 430m in 2016 and 589m for the lowing years. The tax cuts will be limited to 2k and for employees with an annual salary below 50k; National TV license: decrease to 100 from 113.50 and paid with utility bills; Cash: cash payments now permitted for as much as 3k from previous 1k; International cooperation: additional 120m allocated; Fiscal simplification: companies will have VAT reimbursed for credits not collected before legal proceedings; Fight against poverty: establishment of a fund with 600m for 2016 and 1bn for the following years; Retired: increased no tax area to individuals older than 75 years old and a maximum income of 8,000 and 7,750 for those below 75 years old; Pensions safeguard: there will be a safeguard for those individuals in difficulty with their jobs but that have still not matured the minimum required years for retirement. The measure will be financed with the resourced not utilised by the previous safeguards; Women option: trail regime for women that intend to retire after 35 years of contribution and 57-58 years old is extend to 2016; Part-time: to ferry old workers to retirement in an active way. The government will compensate for the lower contributions. The employer shall pay the employee for the share of contribution of the hours not worked, which will be converted into net salary; University: new professors hiring for as much as 500 units with 40m in resources in 2016 and 100m in 2017; Doctors: 6,000 scholarships every year. Stability Law 2016 Expenses and Resources ( bn) Expenses Amount Resources Amount Postponing VAT and excise tax as per safeguarding clauses 16.8 EU flexibility 14.60 TASI-IMU 3.70 Voluntary Disclosure 2.00 Farm IMU 0.40 Game tax 0.50 Municipalities 1.20 Games auctions 0.50 IMU bolted 0.50 Spending review 5.80 Cooperation and development 0.12 Increase efficiency 3.10 Amortization 0.60 Migrants clause 3.10 "Terra dei Fuochi" 0.15 - - Permanent contracts 0.80 - - Professionals and SMEs - - Public employment 0.20 - - Fight against poverty and other social measures 1.10 - - University - Doctors 0.25 - - Other 0.68 - - Ires + school construction 3.10 - - Total 29.60 Total 29.60 Source: Mediobanca Securities, Italian Government 17 November 2015 27
Italy Summary of reforms process and government estimates of GDP impact Policy area Done In progress GDP impact Timeline Institutional Reforms Deputy chamber elector law reform (L. 52/2015) - - D.D.L constitutional reform Enabling law on labour reform (L. 183/20114) - Enabling Leg. Dec. On: perm contract with increasing security according to tenure (L. Decr. N. 23/2015); reorganization of unemployment benefits (L. Decr. N. 22/2015). L. Decr. On: work-life balance (L. Der. N. 80/2015); duties and contracts review (L. Decr. N. 81/2015). - May-15 Within 2016 Dec-15 - Mar-15 - Jun-15 Labour Market and Social Policy L. Decr. On: unemployment benefits (L. Decr. N. 148/2015); simplification and fair opportunities (L. Decr. N. 149/2015). - In 2020: +0.6%; in the Sep-15 long run: +1.3% National Employment Agency - ANPAL (L. Decr. N. 150/2015). ANPAL' president appointment, business plan making and agreements with regions. Sept 2015 (implementation in October 2015 - February 2016) Second level negotiations agreement Feb-16 Justice Civil Justice reform (L/ Decr. N. 132/2014, cvt. N. 162/2014) Penal Justice reform (L/ Decr. N. 92/2014, cvt. N. 117/2014) - - - D.D.L strengthening of courts' powers; rationalization of civil processes and sentences D.D.L changes on penal code and processes lengthy D.D.L.fight against organized crime and fiscal evasion In 2020: +0.1%; in the long run: +0.9% Nov-14 Aug-14 Mar-16 Dec-15 Mar-16 Fiscal enabling law (L 23/2014) - - Mar-14 Capital gain tax and VAT (L. Decr n. 66/2014 cvt L n. 89/2014) - In 2020: -0.2%; in the long run: -0.2% Jun-14 Tax reduction on Labour (2015 Stability Law - n. 190/2014) - In 2020: +0.4%; in the long run: +0.4% Dec-14 Fiscal System Enabling decrees on: fiscal simplification and personal income pre-made model (L. Decr n. 175/2014 Enabling decrees on: tobacco products and similar (L. Decr. N. 188/2014); censorious commissions review (L. Decr n. 198/2014) Enabling decrees on: certain right between fiscal system and tax payers (L. Decr n. 128/2015); telematic transmission of VAT operations (L. Decr n. 127/2015) Enabling decrees on: simplification of international tax payers: (l. Decr n. 147/2015) Enabling decrees on: simplification of tax collection (L. Decr n. 159/2015); tax elusion monitoring (L. Decr n. 160/2015); sanctionary system and tax revision reorganization (L. Decr n. 156/2015); reorganization of fiscal agencies (L. Decr n. 157/2015) - - (included in administrative simplifications' measures' estimates) Nov-14 - - Dec-14 - - Aug-15 - - Sep-15 - - Oct-15 Review of local tax on properties and services (IMU, TASI) Measures to reduce taxes on households and companies - 2016-2016-2018 Source: Mediobanca Securities, MEF 17 November 2015 28
Summary of reforms process and government estimates of GDP impact Policy area Done In progress GDP impact Timeline Fincantieri IPO (from CDP); disposal of CDP's share on Grids; disposal (from CDP) of Trans Austria Gasleitung GMbH - Tag; RAIWay IPO. - - 2014 Privatizations ENEL stake disposal Disposal of stake in POSTE ITALIANE, ENAV, STMicroeletronics Holding, FERROVIE DELLO STATO *Grandi Stazione, Centro Stazioni) Realized proceeds for 0.4 GDP in 2015 and 0.5 between 2016-2018 2015-2018 Airport national plan - - Aug-15 Infrastructures Logistics and national ports plan (foreseen in art. 29 D.L. Sblocca Italia - D.L. N 133/2014 cvt in L. N. 164/2014) preliminary approved in CdM n. 72 of 3/07/2015. - - - - Aug-15 D.D.L enabling of sub contract reform. Under scrutiny by Deputy Chamber's VIII Commission Dec-15 - Broadband plan Within 2015 Competition and Competitiveness - D.D.L. Annual on competition for 2015 In 2020: 0.4%; in the long run: 1.2% Within 2015 - Other measures on competitiveness - Dec-15 Credit Measures on non performing loans (D.L. N 83/2015 cvt. L. N. 132/2015) - - Strengthening of the Guarantee and Support to SMEs Strengthening of contracts Aug-15 Oct-15 - Within 2015 Popular Banks reform (D.L. N. 3/2015 cvt L. N. 33/2015 - Mar-15 - Bank foundations and cooperative banks reform 2015-2018 Education School reform (L. N. 107/2015) - - - National plan on research National plan on digital school In 2020: 0.3%; in the long run: 2.4% Jul-15 - Within 2015-2015-2018 Simplifications Agenda 2015-2017: simplifications for agencies - - Dec-14 Public administration and Simplification Enabling law reform on public administration (L n. 124/2015) - In 2020: 0.4%; in the long run: 1.2% August 2015 - Enabling decrees within 2015 - Public local services reform - Within 2015 Healthcare Agreement 2014-2016 - - Jul-14 Agriculture Environment Measure to re-launch dairy sector (D.L n. 51/2015 cvt L n. 91/2015) - Jul-15 Realization and simplification of PAC - Mar-15 - Green Act - Oct-15 - Environment fiscal - 2015-2016 Review of expense and fiscal benefits - Public expenditure efficiency and tax expenditures review In 2020: -0.2%; in the long run: 0.0% Structural savings until 2019 Source: Mediobanca Securities, MEF 17 November 2015 29
Jobs Act effect on MB coverage: 3% EPS accretion Financials, Utilities, Real Estate and TMT are the sectors best positioned to take advantage of the Jobs Act given their above-average margin exposure to Italy (the new labour reform applies only to the Italian workforce) and their high labour intensity. In order to capture the gearing of our coverage to the labour reform, we assume companies incentivise early retirements via the so-called solidarity fund and fully replace such layoffs with new hiring under the new contract. We therefore aim to capture the potential one-off restructuring costs and the number of years to recoup them via higher recurring EPS due to tax cuts on new hires. Our first conclusion is that roughly 2% of the workforce located in Italy is eligible for early retirement, i.e., 14% of employees older than 50/55 years. As a result, the 45 companies under our coverage included in our analysis face an average 15% negative EPS impact in year 1 from one-off costs related to early retirement, with TMT the sector most impacted (c.-32%). Replacing older workers with new and cheaper hires would boost EPS by c.3% p.a., with TMT leading the pack at +6%, followed by Utilities (+3%), Financials (+2.2%) and Pure Industrials (+2.0%). It follows that it will take on average between five and six years for a company to recoup the initial one-off cost generated by the solidarity fund. We estimate an early retirement plan entirely recovered through new hiring would reduce the labour cost by c.200bps on average and the cost income ratio c.50bps. Companies that could benefit the most from the Jobs Act based on our methodology are RCS (26%), L Espresso (c.+15%) and Mondadori (+13%) among TMT, Finmeccanica (+8%) and Italcementi (+5.5%) as cyclicals, Banco Popolare (c.+5%), UBI and Banca Popolare di Milano (c.+3%) among banks, and Hera (+8%) among utilities. Telecom Italia and Mediaset would also enjoy a mid-single-digit EPS benefit confirming the high gearing of the TMT sector to the Jobs Act. Banks, Utilities, TMT and real estate the winning sectors Labour-intensive companies such as banks and utilities... In this section, we update our estimates of the implications of the Jobs Act on our coverage universe. Capital-intensive and labour-intensive companies are not equally geared to the Jobs Act, as mainly the latter should benefit from greater flexibility in managing their labour costs, especially during market downturns. The impact, however, depends also on the average unit salary of each company and also on the age pyramid. We think labour-intensive companies mainly exposed to the Italian market are the ones best positioned in labour reform. This means banks, media and industrial cyclicals such as cement and automotive, as well as multi-utilities.... with high margin exposure to Italy should benefit the most The chart below shows that Financials, Utilities, Real Estate and TMT are the sectors whose margins are exposed to Italy. The horizontal axis shows labour costs as a share of total costs pointing to Financials as the most labour-intensive sector. 17 November 2015 30
% of EBITDA in Italy Italy Labour Costs on Total Costs (%) vs EBITDA in Italy (%) Our model estimates the tax impact of the Jobs Act The Solidarity Fund is our tool to estimate the one-off redundancy cost In order to estimate the potential benefit of the Jobs Act we look at the time needed to recoup the negative one-off cost of redundancies of the first year. As such we look at the activation of the socalled solidarity fund that is required in order to reduce the workforce before introducing new entry-level employees. The tools provided by the current legislation to reduce the workforce located in Italy allow for layoffs for economic reasons related to the closing of activities, for the suppression of jobs and as a way to incentivise early retirement (in turn sub-divided into mere early retirement and Solidarity Funds), which is the one we will focus on. Incentive to early retirement: the Fornero Law In late 2011, the former Labour Minister Elsa Fornero overhauled Italy s pension system. The reform increased the pensionable age and requirements for retirement on the basis of the number of years of social security contributions as follows: 1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 Oil Utilities Source: Mediobanca Securities on companies data Old-age pension (Pensione di Vecchiaia). Women's retirement age was raised to 62 years in 2012, to 63 years and nine months in 2014-15, and will hit 66 years by 2018. (Female civil servants can retire not before turning 66 years and three months.) Men's retirement age is 66 years and three months, and both genders must have worked at least 20 years. Early retirement pension (Pensione Anticipata). The law amended previous legislation according to which people could retire after having worked 40 years, no matter what their age. Under the current law, men can take early retirement after having worked 42 years and six months, and women can retire early after 41 years and six months. The Italian legislation also provides for the discretion for firms to enter into agreements with unions to encourage early retirement of workers eligible for retirement over the following four years. This was a move to respond to the need of making corporate restructuring (based on the expulsion of older workers) manageable after the pension reform increased the retirement age and increased years of social contributions for early retirement pension. Each month companies will have to pay INPS the workers pension, the social contributions and have a bank guarantee. Applications for early retirement must be submitted to INPS that will verify the existence of the requirements, making it a complicated procedure. Early retirement through Solidarity Funds TMT Real Estate Infrastructure Consumers Pure Industrials Branded Goods Healthcare Financials 0 0.1 0.2 0.3 0.4 0.5 0.6 Labour costs on Total Costs in IT The Fornero Law formalised the system of solidarity funds by establishing mandatory funds for areas not covered by a state-assisted layoff scheme (cassa integrazione) and for firms with more than 15 employees. Solidarity funds have been established for three main reasons: 17 November 2015 31
Provide payments for income support to workers who meet the requirements for retirement or early retirement in the next five years in the context of facilitating headcount rightsizing. Ensure workers a supplementary protection in the event of loss of employment. Contribute to the financing of training programmes for the conversion or re-training. In general terms, solidarity funds allow incentivising employees with no more than 60 months to retirement age to leave the industry in exchange for monthly payments till retirement age. The employer expenses the costs related to the activation of the fund as restructuring costs. Since establishment the solidarity funds have been a fundamental tool for managing surplus personnel, especially but not only in the banking sector. According to the Italian Banking Association (ABI), the cost of activating the fund is 70% of the weighted average cost of employees 55-65 years old. In our analysis, we apply the same percentage to the other sectors. Restructuring costs of early retirements do not vary with tool used Below we show that the cost of early retirement is basically the same whether using the tool of solidarity Fund or the early retirement provided by the national law. A simpler procedure for activating the Solidarity Fund than the traditional early retirement (for example, INPS does not have to verify that requisites for early retirement are satisfied for all employees involved) explains the success of Solidarity Funds over early retirement procedure. Estimated One-off Restructuring Costs for Early Retirement Under Solidarity Fund and Early Retirement Early Retirement (art.4) Solidarity Fund (DM 158) Salary (RAL) 50,000 Salary (RAL) 50,000 Social Security Contribution (INPS, c.30% of RAL) 15,000 Social Security Contribution (INPS, c.30% of RAL) 15,000 Termination Indemnity Contribution (TFR, c.7% of RAL) 3,500 Termination Indemnity Contribution (TFR, c.7% of RAL) 3,500 Health and Accident Contribution (INAIL, 0.4% of RAL) 202 Health and Accident Contribution (INAIL, 0.4% of RAL) 202 Cost per Employee 68,702 Cost per Employee 68,702 Estimated Pension - Sistema Misto 38,705 Estimated Monthly Payment as % of Salary 70% Pension under Sistema Retributivo - 80% of Last Salary 40,000 Estimated Annual Payment from Solidarity Fund 35,000 Pension under Sistema Contributivo - 66% of Sistema Retributivo 26,400 Years of Social Contribution for Early Retirement Eligibility 42 - of which under Sistema Retributivo 38 - of which under Sistema Contributivo 4 Estimated Pension as % of Last Salary 77% Years of Early Retirement 4 Years of Early Retirement 4 Early Retirement Cost - Monthly Payment 154,819 Early Retirement Cost - Monthly Payment 140,000 Early Retirement Cost - Social Contribution 66,000 Early Retirement Cost - Social Contribution 82,500 Source: Mediobanca Securities Bank Guarantee (Fidejussione, 3%) 6,625 Total Cost for Early Retirement 227,444 Total Cost for Early Retirement 222,500 Our assumptions Our model assumes workforce reduction via the solidarity fund in order to introduce new entry level employees. We aim at quantifying the cost savings in the years following the activation of the solidarity fund and at estimating the time needed to recoup the negative one-off effect of the first year. Our analysis is based on the data published by ISTAT in December 2014 (Labour Cost Survey 2012 in the EU28), according to which in 2012 the average labour cost per employee stood at 29.9K per year. Within sectors, the lowest salaries are in some services such as food services (below < 20,000), while on the opposite side we find financial activities and mineral extractions (> 49,000), as shown below. 17 November 2015 32
ISTAT Average gross salary by sector (Index=100): 0 50 100 150 200 Financial and Insurance activities Mineral extractions Pharmaceutical Supply of electricity and gas Information services and communication Real estate activities Manufacturing Food and beverage Building and construction Education Source: Mediobanca Securities, ISTAT Starting from 29.9k National Gross Salary and adding wage inflation in 2013 and 2014 of 1.3% and 1.2%, respectively, we calculate 30.6k average gross salary per employee in 2014. We then apply the appropriate contributions in order to reach the average cost per employee borne by each firm, namely Social Security Contributions (INPS, equal to c.30%), Termination Indemnity Contribution (TFR, c.7%) and Health and Accident Indemnity (INAIL, 0.4%). This gives us an average cost sustained by the firm of 42.0k. People seeking early retirement usually have a higher salary than the national average. We have estimated the cost of older employees based on the data disclosed by ISTAT, according to which the salary of employees aged above 50 years is 28% higher than the national average. This brings our previous 42k estimate to 53.7k as the equivalent cost for older people. Italy - Annual Average Gross Salary Per Capita by Age and Gender - 2014 Index (average =100) Age Male Female Total 20-29 63.6 69.9 66.1 30-39 87.2 90.2 88.2 40-49 105.3 102.5 104.1 50-59 121 119.9 120.6 >60 136.5 124.8 134.6 Source: ISTAT ISTAT data show the salary for employees aged 20-29 stands at 18.8k, or 50% of the salary of employees close to retirement ( 36.4k). Thus, we infer the annual salary of younger employees would amount to c.50% of the salary of retiring employees, i.e., 20.3k. Social contributions increase the cost per young employee to 27.7k. This amount does not account for the deduction of INPS social contributions for the first three years, up to a maximum of 8,060 per year. Hence, we estimate that the cost of young employees under the Jobs Act stands at 21.8k, or 60% below the cost of retiring employees, as shown in the table below. 17 November 2015 33
Jobs Act Estimated Difference between Retiring and Young Employees Cost National Average Gross Salary (RAL) - 2012 29.9k Wage Inflation 2013-14 +2.3% Estimated National Average Gross Salary (RAL) - 2014 30.6k Social Contributions (INPS/TFR/INAIL, c37% of RAL) 11.4k National Average Cost per Employee 42.1k Estimated Higher Cost of Older Employees +28% Estimated Average Cost of Older Employees 53.7k of which salary (RAL) 39.1k of which social contributions 14.6k Estimated Average Cost of Young Employees Pre Jobs Act 27.7k of which salary (RAL) 20.3k of which social contributions 7.4k Social Contribution Deduction (max 8.1k) -5.9k Estimated Average Cost of Young Employees Jobs Act (First 3 yrs) 21.8k Source: Mediobanca Securities, ISTAT Although solidarity funds can be accessed by employees with 60 months to retirement age, we limit our analysis to four years, as early retirement is available only to employees with no more than 48 months to retirement age. We assume the company pays 70% of the total 53.7k cost for four years. This represents the first year one-off cost. We also assume that all employees accessing the solidarity fund will be replaced immediately through new hiring of younger people at entry-level salary under the Jobs Act. The conclusion of this analysis (shown in the following table) suggests that on average, to recoup the initial one-off cost generated by the solidarity fund it will take the company between five and six years. 17 November 2015 34
Italy Estimated Break-even Point between Costs of Early Retirement and Employment of Young Employees under Jobs Act EUR T-0 T+1 T+2 T+3 T+4 T+5 T+6 T+7 T+8 T+9 T+10 Early Retirement Assumptions Solidarity Fund Employees Subject to Early Retirement 100 Estimated Average Annual Cost per Older Employee 53.7 Years of Early Retirement 4 Estimated Annual Payment as % of Avg Annual Cost per Employee 70% Initial One-off Restructuring Costs (A) -15,045 0 0 0 0 0 0 0 0 0 0 Hiring 100 0 0 0 0 0 0 0 0 0 Workforce Replacement 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Costs Related to Hiring of Young Employees Salary (RAL) 20.3 20.3 20.3 20.3 20.3 20.3 20.3 20.3 20.3 20.3 20.3 Social Security Contributions (INPS, c30% of RAL) 7.4 5.9 5.9 5.9 5.9 5.9 5.9 5.9 5.9 5.9 5.9 Termination Indemnity Contribution (TFR, c7%% of RAL) 27.7 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4 Health and Accident Indemnity (INAIL, 0.4% of RAL) 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Max Deduction of Social Security Contribution -5.9-5.9-5.9 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Estimated Average Annual Cost per Employee 21.8 21.8 21.8 27.7 27.7 27.7 27.7 27.7 27.7 27.7 Personnel Expenses for New Hiring (B) 0-2,184-2,184-2,184-2,774-2,774-2,774-2,774-2,774-2,774-2,774 Staff Costs Saving from Employees Subject to Early Retirement (C) 0 +5,373 +5,373 +5,373 +5,373 +5,373 +5,373 +5,373 +5,373 +5,373 +5,373 Total Change in Personnel Expenses (D = A+B+C) -15,045 +3,189 +3,189 +3,189 +2,599 +2,599 +2,599 +2,599 +2,599 +2,599 +2,599 Difference between Initial One-off and Cumulative Savings 15,045-11,856-8,666-5,477-2,878-278 2,321 4,920 7,520 10,119 12,719 Source: Mediobanca Securities estimates 17 Novembr 2015 35
The model applied to the reality Our analysis indicates 9% of Italy s workforce could be eligible for early retirement... Based on ISTAT data we estimate the number of people possibly entitled to go on early retirement is c.2.4m out of the 22.3m employed, or 9% of the population: According to ISTAT, the number of employed people in Italy amounts to 22.3m, corresponding to 37% of the population. Of this amount, 3.5m are between 55-64 years old and 480k are older than 64, for a total of c.4m. Breakdown of the Italian population in regards by employment, 2013 Permanent full-time 12,093 19.9% Dependents 16,878 27.8% Permanent part-time 2,556 4.2% Temporary full-time 1,592 2.6% Employed 22,420 37.0% Temporary part-time 638 1.1% Looking for a job 3,113 5.1% Independents 5,542 9.1% Not actively looking for a job but available to work 1,732 2.9% full-time 4,772 7.8% Part-time 820 1.4% Population 60.668 Inactive in working age (15-64) 14,435 23.8% Not looking for a job but available to work 1,378 2.3% Actively Looking for a job but not available to work 303 0.5% Not looking for a job and not available to work 11,021 18.2% Inactive in non working age 20,700 34.1% <15 years 8,517 14.0% >64 years 12,184 20.1% Source: Mediobanca Securities on ISTAT data In estimating the percentage of the population eligible for early retirement, we include 100% of the population aged 65 years or more, as the Fornero Law which overhauled the pension system set 66 years for men and 64 years for women as threshold to access old-age pensions in 2015-2016, regardless of the number of years of contributions made to the social system. People entitled to receive early retirement are those who have received the payment of social contribution for at least 42 years. Assuming these workers started working at around 17 November 2015 36
18-20 years, we assume employees entitled to early retirement are likely aged between 60-62 years. As early retirement can be offered to workers four years before maturing the requirements for early retirement, we estimate that early retirement packages can be offered to employees aged around 57-58 years. Hence, we calculate that approximately 70% of the employees within the age-band 55-64 could be eligible for early retirement (i.e., the ones aged 58-64). However, we exclude from this group people with a degree, who normally started working at c.25 years old and hence cannot have contributed to the social security system for the full 42 years. According to ISTAT, around 20% of Italian workers within the age-band 55-64 have a degree and hence should be excluded from the number of people eligible for early retirement. Italy Estimated Percentage of Employed Population Eligible for Early Retirement... but our exercise is based on early retirement equal to 2% of the workforce... We have analysed the workforce of about 45 companies within our universe in order to identify the companies that could benefit disproportionately from the Jobs Act, looking at these variables: Population Employed Population 22,320,000 - Aged >65 yrs 484,000 - Aged 55-64 3,591,000 - Aged 55-64 with a Degree 709,000 - Aged 55-64 with a Degree % 20% - Aged 55-64 without a Degree 2,882,000 - Aged 58-64 as % of Aged 55-64 70% - Aged 58-64 without a Degree 2,017,400 Total Employees Eligible for Early Retirement 2,501,400 - Aged >65 yrs 484,000 - Aged >65 yrs Eligible for Early Retirement as % of Aged >65 Yrs 100% - Aged 58-64 without a Degree 2,017,400 - Aged 55-64 Eligible for Early Retirement as % of Aged 55-64 56% Employees Eligible for Early Retirement as % of Employed 9% Source: ISTAT, Mediobanca Securities estimates The number of employees that the company has in Italy, as the Jobs Act only applies to Italian workers. The age pyramid, with particular emphasis on employees younger than 30 and older than 50-55, as our analysis is based on encouraging the early retirement of older employees and replacing them with younger (and cheaper) workers. Cost per employee for the company in Italy. The figure is derived by dividing the personnel costs by the number of employees. Moreover, we assume that for all the companies the weight of social contributions in the salary cost is about 30%. As shown below, the composition of the Italian labour force has a high presence of employees older than 50 years (>20% for most of the sectors), with Utilities and TMT the sectors with the highest percentage of people older than 50. At first glance, these would seem to be the sectors that could benefit the most from job rotation and introduction of younger people. 17 November 2015 37
MB coverage Employees older than 50-55 by sector (%) 32.3% 31.5% 26.0% 24.4% 21.4% 19.0% 14.0% 6.5% Utilities TMT Consumers Infrastructures Pure Industrial Financials Oil Branded Goods Source: Mediobanca Securities, company data... or to 14% of employees older than 50-55 In our calculations, we assume that only 2% of all employees located in Italy will accept early retirement incentives, corresponding to 14% of employees older than 50-55. The number of employees thus involved in early retirement has been estimated in the following way: We start from the workforce breakdown by age disclosed in social reports. For companies disclosing the number of employees aged above 50, we assume c.50% of these could be involved in early retirement, as 58 years (the threshold used to determine the entitlement to early retirement packages) stands between 50 years and the official retirement age of 65 years (66 for men and 64 for women). Following the same argument, we select 70% of employees over age 55 for companies disclosing such breakdown. In the absence of an age breakdown, we use the 18% national average for workers aged more than 55. We select 80% of employees potentially close to early retirement eligibility, as ISTAT data show that 20% of Italy s workforce aged 55-64 has a degree and hence started contributing to the social security system at 25 years rather than at 20 years. Those employees are unlikely to be eligible for early retirement at the age of 58. We assume companies offer early retirement packages to 50% of the employees potentially eligible. Given the one-off severance costs (estimated in approximately 150k at the national level from calculations based on ISTAT data), we believe the initial restructuring costs would overly burden margins in the first year. The acceptance rate by employees included in early retirement plan is assumed at 66%, as early retirement plans are generally voluntary. Modelling the Jobs Act to our companies We apply the methodology described in the previous paragraphs to the companies within our universe. The model is developed with the three steps detailed below. 1. One-off impact of early retirement would clip c.15% of earnings in year 1 The negative one-off in the first year is related to the restructuring costs attributable to encouraging older employees to adhere to the solidarity fund. We assume 70% of the total cost per employee is allocated to the solidarity fund for four years. On average, our analysis assumes early retirement packages are offered to c.2% of employees. Our analysis indicates that companies have a c. negative 15% EPS impact on average in year one (2016 EPS), with the TMT sector the most impacted (c.-32%). The chart below shows the estimated impact by company. Importantly, in our view, the cash impact would be just 25% of the total, since the total payment is spread over a fouryear time horizon. 17 November 2015 38
L'Espresso* Mondadori* Finmeccanica* Hera Mediaset* Telecom Italia Italcementi* A2A Banco Popolare* Iren* AEFFE Autogrill Cairo Communication UBI Banca* Banca Pop. Milano* Credem Acea Creval* Intesa Sanpaolo* Rai Way Unicredit* EI Towers Saras CNH Industrial SIAS Enel Terna Pirelli & C. Snam Cerved Buzzi Unicem Fincantieri* Geox Atlantia Prysmian Generali ENI Tod's Enel Green Power Salini Impregilo Yoox Net-a-Porter Banca Generali Mediolanum L'Espresso* Mondadori* Finmeccanica* Hera Mediaset* Telecom Italia A2A Italcementi* Banco Popolare* Iren* AEFFE Autogrill Cairo Communication UBI Banca* Banca Pop. Milano* Credem Creval* Acea Intesa Sanpaolo* Rai Way Unicredit* EI Towers Saras CNH Industrial SIAS Enel Terna Snam Pirelli & C. Cerved Buzzi Unicem Fincantieri* Geox Atlantia Prysmian Generali ENI Tod's Enel Green Power Salini Impregilo Yoox Net-a-Porter Banca Generali Mediolanum Italy MB One-off cost: EPS Impact after implementation of early retirement plan (spread over four years) 0.0% -10.0% -20.0% -30.0% -40.0% -50.0% -60.0% -70.0% -80.0% -90.0% -100.0% Source: Mediobanca Securities, *we highlight that some companies (almost Media and Banks) have already significantly implemented staff reduction or temporary lay-offs. 2. Replacing old workers with new hires would boost EPS by c.3% in the first three years We estimate the positive impact on EPS from the savings from new-entry salaries and the savings from the exclusion of social contribution for new hiring in the first three years at up to 8k per employee. Obviously the sectors that would suffer the most from the implementation of the one-off solidarity fund are the same ones that would benefit the most on a recurring basis from the introduction of the new legislation. Our estimates are based on the assumption that people who agreed to the early retirement plan will be entirely replaced through hiring of younger and cheaper people. The advantage will be that new people will earn a starting salary 50% lower than the older people leaving the company under the solidarity fund. Additionally, for the first three years the company will not pay for the social contributions (up to 8k). The conclusion of our analysis is that the average EPS impact (like-for-like) is c.+3%, with TMT leading at +6%, followed by Utilities (c.+3%), Financials (+2.2%) and Pure Industrials (+2.0%). In addition, we highlight that, should the company decide to lay off new hires after two years, the severance cost would amount to four months instead of four years paid to older people. The oneoff, in this case, would let the company pay only 5% of the amount that they have paid two years before (7% if they work for three years). Having used the same assumptions, similar to what is thrown off in our model, companies will take around five to six years to recoup the initial one-off cost from expensing early retirements in the first year. The payback period would be shorter if companies distributed the workforce replacement over more years, instead of a simultaneous replacement. In other words, our analysis ignores possible productivity gains from the residual workforce. MB EPS Impact considering the full replacement of early retirements with new hirings 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Source: Mediobanca Securities, *we highlight that some companies (almost Media and Banks) have already significantly implemented staff reduction or temporary lay-offs. 17 November 2015 39
3. Decrease in the cost income ratio in year 2015 would stand at 0.5% Our modelling suggests that if the company implements an early retirement plan entirely recovered through new hiring, the labour costs would decrease by c.200bps per year on average, which would result in the cost income ratio decreasing by c.50bps per year on average. Annual reduction in labour cost and cost income ratio 0.0% -0.5% -1.0% -0.6% -0.7% -0.8% -0.2% -0.4% 0.0% -0.5% -1.5% -2.0% -1.7% -2.0% -1.9% -2.5% -3.0% -2.8% -2.8% UTILITIES & OIL TMT & CONSUMERS FINANCIALS PURE INDUSTRIALS & INFRASTRUCTURES LUXURY TOTAL Labour cost reduction Decrease in cost income ratio Source: Mediobanca Securities, company data 17 November 2015 40
The Mediobanca Jobs Act survey Six months after the approval of the Jobs Act, we surveyed the HR departments of 47 Italian corporates in our coverage universe. The overall message was constructive, as 89% of respondents viewed the labour reform as a positive step. However uncertainty on the macro impact remains, which is why corporates do not seem to have positioned themselves at full speed to take advantage of potential medium-term productivity gains and of short-term tax cuts benefits. Consensus (76%) emerges that the Jobs Act will make new hiring easier but the same does not apply (only 35%) in regards to redundancies. The main negative we found was that only 46% of respondents believe the reform will increase employment and this is mainly due to the persisting uncertainty about the potential link between flexibility and productivity (only 26% see a causal connection). It follows that only 15% of the sample confirms an increase in the workforce so far as a result of the Jobs Act while 55% expect the reform to bear fruit only in the long run. Surprising to us, corporates seem reluctant to admit their new hiring policy has been mainly driven by INPS tax incentives, as two-thirds disagree that tax cuts explain their new perm hiring and only 21% expect an acceleration in new perm hires before year end when 2015 tax incentives will terminate. Moreover none of respondents intends to relocate its foreign activity back in Italy to take full advantage of the new labour reform. Interestingly, there seems to be no consensus on whether increased flexibility has come at the expense of job security, as almost 36% disagree that employees feel less protected and another 28% have a neutral opinion. As far as unions are concerned, only 9% think the Jobs Act has complicated relations with unions, while 56% believe the relevance of unions is poised to decrease over time with individual negotiations gaining sway. In summary, what emerges is a picture of a positive but slow reaction to the new labour reform due to persisting macro uncertainty, to scepticism on related productivity gains and to the oneoff tax cuts attached to the reform. We collected these views in late summer. Two relevant things have happened since then: consistent GDP upgrades and rollover of the tax cuts into 2016. We think these two factors will help make our sample more comfortable towards new hiring, which is why we expect 2016 to show an acceleration in the trend of net new perm hiring analysed in Chapter 2. Our survey of 47 companies under coverage The Jobs Act is a positive for 89% of respondents Six months after the approval of the Jobs Act, we collected the views of the HR departments of 47 Italian corporates in our coverage 1. The overall message is very constructive, as 89% of respondents viewed the labour reform as positive. Moreover, 50% think the new contract with increasing protection according to tenure is just a first step towards wider reforms of the labour market and that the government will likely introduce more changes to increase flexibility further. However, in practice Italian corporates appear cautious about the implementation of the new tools that the reform offers as they do not expect significant productivity gains short term and believe the benefits will accrue only in the long run. Also, the fiscal incentive for new hirings in 2015 seems not to be attractive enough to speed that process. Indeed, the recovery of the Italian economy is considered still too fragile and fragmented to risk going all-in with new hiring. 1 Participating companies are: A2A, Acea, Aeffe, Autogrill, Axelero, Banca Generali, Banco Popolare, Beni Stabili, BPER, Buzzi Unicem, Cairo Communication, Campari, Cattolica Assicurazioni, Cementir, Cerved, Credem, Danieli, De Longhi, Enel, Eurotech, Finecobank, Hera, IMA, Interpump, Intesa Sanpaolo, Inwit, Iren, L Espresso, Maire Tecnimont, Marr, Mediaset, Mondadori, Nice, Pirelli, RCS, Saipem, Salini Impregilo, SAVE, Sogefi, Telecom Italia, Terna, Tesmec, Trevi, UBI Banca, Unicredit,Unipol Gruppo Finanziario, Unipol-SAI. 17 November 2015 41
Mediobanca Jobs Act survey Do you see the labour reform (Jobs Act) as positive? 33% Disagree 2% Neutral 8% Do you think that more labour flexibility and increased ease in making redundancies will result in an increase of employment? Agree 37% 9% disagree 9% Disagree 15% Agree 56% Neutral 30% Source: Mediobanca Securities Mediobanca Jobs Act survey In detail, the key messages from the Mediobanca Jobs Act survey are the following: The focus is much more on new hires than on redundancies as 76% of Italian corporates believe that the new legislative framework has made hiring easier, while only 35% of respondents view redundancies as being easier; Worker security still controversial: 40% of Italian corporates think their employees feel less protected as a consequence of the Jobs Act, while 35% disagree with this statement and another 24% have a neutral opinion; Italian corporates appear unsure on productivity gains, as only 23% of respondents think that greater flexibility and easier redundancies will have a positive impact on productivity; Benefits of the reform will arise in the long term is what 56% of respondents say; Short-term fiscal incentives as the driver of new hires is what only 24% admit; Although the relevance of labour unions is unaffected for 78% of respondents, a greater role for individual negotiation is expected by 57% of respondents; and Increased employment of young workers is expected as 69% of corporates believe that most new hiring will be of workers aged below 30 and only 25% think that it will come to any great extent from temporary workers already with the company. Agreement on ease of new hires, uncertainty about redundancies With the enactment of the new law, the Mediobanca Jobs Act survey indicates that almost 76% of Italian corporates believe that the new legislative framework has made new hiring easier but interestingly enough only 31% of the respondents have the same view in regards to redundancies, with additional 42% sitting on a neutral opinion. However, in line with our methodology in the previous chapter, 56% of Italian corporates believe that most of the employees who can benefit from early pension schemes will take this opportunity. Our reading is that while new hires are a clear objective of the reform and are therefore preferred, there is still uncertainty about the impact on redundancies, probably because redundancies are not a priority currently, despite being easier to implement. Has the Jobs Act made it easier to hire people? 13% Has the Jobs Act made it easier to make redundancies? Agree 31% Agree 63% Disagree 8% 4% disagree 4% Neutral 17% Neutral 42% Disagree 18% Source: Mediobanca Securities 17 November 2015 42
Mediobanca Jobs Act survey Worker security still controversial Looking at another controversial point of the reform security versus flexibility almost 40% of Italian corporates think employees feel less protected as a consequence of the Jobs Act, while 36% disagree with this statement and another 26% have a neutral opinion. Interestingly, there seems to be no consensus on whether increased flexibility has come at the expense of job security. Do you think that employees at your company feel they have less job security with the Jobs Act? Agree 28% 11% disagree 13% Do you think that more labour flexibility and increased ease in making redundancies will result in an increase of employment? Agree 37% 9% disagree 9% Neutral 26% Disagree 23% Neutral 30% Disagree 15% Source: Mediobanca Securities Mediobanca Jobs Act survey Italian corporates are sceptical that the reform will produce much-needed productivity gains Only 46% of respondents believe that the reform will result in an increase in employment (rhs chart above). Moreover high uncertainty emerges on the presumed link between flexibility and productivity, as only 26% believe in a positive relation between the two. This is supported by the fact that only 17% of respondents think the reform will create a different level of productivity for employees hired with the new contract vs those working under an old contract; in fact 50% of respondents disagree with a two-tier productivity scenario. Do you think that increased labour flexibility and making redundancies easier will increase employee productivity? Agree 24% How much does your company need the greater flexibility of the labour force that the Jobs Act can bring? In other words, do you think that a higher turnover could increase productivity? Agree 42% 7% Neutral 46% 2% disagree 11% disagree 13% Disagree 17% Neutral 22% Disagree 16% Source: Mediobanca Securities Benefits of reform will appear in the long term... According to the Italian corporates in our coverage space, the impact of the reform is yet to come, as only 15% report an increase in new hires as a result of the Jobs Act, and 55% believe that benefits will be seen only in the long run. Only 15% confirm an increase in their workforce due to the Jobs Act; and Some 55% expect the Jobs Act to bear fruit only in the long term. 17 November 2015 43
Mediobanca Jobs Act survey Have you already seen an increase of the headcount at your company as a result of the Jobs Act? Neutral 21% Agree 13% 2% Do you think the benefits of the Jobs Act will only be seen in the long term? disagree 2% 13% Disagree 19% Disagree 28% disagree 36% Agree 42% Neutral 25% Source: Mediobanca Securities Mediobanca Jobs Act survey... as indeed it is the tax incentives that drive new perm hires short term The corporates view of a limited short-term impact of the new perm contract on new hiring confirms our findings in Chapter 2 that it is INPS tax incentives more than the new contract per se that explain the large majority of net new perm hires registered YTD. However corporates do not appear so straightforward in recognising tax cuts as strong short-term drivers in their decision making on new hiring. Some two thirds of the sample disagrees that tax cuts drive new perm hiring in the short term and is therefore not expecting significant EPS impact in 2016 from tax deductibility; Moreover, only 21% of corporates forecast acceleration in new hires before year end and only 31% expect to see a drop in new hires next year once tax deductibility is no longer applicable (the landscape here has now changed, since the government is extending tax incentives to 2016, although to a lesser extent); and Finally no respondent has a high conviction on relocating its foreign activity into Italy as a means to further exploit the Jobs Act. Do you think that tax deductability will have a significant impact on net income in 2016? Neutral 20% Is tax deductibility enough to incentivise your company to relocate foreign activities to Italy? Disagree 18% Disagree 39% Agree 9% Neutral 21% disagree 62% Source: Mediobanca Securities disagree 33% Labour unions and collective agreements to be less relevant According to the respondents to our survey, the labour reform has not necessarily made relations with the labour unions more complicated (only 9% think so) even though 57% believe that the relevance of unions will decrease, as more flexibility will translate into a greater role for individual negotiation. 17 November 2015 44
Mediobanca Jobs Act survey Are relations with the labour unions within your company more difficult as a consequence of the Jobs Act? 2% Agree 7% Do you think that the changes introduced by the government will have an impact of the role of the labour unions, with an increase in the importance of negotiation by the individual? Agree 43% 13% Neutral 13% disagree 63% disagree 2% Disagree 15% Disagree 15% Neutral 26% Source: Mediobanca Securities Mediobanca Jobs Act survey Changing profile of the labour force While 59% of corporates that responded think that the new contract giving increased protection will become the preferred contract at the expense of temporary contracts, only 26% of respondents think that new perm hires will come to any large extent from the temporary workers already employed by the company. Interestingly, Italian corporates think that new hiring will be mostly of young people aged below 30 (to a large extent for 68% of respondents); moreover they do not think that the new law will make the hiring of skilled workers more costly (as a consequence of their higher degree of protection at the current employers due to longer experience); only 26% agree with such a statement. To what extent are new hires temporary workers already employed at your company? 4% disagree 24% Agree 22% Do you think the Jobs Act could deter companies from employing skilled workers or does it make it more costly to hire them? Agree 22% Neutral 38% 4% Disagree 20% disagree 13% Neutral 30% Disagree 22% Source: Mediobanca Securities 17 November 2015 45
Mediobanca Jobs Act survey results Mediobanca Jobs Act survey results Do you see the labour reform (Jobs Act) as positive? Has the Jobs Act made it easier to hire people? 33% Disagree 2% Neutral 8% 13% Disagree 8% Agree 63% Neutral 17% Agree 56% Has the Jobs Act made it easier to make redundancies? Agree 31% 4% disagree 4% Have you already seen an increase of the headcount at your company as a result of the Jobs Act? Neutral 21% Agree 13% 2% Neutral 42% Disagree 18% Disagree 28% disagree 36% Do you think the benefits of the Jobs Act will only be seen in the long term? disagree 2% 13% Disagree 19% Do you think that employees at your company feel they have less job security with the Jobs Act? Agree 28% 11% disagree 13% Agree 42% Neutral 25% Neutral 26% Disagree 23% Do you think that increased labour flexibility and making redundancies easier will increase employee productivity? Agree 24% Are relations with the labour unions within your company more difficult as a consequence of the Jobs Act? 2% Agree 7% Neutral 46% 2% Neutral 13% disagree 63% disagree 11% Disagree 17% Disagree 15% 17 November 2015 46
Would you expect differences in productivity from employees under the Jobs Act versus those under the old legislation? Agree 15% Do you think that most of new permanent hiring at your company was done in order to benefit from the tax deductibility? Agree 20% Neutral 33% 2% Neutral 29% 4% disagree 22% disagree 20% Disagree 28% Would you expect new hiring to accelerate before the deadline in order to benefit from the tax deductibility? Disagree 27% Would you expect to see a drop in new hires next year given that the tax deductibility will not yet be applicable? Neutral 33% Agree 17% Agree 27% Neutral 27% 4% disagree 13% 4% disagree 7% Disagree 33% Do you think that more labour flexibility and increased ease in making redundancies will result in an increase of employment? Agree 37% 9% disagree 9% Disagree 36% Do you think that the new labour contract with increasing job protection will become the preferred contract at the expense of temporary contracts? Agree 46% 13% disagree 4% Disagree 15% Disagree 13% Neutral 30% Do you think that tax deductability will have a significant impact on net income in 2016? Neutral 20% Neutral 24% Is tax deductibility enough to incentivise your company to relocate foreign activities to Italy? Disagree 18% Disagree 39% Agree 9% Neutral 21% disagree 62% disagree 33% Do you think that most of the employees who could benefit from early pension schemes will take this opportunity, thereby increasing employment opportunities for younger people? Agree 32% 24% To what extent are new hires temporary workers already employed at your company? 4% disagree 24% Agree 22% Neutral 20% Disagree 15% disagree 10% Neutral 30% Disagree 20% 17 November 2015 47
To what extent are new employees below the age of 30? 20% Disagree 20% Do you think the Jobs Act could deter companies from employing skilled workers or does it make it more costly to hire them? Agree 22% Neutral 13% Neutral 38% 4% disagree 13% Agree 48% Considering that companies tend to use temporary contracts to bring in new resource, do you think the Jobs Act will change this approach? Neutral 39% Agree 11% 8% disagree 13% Disagree 22% How much does your company need the greater flexibility of the labour force that the Jobs Act can bring? In other words, do you think that a higher turnover could increase productivity? Agree 42% 7% disagree 13% Disagree 29% Neutral 22% Disagree 16% Do you think that the new contract is just a first step towards the wider reform of the labour market and that the government will introduce further changes to increase flexibility further? Do you think that the changes introduced by the government will have an impact of the role of the labour unions, with an increase in the importance of negotiation by the individual? Agree 33% 17% Agree 43% 13% disagree 2% Disagree 15% Disagree 15% Neutral 35% Neutral 26% 17 November 2015 48
Tax Credit Notes to complement the Jobs Act The recent government projections increased GDP growth rate to +0.9% in 2015 and 1.6% in 2016. We deem this a positive but not enough to tackle unemployment at 11.8% and recover the 10% output lost between 2008 and 2014. We believe the reforms implemented by the government, as long as positive, are mainly focused on the supply-side whereas we think demand-side policies would also be greatly needed to fight the current economic depression. Classic expansionary policy would increase public investments and/or lower taxes to increase output, lower unemployment and boost workers purchasing power. However, euro area regulations limit or rather forbid most of these actions, forcing austerity. The Solow model adopted by the EC to calculate real versus potential GDP keeps assuming 10% as a structural rate of unemployment for Italy versus the 8% average in the previous decade. This leaves very limited room for manoeuvring the deficit in Rome, which is why the structural versus cyclical deficit remains at the heart of the ongoing debate between Rome and Brussels on the 2016 Stability Law. An interesting solution analysed in this chapter aims at combining the supply side intervention achieved via the Jobs Act with a demand-side initiative to boost growth while complying at the same time with the EU regulation: the Tax Credit Certificates (TCCs). Following a similar mechanism adopted by Germany with the so-called MEFO bills in 1933, TCCs are claims that give the owner the right to pay for liabilities to the government for taxes, contributions, sanctions, etc. They are not to be considered debt as the government would never reimburse them in euro whereas it would accept them to reduce the tax burden. Equally they are not currency as they are not legal tender. As such, TCCs could be seen as fiscal or quasi money. We simulate TCCs to be assigned for 20bn in 2016, 40bn in 2017 and 40bn in 2018. Twothirds would be assigned to sustain demand, one third to improve competitiveness. All of them would have a deferral of two years so not to jeopardise the financial stability of the government and having enough time for TCCs to generate additional output via a 1.2x Keynesian multiplier. Our simulation indicates GDP growth would double in 2016 and 2017 to 3%, surplus would reach 0.8% in 2017 versus the 1.1% deficit assumed today, debt / GDP would land at 112% in 2019 versus current base case at 120%. In summary, injecting such a shock via an implicit tax cut achieved through TCCs deferred by two years, GDP would be 77bn higher in 2017. This would generate extra tax revenues of 36bn, which would decrease to 16bn after accepting 20bn of TCCs issued two years before and due to mature, thus still leaving the government with a positive delta on tax revenues. TCCs could be used in various ways, such as financing public works initiatives of the government or supporting expansionary projects via CDP. Reforms are a positive, but we need more on the demand side Italy s mild recovery: GDP +0.9% in 2015e and +1.6% in 2016e The update of the Minister of Finance s Documento di Economia e Finanza (Government economic and financial plan) published on 18 th September 2015 foresees GDP increasing for the first time after three negative years (2012-2013-2014) with +0.9% in 2015, +1.6% in both 2016 and 2017. As much as we deem this likely and positive, we believe it is still not enough to overturn the effects of the -10% GDP recorded between 2008 and 2014 and tackle the unemployment rate and the output gap. 17 November 2015 49
GDP breakdown Q1 2010:Q1 2015 (qoq, %) 1.5 National final consumption expenditure Changes in inventories, acquisitions less disposals of valuables GDP at market prices Gross fixed capital formation External balance of goods and services 1 0.5 0 0.5 0.7 0.5 0.4 0.4 0.2 0.1 0.0 0.0 0.4 0.3-0.5-1 -0.5-0.5-0.5-0.1-0.2-0.2-0.1-1.5-2 -1.0-1.0-0.7-0.9-2.5 Source: Mediobanca Securities, ISTAT High Structural unemployment limits the room to manoeuvre the deficit Member states fiscal policy constrained by the NAIRU equilibrium concept... Eurozone fiscal policy is based on cyclically adjusted macro trends, therefore distinguishing between potential and real GDP. The Solow model adopted by the European Commission to calculate real GDP takes into account the output gap calculated on the so-called structural rate of unemployment based on NAIRU (Non Accelerating Inflation Rate of Unemployment). This refers to the level of unemployment that exists in an economy that does not cause inflation to increase. As such NAIRU is considered the Phillips curve equilibrium between the state of the economy and the labour market. This approach implies that a certain level of unemployment is unavoidable, so if a country tries to lower it, it will generate inflation, which will drive the employment rate back down, as shown in the chart below. NAIRU equilibrium Phillips Curve Inflation Rate Nairu or Long-Run Phillips Curve B c New Short-Run Phillips Curve A Initial Short-Run Phillips Curve Unemployment Rate Source: Mediobanca Securities Starting from point A, a decrease in the unemployment rate below the structural level of unemployment rate (which could be the consequence of higher public expenditure or of a reduction in the main interest rate by the central bank) leads to an inflation hike to point B, along the shortterm Phillips curve. Then it is expected that future inflation will be the same as in the present, therefore driving up the Phillips curve and, at the same time, dragging the unemployment rate back up to the prior level but with a higher inflation rate. The concept of this model is that a fiscal 17 November 2015 50
expansionary policy will never reduce the unemployment rate below a certain level, it will just translate into inflation.... preventing EU countries from implementing expansionary fiscal policy It follows that the already-limited room for macro-economic initiatives at the country level is further severely constrained by what Europe considers to be the structural level of unemployment in each country, or NAWRU (Non Accelerating Wage Rate of Unemployment). This creates a perverse pro-cyclical mechanism based on which the more a country sees its level of structural unemployment rise, the more its potential GDP decreases and the more its deviation from its structural balance widens. Structural unemployment (NAWRU) the Italian case Italy is a clear example of such pro-cyclicality. According to the European Commission, this year Italy will see its structural deficit increase from 0.6% of GDP to 0.9% in spite of its nominal deficit decreasing from 3% of GDP to 2.2%. The NAWRU assumed by the EC behind the 0.9% deficit figure in fact stands now at 10%. This compares with an 8% average in the period 1999-2008, implying that part of the output gap emerging during the crisis is considered structural and not cyclical and as such can never be reversed. If the EC had maintained Italy s NAWRU at 8%, in line with the precrisis average, the estimated 0.9% structural deficit in 2015 would have translated into a 0.3% surplus. The table below compares the difference between the loss in GDP and the so-called output gap for select countries, i.e., the GDP loss adjusted for the structural unemployment level. GPD loss versus Output gap - 2014 Country Loss in Potential 2013 Output Gap, 2013 Loss in Potential, 2015 Output Gap, 2015 Growth Rate of potential pre-crisis Growth Rate of potential 2014-2015 Australia 1.40% 1.60% 1.83% 2.27% 3.33% 3.11% Austria 6.02% 2.75% 7.14% 2.64% 2.36% 1.75% Belgium 7.54% 1.73% 8.82% 1.19% 2.07% 1.36% Canada 8.24% 0.75% 9.71% -0.16% 2.90% 2.08% Czech Republic 18.24% 3.58% 22.40% 3.52% 4.62% 1.92% Denmark 9.73% 2.93% 11.32% 1.63% 1.76% 0.86% Finland 15.66% 2.63% 18.99% 3.08% 3.09% 1.04% France 7.50% 2.68% 8.58% 3.08% 2.08% 1.48% Germany 2.87% 0.56% 3.39% -0.87% 1.52% 1.25% Greece 29.98% 9.33% 35.40% 7.59% 3.96% -0.15% Hungary 25.69% 1.93% 30.51% 0.69% 4.42% 0.98% Ireland 27.70% 6.32% 34.15% 4.45% 5.75% 0.93% Italy 9.88% 5.04% 12.05% 3.74% 1.34% 0.11% Japan 8.47% -0.15% 9.57% -0.89% 1.40% 0.79% Netherlands 6.83% 4.01% 8.53% 4.09% 2.14% 1.20% New Zealand 6.50% 0.29% 7.47% -1.22% 3.07% 2.53% Poland 5.24% 0.66% 7.42% 0.16% 4.11% 2.91% Portugal 11.41% 6.42% 13.74% 4.98% 1.83% 0.49% Spain 18.21% 4.37% 22.33% 3.52% 3.47% 0.83% Sweden 7.58% 1.75% 8.66% 0.76% 3.02% 2.41% Switzerland -0.42% 0.76% -0.88% 0.39% 1.81% 2.04% United Kingdom 10.98% 2.14% 12.37% 0.32% 2.66% 1.85% United States 4.70% 3.35% 5.33% 1.87% 2.57% 2.23% Weighted Average 7.18% 2.56% 8.38% 1.49% 2.39% 1.68% Source: Mediobanca Securities on OECD data The table below summarizes how the EC assumptions on NAWRU have changed since 2009. The procyclicality of the way structural unemployment is estimated appears very clear: in the case of growing core countries like Germany structural unemployment kept declining. The opposite 17 November 2015 51
happened in peripheral countries, which saw their room for economic expansionary measures further compressed. NAWRU (structural unemployment) assumed by the European Commission,2009-15e Average 1989-98 Average 1999-08 2009 2010 2011 2012 2013 2014 2015 Austria 3.8 4.2 4.4 4.3 4.3 4.3 4.3 4.3 4.3 Belgium 8.2 8.0 8.0 8.0 7.9 7.9 7.9 7.9 7.9 Canada 9.2 7.5 7.3 7.3 7.3 7.3 7.2 7.1 7.1 Czech Republic 5.6 7.2 6.5 6.3 6.1 6.1 6.1 6.1 6.1 Denmark 6.5 5.1 5.3 5.5 5.6 5.7 5.7 5.7 5.6 Estonia.. 10.0 9.7 10.0 10.2 10.3 10.3 10.3 10.3 Finland 10.6 9.0 7.7 7.7 7.5 7.2 7.2 7.2 7.2 France 9.4 8.7 8.8 8.9 9.0 9.1 9.2 9.2 9.2 Germany 7.0 7.8 7.3 7.1 6.8 6.7 6.5 6.3 6.3 Greece 8.2 10.3 11.8 12.5 12.9 13.3 15.6 16.8 17.5 Hungary 8.4 7.1 9.3 9.4 9.7 9.9 10.0 10.0 10.0 Iceland 3.2 3.3 4.4 4.7 4.9 5.0 5.0 5.0 5.0 Ireland 12.2 7.9 8.8 9.7 10.2 10.5 10.6 10.6 10.5 Italy 9.2 8.2 7.6 7.6 7.8 8.6 9.5 9.9 10.1 Netherlands 5.8 3.8 3.7 3.7 3.8 3.8 3.9 3.9 4.0 Poland 13.0 14.8 9.6 10.0 10.0 10.0 10.0 10.0 10.0 Portugal 6.0 6.9 9.0 9.5 9.8 10.7 12.0 12.2 12.3 Slovak Republic 13.2 15.4 13.2 13.8 13.6 13.3 13.1 13.0 13.0 Slovenia.. 6.3 6.2 6.5 6.8 7.2 7.9 8.1 8.3 Spain 15.1 13.3 16.6 18.3 19.7 20.8 21.4 21.5 21.4 Sweden 6.8 7.4 7.3 7.2 7.0 7.0 7.0 7.0 7.0 Switzerland 2.5 3.5 3.9 3.9 3.9 3.9 3.9 3.9 3.9 United Kingdom 8.3 5.9 6.6 6.7 6.9 6.9 6.9 6.7 6.6 United States 5.7 5.5 6.0 6.1 6.1 6.1 6.1 6.1 6.1 Euro area 8.7 8.7 9.1 9.3 9.5 9.8 10.1 10.2 10.2 Total OECD 6.6 6.5 6.8 6.9 6.9 7.0 7.1 7.1 7.1 Source: Mediobanca Securities based on OECD The charts below show the difference between the OECD assumptions on structural unemployment and the EC ones. The latter is higher than the former in the case of Italy (rhs chart), which further restricts the room for manoeuvring the deficit at the local government level, the opposite being true in the case of Germany. Structural unemployment - Germany... 9 8 7 6 5 Unemployment rate OECD European Commission... and Italy, 2009-15 14 13 12 11 10 9 8 Unemployment rate OECD European Commission 4 2009 2010 2011 2012 2013 2014 2015 7 2009 2010 2011 2012 2013 2014 2015 Source: Mediobanca Securities on OECD and EC data 17 November 2015 52
The chart below compares for each EU country the change in assumption on structural unemployment throughout the crisis (rebasing it to 100 in 2009). This has further widened the core versus periphery divide. Divergence in NAWRU (structural unemployment levels), 2009-15 150 Greece 140 130 Portugal Italy Spain 120 110 100 90 Ireland EURO area Netherlands Denmark France Belgium Austria Sweden Finland Germany 80 2009 2010 2011 2012 2013 2014 2015 Source: Mediobanca Securities on Eurostat data Reforms are a positive... The potential for the Italian economy is well above the growth rate forecasted for the next few years, as confirmed by its large output gap. In order to organically boost the economy we think the reforms done or underway are very positive but generally lack focus on the demand side of the equation. No doubt Italy needs to regain competitiveness via higher productivity, which is the focus of Renzi s economic reforms. However such a supply side focus requires time to spread its long term positives on internal devaluation. As such, it is the negative of the austerity measures to prevail short term and to reduce the spending power.... but need more on the demand side to boost consumption We welcome Renzi s focus on tax deductions, as shown by the INPS tax cuts on new perm hiring or the proposed cut of IMU and TASI (taxes on real estate properties). However the magnitude of such tax cuts can hardly be enough to significantly fuel consumer spending given the limited room allowed by the EU Treaties in light of the high structural unemployment attached to Italy which in turn does not leave much room for manoeuvre on the deficit. Leveraging on Renzi s focus on tax cuts and considering the constraints imposed by the common currency we think tax credit certificates would represent a viable solution for a more aggressive tax cuts plan without being in breach of EU constraints. Actions on the demand side Tax Credit Certificates (TCC) Demand side actions are limited within the common currency area The implementation of measures on the demand side of the economy has been very limited given the monetary union Italy is part of. Expansive policies envisage the introduction of more purchasing power for citizens and companies. And to do this the way is to either decrease taxes, increase transfers or increase direct public spending. However, in a union such as the euro area, not all the countries need such expansionary measures at the same time, so the general approach is to simply refuse to try and fix issues via more debt. As such, deficit spending through monetary injections by the ECB, which would increase the purchasing power for countries such as Italy, is just not a viable road to travel in the Eurozone. The chart below shows the Keynesian long run aggregate supply curve (LRAS) in its three phases: 17 November 2015 53
) Italy The aggregate supply curve is perfectly elastic at low levels of activity and there is spare capacity in the economy, i.e. unutilized capital or unemployed labour, thus increasing production wouldn t bring to accelerated inflation; Curve is sloping upwards the economy reaches the level where the available factors of production become scarce so that increasing output, from Y₁ to Y₂, brings to increasing prices from P₁ to P₂; The curve is now fully inelastic as the economy has reached its full capacity and the output cannot increase anymore but only prices can go up. Keynesian long run aggregate supply curve (LRAS) Source: Mediobanca Securities Tax credit certificates... The key features of TCCs are listed below: TCC are claims that give the owner the right to pay liabilities in respect to the government for taxes, contribution, sanctions, etc. They are sometimes defined as fiscal money or quasi money as they serve the purpose to pay taxes or more precisely to reduce the taxes outstanding. Though, deeming TCC as money is not appropriate as, even if denominated in euro, they are not legal tender within the euro area. Indeed the monopoly of the euro currency issuance would still remain within the ECB. As well as not a legal currency, TCCs are not debt: the state accepts them as a mean to pay taxes but in no circumstance it would reimburse them in euro. Therefore, TCC are neither legal money nor debt but just a mean of payment of taxes to be accepted by the Treasury....with a two-year exercise timeframe... Recent proposal focused on TCCs* foreseen that TCCs would be usable two years after their issuance. Such deferral serves to avoid TCCs leading to lower tax income for the government at issuance and to create a time lag long enough to activate the Keynesian multiplier. Indeed, the expansionary effect on the demand side of the economy stemming from TCCs is expected to generate extra GDP and thus extra tax revenues, which should more than compensate for the tax revenue shortfall created by the government accepting TCCs as a mean of paying taxes, after two years from their issuance....tradable and transferrable It is also feasible in our view to conceive TCCs as tradable instruments which can be transferrable immediately after their issuance. The right for the tax relief will merely be transferred from the original owner to another party. As they are deferred by two years after the issuance date, the TCCs should have a lower market value than their face value in a way not very different from what happens today on Italian Treasury bills with zero coupon of similar maturity. * See B. Bossone, M. Cattaneo, L. Gallino, E. Grazzini, S. Sylos Labini Fiscal Debit and Tax Credit Certificates: The Best Way to boost Economic Recovery in Italy (September 2015) and Free fiscal money: exiting austerity without breaking up the euro (March 2015) 17 November 2015 54
Several purposes depending on who are the beneficiaries of TCCs A key political decision lies in identifying the potential beneficiaries of TCCs as they could serve different purposes such as: Increasing the purchasing power of low-income workers, i.e., maximising the effect of the fiscal multiplier; Reducing the labour cost by assigning a certain amount of TCCs to employers so as to lower tax contributions on labour costs, i.e., maximising the increase in competitiveness; and Sustaining demand by assigning TCCs in other ways such as retirement incentives, unemployment contributions, public investments, etc. A combination of the above would support GDP growth as a way of strengthening internal demand via increasing purchasing power of low income people and boosting at the same time external demand via lower unit labour cost, so to raise competitiveness whilst avoiding a deterioration of the balance of payments. Moreover, the above GDP boost would materialise without generating more public debt, rather it would contribute to lower the debt to GDP ratio via the denominator effect. Indeed, TCCs cannot be cashed in in euro. At the same time there would not be any increase of legal tender of currency that can be used to extinguish government bonds within the euro area, i.e., you could not use Italian TCCs to pay taxes in Belgium. National TCCs would therefore bring back the necessary flexibility that existed before the euro area countries lost their respective sovereign currencies, but at the same time without breaking the union or violating the legal tender right of the ECB. TCCs as a way of softening austerity without being in breach of EU rules The deficit constraint... The present EU regulation foresees that a government would implement compensating actions if its deficit to GDP level goal were not met via the so-called safeguarding clauses. The problem though, is that these actions have a pro-cyclical impact consisting either in cuts to public expenditure or in tax hikes. As these measure are implemented in times of economic weakness they result in a downward spiral: the restrictive actions compress further the demand, the GDP shrinks more than expected as do the tax revenues. Therefore the balance in the public finance is achieved only at the expense of very negative impacts on GDP and employment.... can be eased via TCCs The introduction of TCCs can be integrated with safety clauses that would grant the government s accounts to shield from a more adverse scenario. TCCs could be used to pay for certain expenses instead of implementing tax hikes or public expenditure cuts. Indeed instead of raising taxes, the government could assign a certain amount of TCC similar to that of the taxes paid in euros by the taxpayer. This wouldn t be a fiscal imposition but rather an enforced version of euros into TCC. If a citizen or a company has to pay for a higher amount of taxes in euro, or receive a lower payment in euro, but in both cases the balance is bridged via TCCs (tradable and able to be monetized in the market) it wouldn t take any financial hit from the lower value of the TCC given by the market in respect to the face value. In the event this happened the pro-cyclical effect of the safety clauses is way lower, i.e., paying 100 in taxes has a different impact from paying 100 in taxes but with the same value in TCC, even though with a market value of, e.g., 80. The lower pro-cyclical effect contributes to narrow the financial tension....which could help to achieve public finance goals as well as flexibility The government could differentiate the usage of the TCCs based on the timeframe of the deferral. This means, in times of an economic weakness, it is possible to reduce the quantity of TCCs that are being used, though a longer deferral. This, in turn, would increase tax revenues in euro during a 17 November 2015 55
difficult time and the opposite once the economy recovers. TCCs would therefore provide the government with more flexibility in a non pro-cyclical way. At the same time this would still comply with regulations in respect to deficit and debt to be reimbursed in euro while at the same time reducing the debt GDP via denominator. TCCs would be denominated in euro and limited in their usage within the country of issuance without generating any public debt. The case of German MEFO bills There is actually nothing new in the TCC idea. Interestingly enough Germany was the first EU country to use a similar instrument with great success between 1933-1937, the so called MEFO bills. At that time when Hitler was rising to power, Germany was experiencing an economic depression, with the unemployment rate at 25%. After the Wall Street crisis of 1929, Germany lost the ability to finance its large stock of foreign debt originated from the war repayments under the Versailles Treaty. The response of the Bruening government at that time was to implement harsh austerity measures in order to service foreign debt, which in turn led to the economy falling into recession and the unemployment rate skyrocketing. A few years later, during the rise of Hitler, the minister of finance and president of the Reichsbank, H. Schacht, introduced the MEFO bills. Indeed, even if Germany had its sovereign currency, the Versailles treaty forbid it from certain banking activities. This is why the MEFO bills were used to bypass these restrictions. The government established a company, the Metallurgische Forschungsgesellschaft, which issued these obligations. The bills were then used to finance public expenditure and the counterparties would accept them as there was a state guarantee that the government would accept them. Schacht s initiative managed to considerably expand internal demand and consequently increase GDP and employment. In four years, Germany, reabsorbed almost in full the huge numbers of unemployed accumulated between 1929 and 1933. Modelling TCCs to the Italian economy a base case scenario Macroeconomic assumptions in line with the government s We aim at modelling in this section the impact on the Italian economy of the introduction of TCCs. Our simulation is entirely based on the Minister of Finance projections as of mid-september: GDP growth at +0.9% in 2015 and +1.6% for both 2016 and 2017 and 1.5% growth rate in 2018; Inflation is expected to grow slowly and reach the close but under 2% ECB s target; Public deficit as a % of GDP is forecasted at 2.6% in 2015 with breakeven in 2018; As a result the debt / GDP ratio peaks at 133% at the end of 2015 before starting to decrease in 2016 and reach 120% in 2019; and Trade balance records a positive >3% between 2015 and 2019. The table below summarises the key macro assumptions from the government which we used for our simulation. 17 November 2015 56
Public finance indicators ( bn) Government assumptions 2015 2016 2017 2018 2019 GDP 1,635 1,679 1,735 1,793 1,849 Tax Revenues 790 803 824 850 872 Public Expense 832 840 843 854 866 Surplus / (deficit) -42-37 -19-4 6 Revenue % GDP 48.3% 47.8% 47.5% 47.4% 47.2% Expense % GDP 50.9% 50.0% 48.6% 47.6% 46.8% Surplus / (deficit) % GDP -2.6% -2.2% -1.1% -0.2% 0.3% Government debt 2.172 2.209 2.228 2.232 2.226 Government debt/ GDP 132.8% 131.6% 128.4% 124.5% 120.4% Real GDP growth 0.9% 1.6% 1.6% 1.5% 1.3% Inflation - 1.1% 1.7% 1.8% 1.8% Export growth - 5.1% 6.1% 6.0% 5.6% Import/ GDP -26.4% -27.1% -28.0% -28.9% -29.7% Exports of goods and service 485 510 541 573 605 Imports of goods and service -431-456 -486-518 -548 Exports minus imports 54 54 55 56 57 Other -15-15 -15-15 -15 Trade balance 39 39 40 41 42 Trade balance / GDP 3.3% 3.2% 3.2% 3.1% 3.1% Balance current accounts / GDP 2.4% 2.3% 2.3% 2.3% 2.3% Source: Mediobanca Securities based on the update of Documento di Economia e Finanza (MEF 18.9.2015) Simulating the injection of 20bn (face value) of TCC in 2016, increased by 40bn in 2017... In our modelling we have assumed TCCs to be exercisable for tax benefits and to reduce the fiscal contribution towards public entities in general two years after their issuance. According to our hypothesis the TCCs in circulation would be as follows: 20bn face value in 2016; 60bn at end 2017 (i.e. 40bn to be added to the 20bn issued in 2016); and 80bn, constant, successively (every year 40bn are issued and 40bn are used). Two years delay means that TCCs issued in 2016 are utilized to pay taxes in 2018, TCCs issued in 2017 are used to pay taxes in 2019 and so on. This implies that total TCCs outstanding amount to 20bn at year-end 2016, 60bn at year-end 2017, 80bn at year-end 2018 and stay unchanged thereafter. We assume two thirds of TCCs to be allocated to sustain demand: integration of workers salaries, people in poverty status, co-financing of public investments. The remaining one third is assigned to corporates as a reduction of labour cost. This way we aim at offsetting the potential negative impact on the external balance coming via higher imports (including raw material) due to the expansionary component related to internal demand, with increased competitiveness boosting exports and also creating positive import substitution effects. The result will be to raise the GDP growth rate and bring it back to levels where the Italian economy s recovery can change pace. We also assume CCFs affect inflation as, unlike QE, such quasi money will not be parked with the banks but go straight to the final consumer and in turn affect pricing. We therefore assume in our modelling 90bps higher than currently forecasted inflation in 2016 and 20bps from 2017 onward reaching the 2% ECB target. 17 November 2015 57
... via a fiscal multiplier of 1.2x... We assume that the distribution of TCCs would generate an expansionary effect on GDP equal to 1.2x their amount. We consider such an assumption prudent enough. Indeed as largely proved by the recessionary effect of the austerity applied to peripheral Europe, the fiscal multiplier proved to be well above 1.2x, at least on the way down for the economy. In a recent paper the IMF estimated that the Keynesian multiplier can reach 1.7x in a situation where the economy recovers from depressed demand levels, which mirrors the current situation of Italy. The math thus brings a real GDP pick-up in 2016 of 20 x 1.20 = 24bn. In 2017 40 20 = 20 in increased TCC issuances, so a further real GDP pickup of 20 x 1.20 = 24 billion. From 2018 onwards, TCCs issuances are steady, so no further pickup in real growth is expected. We consider this conservative, as it assumes no spillover / benefit in future years from the improved economic landscape, which presumably, instead, will stimulate private credit expansion, corporate investment, etc.... would result in real GDP growth of 3% for both 2016 and 2017 and a surplus of 1.6% in 2017 In the table below we summarise the key findings of our macro simulation: Real GDP growth would stand at 3.1% in 2016 and 3.0% in 2017, twice current estimates. In addition, our 2018-2019 forecasts are conservative in that Italy achieves a budget surplus (euro receipts exceeding euro outlays) in those years and could use part of the surplus to further support demand and achieve higher real growth in the following years. The deficit / GDP ratio would quickly recover and reach a 0.8% surplus in 2017 versus -1.1% currently estimated. Accounting for a modest increase in inflation, until 2%, the decrease of the debt to GDP ratio would gain speed. The forecast at end 2019 is 8 p.p. lower than current government estimate as debt GDP falls from 133% as of 2015 year-end to 112% in 2019, versus 120% in the current without CCFs scenario. TCCs outstanding are not included in the debt / GDP ratio as they are not debt because they are not redeemable for euros. TCCs outstanding as of 2019 year-end ( 80 billion) are just slightly above 4% of GDP. The trade balance would stay positive, even though at a lower level than the base hypothesis (but still above 2% of GDP). TCC issuances are expected to go to enterprises based on their labour costs, which reduces actual cost of labour for Italian-based companies and improves competitiveness, both via higher exports and via import substitution effects. This mostly offsets the impact of higher internal demands on import of raw materials and other non-domestically-produced inputs. The result is a trade balance of 31bn in 2017 compared to 40bn in the no-ccfs scenario, i.e., 2.5% versus 3.2%. As concerns public receipts, actual receipts benefit from the higher nominal (and real) GDP, which is partially offset from 2018 onwards as TCCs start getting utilized. The no-ccf scenario suggests tax revenues for the government in 2018 of 850bn. Under the CCFs scenario that would be the first year of redemption of 20bn CCFs issued in 2016. The result will be tax revenues at 886bn, which drops to 866bn when accounting for 20bn TCCs to be redeemed. This shows that higher GDP growth will generate extra tax revenues, which would more than offset the 20bn CCFs issued in 2016 and redeemed in 2018, leaving us with a positive delta of 16bn. Obviously should the fiscal multiplier prove to be higher than our 1.2x assumption, there would be upside to such delta. 17 November 2015 58
Forecast public finance indicators after TCCs introduction ( bn) Hypothesis with TCC 2015 2016 2017 2018 2019 GDP 1,635 1,719 1,806 1,870 1,932 TCC issued - 20 40 40 40 TCC utilized - - - 20 40 TCC outstanding 20 60 80 80 Fiscal Multiplier - 1.20 1.20 1.20 1.20 Increase TCC assignments - 20 20 - - Real GDP increase due to TCC via multiplier at 1.2x - 24 24 - - Tax Revenues 790 822 858 886 911 TCC utilized - - - 20 40 Revenues net of TCC utilized 790 822 858 866 871 Public Expenditure 832 840 843 854 866 Surplus / (deficit) -42-18 15 12 5 Tax Revenue % GDP 48.3% 47.8% 47.5% 47.4% 47.2% Tax Revenue % GDOP net of TCC utilized 48.3% 47.8% 47.5% 46.3% 45.1% Public Expenditure % GDP 50.9% 48.9% 46.7% 45.7% 44.8% Surplus / (deficit) % -2.6% -1.0% 0.8% 0.7% 0.3% Public debt 2.172 2.190 2.175 2.163 2.158 Public debt / GDP 132.8% 127.4% 120.5% 115.7% 111.7% TCC outstanding end of year - 20 60 80 80 TCC outstanding end of year / GDP - 1.2% 3.3% 4.3% 4.1% Real GDP growth - 3.1% 3.0% 1.5% 1.3% Inflation - 2.0% 2.0% 2.0% 2.0% % TCC to corporates - 33% 33% 33% 33% TCC to companies - 7 13 13 13 Benefit on trade balance- multiplier - 1.00 1.00 1.00 1.00 Benefit on trade balance - 7 13 13 13 Of which: Higher export - 3 7 7 7 Substation of imports - 3 7 7 7 Export increase exl TCC effect - 5.1% 6.1% 6.0% 5.6% Import / GDP exl TCC effect -26.4% -27.1% -28.0% -28.9% -29.7% Export of goods and services 485 513 548 581 613 Imports of goods and services -431-463 -502-540 -573 Export minus imports 54 50 46 41 40 Other items -15-15 -15-15 -15 Trade balance 39 35 31 26 25 Trade balance/ GDP 3.3% 2.9% 2.5% 2.2% 2.1% Current account balance / GDP 2.4% 2.0% 1.7% 1.4% 1.3% Source: Mediobanca Securities (*) Based on the update of Documento di Economia e Finanza (MEF 18.9.2015) 17 November 2015 59
Reconciling the numbers to unhide the CCFs benefit Our modelling is based on a static approach, which means we are not considering any second derivative effect stemming from the virtuous circle that CCFs would activate. This is why we deem our conclusions conservative: such recovery would also benefit the overall sentiment and expectations of the economy s participants. The table below summarizes the impact of the CCFs injections simulated above by breaking down the drivers of GDP boost and tax revenues increase: GDP under TCCs would be 4% higher than the base case scenario in 2017, i.e., 71bn. As shown below TCCs would explain 67% of such delta, i.e., 48bn. The remaining one third is expected to come from inflation generated by TCCs. The tax revenues impact of TCCs is better captured in 2018 when the first 20bn TCCs issued in 2016 will be redeemable. As we can see the delta 77bn of GDP generated by TCCs would lead to 36bn extra tax revenues, which would more than offset the redemption of TCCs, leaving a positive 16bn delta. Put differently, TCCs would reduce fiscal pressure by 90bps in 2018, from 47.4% to 46.3%. Reconciling the numbers from no CCFs to CCFs issuance 2015 2016 2017 2018 2019 Base case GDP 1,679 1,735 1,793 1,849 Direct GDP increase from TCC: cumulative 24 48 48 48 Effect of higher inflation 15 21 25 29 Effect of compounded real growth 0 2 4 5 New GDP with TCCs 1,719 1,806 1,870 1,932 Inflation - without TCCs 1.1% 1.7% 1.8% 1.8% Inflation - with TCCs 2.0% 2.0% 2.0% 2.0% Price index - without TCCs 100.00 101.07 102.80 104.67 106.55 Price index - with TCCs 100.00 102.00 104.04 106.12 108.24 Higher GDP 40 71 77 83 Tax rate % 47.8% 47.5% 47.4% 47.2% Higher gross government revenues 19 34 36 40 TCC utilised -20-40 Higher net government revenues 19 34 16 0 Source: Mediobanca Securities (*) Based on the update of Documento di Economia e Finanza (MEF 18.9.2015) TCCs for industrial projects Financing CDP public investments There are many ways of using the concept of TCCs. The most obvious one applies to the Italian Cassa Depositi e Prestiti. CDP could indeed finance public investment by issuing, for instance, bonds that are convertible into TCCs after two years. In the case of conversion, the owner of the bond would receive TCCs and the CDP s debt to the owner of the bond would be extinguished and replaced by one to the government which the CDP would serve with the proceeds of the investment financed in the first place. The decrease in fiscal revenue for the government would be compensated by the expansionary impact on GDP and on demand. Alternatively, government suppliers could be paid via CDP bonds so to put an end to the government s tedious delay in clearing public administration arrears estimated to still amount to 100bn. 17 November 2015 60
Bond issued by CDP in euro and convertible in TCC with the support of MEF Source: Mediobanca Securities Fiscal card and citizenship wage Another way of using TCCs would be to assign them through a Fiscal card that would expire if not utilized within a certain period, say, 12 months. This way the expansionary impact of TCC on demand would be greater, as TCCs holders would be incentivised to use them and reduce savings. Equally, TCCs could be distributed as a form of citizenship wage so to help those in a poverty situation. Greece would be a perfect fit The TCC project can apply to every country experiencing a compression of internal demand and needing to improve its competiveness. A simultaneous implementation of TCCs in different countries would create a virtuous circle thanks to a joint expansion of their respective economies. An appropriate candidate would be Greece, which with the introduction of TCCs would increase its internal demand, citizens purchasing power and companies competitiveness. This would make the surplus required by its creditors more feasible. TCC to reduce dualism between North and South Last but not least TCCs are the perfect way to help narrow the persistent gap between North regions of the country, where GDP per capita is close to German levels, and Southern regions, normally running 45% lower, in line with Greece. It has long been argued that these two areas should have different currencies so to create the conditions for an alignment of competitiveness. TCCs would represent a smart solution to such competitiveness gap if distributed mainly to Southern-based corporates so to make Southern Italy more attractive as a production site. Obviously such a process would require time but would ultimately reduce the dualism between North and South. 17 November 2015 61
Disclaimer Italy Disclaimer GENERAL DISCLOSURES This research report is prepared by Mediobanca - Banca di credito finanziario S.p.A. ( Mediobanca S.p.A. ), authorized and supervised by Bank of Italy and Consob to provide financial services, and is compliant with the relevant European Directive provisions on investment and ancillary services (MiFID Directive) and with the implementing law. Unless specified to the contrary, within EU Member States, the report is made available by Mediobanca S.p.A. The distribution of this document by Mediobanca S.p.A. in other jurisdictions may be restricted by law and persons into whose possession this document comes should inform themselves about, and observe, any such restrictions. All reports are disseminated and available to all clients simultaneously through electronic distribution and publication to our internal client websites. The recipient acknowledges that, to the extent permitted by applicable securities laws and regulations, Mediobanca S.p.A. disclaims all liability for providing this research, and accepts no liability whatsoever for any direct, indirect or consequential loss arising from the use of this document or its contents. This research report is provided for information purposes only and does not constitute or should not be construed as a provision of investment advice, an offer to buy or sell, or a solicitation of an offer to buy or sell, any financial instruments. It is not intended to represent the conclusive terms and conditions of any security or transaction, nor to notify you of any possible risks, direct or indirect, in undertaking such a transaction. Not all investment strategies are appropriate at all times, and past performance is not necessarily a guide to future performance. Mediobanca S.p.A. recommends that independent advice should be sought, and that investors should make their own independent decisions as to whether an investment or instrument is proper or appropriate based on their own individual judgment, their risk-tolerance, and after consulting their own investment advisers. Unless you notify Mediobanca S.p.A. otherwise, Mediobanca S.p.A. assumes that you have sufficient knowledge, experience and/or professional advice to undertake your own assessment. This research is intended for use only by those professional clients to whom it is made available by Mediobanca S.p.A. The information contained herein, including any expression of opinion, has been obtained from or is based upon sources believed to be reliable but is not guaranteed as to accuracy or completeness although Mediobanca S.p.A. considers it to be fair and not misleading. Any opinions or estimates expressed herein reflect the judgment of the author(s) as of the date the research was prepared and are subject to change at any time without notice. Unless otherwise stated, the information or opinions presented, or the research or analysis upon which they are based, are updated as necessary and at least annually. Mediobanca S.p.A. may provide hyperlinks to websites of entities mentioned in this document, however the inclusion of a link does not imply that Mediobanca S.p.A. endorses, recommends or approves any material on the linked page or accessible from it. Mediobanca S.p.A. does not accept responsibility whatsoever for any such material, nor for any consequences of its use. Neither Mediobanca S.p.A. nor any of its directors, officers, employees or agents shall have any liability, howsoever arising, for any error, inaccuracy or incompleteness of fact or opinion in this report or lack of care in its preparation or publication. Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research. Our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research. The analysts named in this report may have from time to time discussed with our clients, including Mediobanca S.p.A. salespersons and traders, or may discuss in this report, trading strategies that reference catalysts or events that may have a near-term impact on the market price of the equity securities discussed in this report, which impact may be directionally counter to the analysts' published price target expectations for such stocks. Any such trading strategies are distinct from and do not affect the analysts' fundamental equity rating for such stocks, which rating reflects a stock's return potential relative to its coverage group as described herein. ADDITIONAL DISCLAIMERS TO U.S. INVESTORS: This research report is prepared by Mediobanca S.p.A. and distributed in the United States by Mediobanca Securities USA LLC, which is a wholly owned subsidiary of Mediobanca S.p.A., is a member of Finra and is registered with the US Securities and Exchange Commission. 565 Fifth Avenue - New York NY 10017. Mediobanca Securities USA LLC accepts responsibility for the content of this report. Any US person receiving this report and wishing to effect any transaction in any security discussed in this report should contact Mediobanca Securities USA LLC at 001(212) 991-4745. Please refer to the contact page for additional contact information. All transactions by a US person in the securities mentioned in this report must be effected through Mediobanca Securities USA LLC and not through a non-us affiliate. The research analyst(s) named on this report are not registered / qualified as research analysts with Finra. The research analyst(s) are not associated persons of Mediobanca Securities USA LLC and therefore are not subject to NASD rule 2711 and incorporated NYSE rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst. ADDITIONAL DISCLAIMERS TO U.K. INVESTORS: Mediobanca S.p.A. provides investment services in the UK through a branch established in the UK (as well as directly from its establishment(s) in Italy) pursuant to its passporting rights under applicable EEA Banking and Financial Services Directives and in accordance with applicable Financial Services Authority requirements. ADDITIONAL DISCLAIMERS TO U.A.E. INVESTORS: This research report has not been approved or licensed by the UAE Central Bank, the UAE Securities and Commodities Authority (SCA), the Dubai Financial Services Authority (DFSA) or any other relevant licensing authorities in the UAE, and does not constitute a public offer of securities in the UAE in accordance with the commercial companies law, Federal Law No. 8 of 1984 (as amended), SCA Resolution No.(37) of 2012 or otherwise. This research report is strictly private and confidential and is being issued to sophisticated investors. REGULATORY DISCLOSURES Mediobanca S.p.A. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Mediobanca S.p.A. or its affiliates or its employees may effect transactions in the securities described herein for their own account or for the account of others, may have long or short positions with the issuer thereof, or any of its affiliates, or may perform or seek to perform securities, investment banking or other services for such issuer or its affiliates. The organisational and administrative arrangements established by Mediobanca S.p.A. for the management of conflicts of interest with respect to investment research are consistent with rules, regulations or codes applicable to the securities industry. The compensation of the analyst who prepared this report is determined exclusively by research management and senior management (not including investment banking). Analyst compensation is not based on investment banking revenues, however, compensation may relate to the revenues of Mediobanca S.p.A. as a whole, of which investment banking, sales and trading are a part. 17 November 2015 62
Disclaimer For a detailed explanation of the policies and principles implemented by Mediobanca S.p.A. to guarantee the integrity and independence of researches prepared by Mediobanca's analysts, please refer to the research policy which can be found at the following link: http://www.mediobanca.it/static/upload/b5d/b5d01c423f1f84fffea37bd41ccf7d74.pdf Unless otherwise stated in the text of the research report, target prices are based on either a discounted cash flow valuation and/or comparison of valuation ratios with companies seen by the analyst as comparable or a combination of the two methods. The result of this fundamental valuation is adjusted to reflect the analyst's views on the likely course of investor sentiment. Whichever valuation method is used there is a significant risk that the target price will not be achieved within the expected timeframe. Risk factors include unforeseen changes in competitive pressures or in the level of demand for the company's products. Such demand variations may result from changes in technology, in the overall level of economic activity or, in some cases, from changes in social values. Valuations may also be affected by changes in taxation, in exchange rates and, in certain industries, in regulations. All prices are market close prices unless differently specified. Since 1 July 2013, Mediobanca uses a relative rating system, based on the following judgements: Outperform, Neutral, Underperform and Not Rated. Outperform (O). The stock s total return is expected to exceed the average total return of the analyst s industry (or industry team s) coverage universe, on a risk-adjusted basis, over the next 6-12 months. Neutral (N). The stock s total return is expected to be in line with the average total return of the analyst s industry (or industry team s) coverage universe, on a risk-adjusted basis, over the next 6-12 months. Underperform (U). The stock s total return is expected to be below the average total return of the analyst s industry (or industry team s) coverage universe, on a risk-adjusted basis, over the next 6-12 months. Not Rated (NR). Currently the analyst does not have adequate confidence about the stock s total return relative to the average total return of the analyst s industry (or industry team s) coverage, on a risk-adjusted basis, over the next 6-12 months. Alternatively, it is applicable pursuant to Mediobanca policy in circumstances when Mediobanca is acting in any advisory capacity in a strategic transaction involving this company or when the company is the target of a tender offer. Our recommendation relies upon the expected relative performance of the stock considered versus its benchmark. Such an expected relative performance relies upon a valuation process that is based on the analysis of the company's business model / competitive positioning / financial forecasts. The company's valuation could change in the future as a consequence of a modification of the mentioned items. Please consider that the above rating system also drives the portfolio selections of the Mediobanca's analysts as follows: long positions can only apply to stocks rated Outperform and Neutral; short positions can only apply to stocks rated Underperform and Neutral; portfolios selection cannot refer to Not Rated stocks; Mediobanca portfolios might follow different time horizons. Proportion of all recommendations relating to the last quarter Outperform Neutral Underperform Not Rated 50.40% 38.01% 9.97% 1.62% Proportion of issuers to which Mediobanca S.p.A. has supplied material investment banking services relating to the last quarter: Outperform Neutral Underperform Not Rated 10.77% 9.26% 7.69% 25.00% The current stock ratings system has been used since 1 July 2013. Before then, Mediobanca S.p.A. used a different system, based on the following ratings: outperform, neutral, underperform, under review, not rated. For additional details about the old ratings system, please access research reports dated before 1 July 2013 from the restricted part of the MB Securities section of the Mediobanca S.p.A. website at www.mediobanca.com. 17 November 2015 63
Disclaimer COMPANY SPECIFIC REGULATORY DISCLOSURES SPECIALIST This report was prepared by Mediobanca S.p.A. in its capacity as specialist of the following companies, in compliance with the obligations set forth by the rules of the markets organized and managed by Borsa Italiana S.p.A.: Aeffe, EI Towers. Mediobanca S.p.A. expects to prepare research reports on the following companies at least on a semi-annual basis: Aeffe, EI Towers. MARKET MAKER Mediobanca S.p.A. is currently acting as market maker on equity instruments, or derivatives whose underlying financial instruments are materially represented by equity instruments, issued by the following companies: A2A, Acea, Atlantia, Autogrill, Banca Pop. Milano, Banco Popolare, Buzzi Unicem, Credem, Enel, Enel Green Power, Eni, Finmeccanica, Generali, Geox, Hera, Intesa Sanpaolo, Iren, Italcementi, L'Espresso, Mediaset, Mediolanum, Mondadori, Pirelli & C., Prysmian, Snam, Telecom Italia, Tod's, UBI Banca, Unicredit. MEDIOBANCA REPRESENTATION ON GOVERNING BODIES Mediobanca S.p.A. or one or more of the companies belonging to its group have a representative on one of the governing bodies of the following companies: Atlantia, Generali. MEDIOBANCA SIGNIFICANT FINANCIAL INTERESTS Mediobanca S.p.A. or one or more of the companies belonging to its group owns a major holding (as defined in the EU Transparency Directive as implemented in each relevant jurisdiction) in the following companies: Generali, Pirelli & C., RCS Mediagroup. Please consult the website of the relevant competent authority for details. As of the date of publication of this research report, Mediobanca Securities USA LLC's parent company, Mediobanca S.p.A. beneficially owns 1% or more of any class of common equity securities of the securities of the following companies: Generali, Pirelli & C., RCS Mediagroup. As of the date of publication of this research report, Mediobanca Securities USA LLC's parent company, Mediobanca S.p.A. beneficially owns 1% or more of any class of common equity securities of the securities of the following companies: Unicredit. Mediobanca S.p.A. or one or more of the companies belonging to its group hold material open positions in financial instruments, or derivatives whose underlying financial instruments are materially represented by financial instrument, issued by the following companies: Generali. ISSUER REPRESENTATION ON MEDIOBANCA GOVERNING BODIES Certain members of the governing bodies of the following companies are also members of the governing bodies of Mediobanca S.p.A. or one or more of the companies belonging to its group: Atlantia, Autogrill, Generali, Mediolanum, Pirelli & C., RCS Mediagroup, Salini Impregilo, Telecom Italia, Unicredit. ISSUER SIGNIFICANT FINANCIAL INTERESTS ON MEDIOBANCA The following companies own a major holding (as defined in the EU Transparency Directive as implemented in each relevant jurisdiction) in Mediobanca S.p.A.: Mediolanum, Unicredit. Please consult the website of the relevant competent authority for details. LENDING RELATIONSHIP Mediobanca S.p.A. or one or more of the companies belonging to its group have a significant lending relationship with the following companies or one or more of the companies belonging to their group: Atlantia, Autogrill, Banca Generali, Generali. CORPORATE FINANCE SERVICE CONTRACTS Mediobanca S.p.A. or one or more of the companies belonging to its group are currently providing corporate finance services to the following companies or one or more of the companies belonging to its group: Banco Popolare, Enel, Finmeccanica, Generali, RCS Mediagroup, Telecom Italia. In the past 12 months, Mediobanca S.p.A. or one or more of the companies belonging to its group have entered into agreements to deliver corporate finance services to the following companies or one or more of the companies belonging to its group: Enel. RATING The present rating in regard to A2A has not been changed since 13/04/2015. In the past 12 months, the rating on A2A has been changed. The previous rating, issued on 03/08/2012, was Neutral. The present rating in regard to Acea has not been changed since 29/09/2014. The present rating in regard to Aeffe has not been changed since 28/04/2015. In the past 12 months, the rating on Aeffe has been changed. The previous rating, issued on 10/06/2014, was Outperform. The present rating in regard to Atlantia has not been changed since 04/12/2007. The present rating in regard to Autogrill has not been changed since 11/10/2013. The present rating in regard to Banca Generali has not been changed since 25/03/2013. The present rating in regard to Banca Pop. Milano has not been changed since 21/01/2015. In the past 12 months, the rating on Banca Pop. Milano has been changed. The previous rating, issued on 08/09/2014, was Neutral. The present rating in regard to Banco Popolare has not been changed since 08/09/2014. The present rating in regard to Buzzi Unicem has not been changed since 16/03/2015. In the past 12 months, the rating on Buzzi Unicem has been changed. The previous rating, issued on 01/12/2014, was Neutral. The present rating in regard to Cairo Communication has not been changed since 06/08/2014. The present rating in regard to Cerved has not been changed since 04/08/2014. The present rating in regard to Credem has not been changed since 05/01/2009. The present rating in regard to Creval has not been changed since 06/06/2012. The present rating in regard to EI Towers has not been changed since 24/10/2006. The present rating in regard to Enel has not been changed since 09/03/2012. The present rating in regard to Enel Green Power has not been changed since 20/03/2015. In the past 12 months, the rating on Enel Green Power has been changed. The previous rating, issued on 10/11/2014, was Outperform. The present rating in regard to Eni has not been changed since 04/09/2015. In the past 12 months, the rating on Eni has been changed. The previous rating, issued on 06/10/2014, was Neutral. The present rating in regard to Fincantieri has not been changed since 11/11/2015. In the past 12 months, the rating on Fincantieri has been changed. The previous rating, issued on 13/08/2014, was Outperform. The present rating in regard to Finmeccanica has not been changed 17 November 2015 64
Disclaimer since 21/04/2015. In the past 12 months, the rating on Finmeccanica has been changed. The previous rating, issued on 03/07/2014, was Neutral. The present rating in regard to Generali has not been changed since 01/08/2014. The present rating in regard to Geox has not been changed since 03/07/2014. The present rating in regard to Hera has not been changed since 03/03/2014. The present rating in regard to Intesa Sanpaolo has not been changed since 08/09/2014. The present rating in regard to Iren has not been changed since 09/02/2015. In the past 12 months, the rating on Iren has been changed. The previous rating, issued on 16/11/2011, was Neutral. The present rating in regard to Italcementi has not been changed since 29/07/2015. In the past 12 months, the rating on Italcementi has been changed. The previous rating, issued on 19/03/2015, was Outperform. The present rating in regard to L'Espresso has not been changed since 30/07/2013. The present rating in regard to Mediaset has not been changed since 27/08/2015. In the past 12 months, the rating on Mediaset has been changed. The previous rating, issued on 20/07/2015, was Neutral. The present rating in regard to Mediolanum has not been changed since 02/02/2015. In the past 12 months, the rating on Mediolanum has been changed. The previous rating, issued on 25/03/2013, was Neutral. The present rating in regard to Mondadori has not been changed since 22/09/2015. In the past 12 months, the rating on Mondadori has been changed. The previous rating, issued on 05/03/2013, was Neutral. The present rating in regard to Pirelli & C. has not been changed since 14/05/2015. In the past 12 months, the rating on Pirelli & C. has been changed. The previous rating, issued on 01/04/2015, was Not Rated. The present rating in regard to Prysmian has not been changed since 31/07/2015. In the past 12 months, the rating on Prysmian has been changed. The previous rating, issued on 07/11/2014, was Outperform. The present rating in regard to Rai Way has not been changed since 31/07/2015. In the past 12 months, the rating on Rai Way has been changed. The previous rating, issued on 30/12/2014, was Outperform. The present rating in regard to RCS Mediagroup has not been changed since 16/11/2015. In the past 12 months, the rating on RCS Mediagroup has been changed. The previous rating, issued on 13/03/2014, was Outperform. The present rating in regard to Salini Impregilo has not been changed since 31/07/2014. The present rating in regard to Snam has not been changed since 02/11/2015. In the past 12 months, the rating on Snam has been changed. The previous rating, issued on 11/06/2015, was Neutral. The present rating in regard to Telecom Italia has not been changed since 05/08/2015. In the past 12 months, the rating on Telecom Italia has been changed. The previous rating, issued on 09/07/2013, was Not Rated. The present rating in regard to Tod's has not been changed since 05/10/2011. The present rating in regard to UBI Banca has not been changed since 15/11/2013. The present rating in regard to Unicredit has not been changed since 26/03/2012. INITIAL COVERAGE A2A initial coverage as of 21/03/2003.Acea initial coverage as of 03/02/2004.Aeffe initial coverage as of 17/09/2007.Atlantia initial coverage as of 10/04/2003.Autogrill initial coverage as of 21/02/2003.Banca Generali initial coverage as of 17/01/2007.Banca Pop. Milano initial coverage as of 05/03/2003.Banco Popolare initial coverage as of 25/07/2007.Buzzi Unicem initial coverage as of 21/03/2003.Cairo Communication initial coverage as of 12/02/2003.Cerved initial coverage as of 01/08/2014.Credem initial coverage as of 21/03/2003.Creval initial coverage as of 18/12/2007.EI Towers initial coverage as of 24/10/2006.Enel initial coverage as of 09/05/2003.Enel Green Power initial coverage as of 26/01/2011.Eni initial coverage as of 25/02/2004.Fincantieri initial coverage as of 12/08/2014.Finmeccanica initial coverage as of 28/03/2003.Generali initial coverage as of 23/01/2003.Geox initial coverage as of 01/03/2005.Hera initial coverage as of 30/07/2003.Intesa Sanpaolo initial coverage as of 16/04/2007.Iren initial coverage as of 20/07/2010.Italcementi initial coverage as of 31/01/2003.L'Espresso initial coverage as of 17/04/2003.Mediaset initial coverage as of 19/03/2003.Mediolanum initial coverage as of 19/03/2003.Mondadori initial coverage as of 06/02/2003.Pirelli & C. initial coverage as of 12/05/2004.Prysmian initial coverage as of 26/06/2007.Rai Way initial coverage as of 29/12/2014.RCS Mediagroup initial coverage as of 25/06/2003.Salini Impregilo initial coverage as of 24/06/2005.Snam initial coverage as of 21/02/2003.Telecom Italia initial coverage as of 12/02/2003.Tod's initial coverage as of 28/01/2003.UBI Banca initial coverage as of 16/04/2007.Unicredit initial coverage as of 30/06/2003. ANALYST S PERSONAL FINANCIAL INTERESTS COPYRIGHT NOTICE No part of the content of any research material may be copied, forwarded or duplicated in any form or by any means without the prior consent of Mediobanca S.p.A., and Mediobanca S.p.A. accepts no liability whatsoever for the actions of third parties in this respect. END NOTES The disclosures contained in research reports produced by Mediobanca S.p.A. shall be governed by and construed in accordance with Italian law. Additional information is available upon request. 17 November 2015 65
Disclaimer ANALYSTS Mediobanca S.p.A. Antonio Guglielmi Head of European Equity Research +44 203 0369 570 antonio.guglielmi@mediobanca.com European Banks Alain Tchibozo France/IBK +44 203 0369 573 alain.tchibozo@mediobanca.com Adam Terelak France/IBK +44 203 0369 574 adam.terelak@mediobanca.com Andrea Filtri Spain/Italy +44 203 0369 571 andrea.filtri@mediobanca.com Andres Williams Spain +44 203 0369 577 andres.williams@mediobanca.com Riccardo Rovere Italy/Scandinavia/CEE/Germany +39 02 8829 604 riccardo.rovere@mediobanca.com Robin van den Broek Benelux +44 203 0369 672 robin.vandenbroek@mediobanca.com Vivek Raja UK +44 203 0369 623 vivek.raja@mediobanca.com European Insurance Gianluca Ferrari Global multi-liners/italy/asset Gatherers +39 02 8829 482 gianluca.ferrari@mediobanca.com Robin van den Broek Benelux/UK +44 203 0369 672 robin.vandenbroek@mediobanca.com Simonetta Chiriotti Nordics +39 02 8829 933 simonetta.chiriotti@mediobanca.com Vinit Malhotra Global multi-liners/reinsurers +44 203 0369 585 vinit.malhotra@mediobanca.com Italian Research Alessandro Pozzi Oil & Oil Related +44 203 0369 617 alessandro.pozzi@mediobanca.com Alessandro Tortora Building Materials/Industrials/Capital Goods +39 02 8829 673 alessandro.tortora@mediobanca.com Chiara Rotelli Branded Goods/Consumers Goods +39 02 8829 931 chiara.rotelli@mediobanca.com Fabio Pavan Media/Telecommunications/Consumer Goods +39 02 8829 633 fabio.pavan@mediobanca.com Javier Suárez Utilities +39 028829 036 javier.suarez@mediobanca.com Jean Farah Utilities +44 203 0369 665 jean.farah@mediobanca.com Massimo Vecchio Auto & Auto Components/Industrials/Holdings +39 02 8829 541 massimo.vecchio@mediobanca.com Niccolò Storer Auto & Auto Components/Industrials/Holdings +39 02 8829 444 niccolo.storer@mediobanca.com Nicolò Pessina Consumer Goods/Infrastructure +39 02 8829 796 nicolo.pessina@mediobanca.com Sara Piccinini Utilities +39 02 8829 295 sara.piccinini@mediobanca.com Simonetta Chiriotti Real Estate/ Industrials +39 02 8829 933 simonetta.chiriotti@mediobanca.com FOR NON US PERSON receiving this document and wishing to effect transactions in any securities discussed herein, please contact: SALES Mediobanca S.p.A. Carlo Pirri Head of Equity Sales +44 203 0369 531 carlo.pirri@mediobanca.com Angelo Vietri +39 02 8829 989 angelo.vietri@mediobanca.com Christopher Seidenfaden +44 203 0369 610 christopher.seidenfaden@mediobanca.com Lorenzo Angeloni +39 02 8829 507 lorenzo.angeloni@mediobanca.com Matteo Agrati +44 203 0369 629 matteo.agrati@mediobanca.com Timothy Pedroni +44 203 0369 635 timothy.pedroni@mediobanca.com Stephane Langlois +44 203 0369 582 stephane.langlois@mediobanca.com European Spec Sales Carlo Pirri Banks +44 203 0369 531 carlo.pirri@mediobanca.com Gert-Jaap Kraan Banks/Insurance +44 203 0369 510 gert-jaap.kraan@mediobanca.com SALES/TRADERS Mediobanca S.p.A. Cedric Hanisch Head of Equity Trading and Sales Trading +44 203 0369 584 cedric.hanisch@mediobanca.com Alessandro Gobbi +39 02 8829 263 alessandro.gobbi@mediobanca.com Andrew Westoby +44 203 0369 513 andrew.westoby@mediobanca.com Michael Sherry +44 203 0369 605 michael.sherry@mediobanca.com Roberto Riboldi +39 02 8829 639 roberto.riboldi@mediobanca.com FOR US PERSON receiving this document and wishing to effect transactions in any securities discussed herein, please contact: Mediobanca Securities USA LLC Pierluigi Gastone Head of Mediobanca Securities USA LLC +1 212 991 4745 pierluigi.gastone@mediobanca.com Massimiliano Pula +1 646 839 4911 massimiliano.pula@mediobanca.com Robert Perez +1 646 839 4910 robert.perez@mediobanca.com MEDIOBANCA Banca di Credito Finanziario S.p.A. Piazzetta Enrico Cuccia, 1-20121 Milano - T. +39 02 8829.1 33 Grosvenor Place London SW1X 7HY T. +44 (0) 203 0369 530 17 November 2015 66