Nº 2 2015 > Telecom Industry
Europe — Thirty Years on from Liberalization
Contributed by Philip Carse, Lead ICT Analyst, Megabuyte.com
Editor’s note: In this article, the use of italics refers to the results of Megabuyte’s analysis of its sample database of companies.
European telecommunication markets have been subject to competition since the mid-1980s, when many countries licensed mobile operators, typically the incumbent fixed-line telco and one other. The pace of market liberalization has varied significantly by country, but has typically involved a mix of: carrier pre-select, wholesale lines and broadband and local loop unbundling by the incumbent; full infrastructure competition; the licensing of additional mobile operators, as well as mandating MVNO (mobile virtual network operator) services; and allowing cable TV companies to offer telephony. Thirty years on, what does the European telecom industry look like in terms of growth, challenges and opportunities?
Megabuyte tracks and analyses the financial, corporate and strategic activity of over 80 mainly European-based telecoms and network operators with revenues of at least Euro 50 million, generating a total of Euro 260 billion revenues from the major European markets (and Euro 410 billion in total). In our analysis, the top nine players comprise incumbents or early mobile pioneers (led by Deutsche Telekom, Telefonica, Vodafone and Orange). Liberty Global is the top non-European player/outsider from the United States at number ten. The 80 companies are broadly divided into those with revenues of at least Euro 1 billion and a long tail of companies below Euro 1 billion, the latter mostly serving business communications markets. Of the larger companies, most are incumbents, second/third mobile operators or cable operators, with a few limited exceptions (notably, including United Internet in Germany, Talk Talk in the United Kingdom and COLT).
Overall, “incumbents” still account for around two-thirds of total industry revenues, with most incumbents still occupying the number one position in their domestic markets in both fixed-line and mobile, as well as being leading competitors in other geographic markets. Mobile-only companies (e.g. EE, Bouygues, Hutchison 3G) account for around one fifth of total industry revenues, with the remainder belonging to Cable TV companies (such as Virgin Media, Telenet and ComHem), and companies which can be termed “altnets” — independent companies ranging from infrastructure-rich specialist network companies to pure business communications resellers. Each group has somewhat different financial characteristics, although in general, cable companies currently compare very favourably with their incumbent and mobile peers, with the latter in particular suffering declining revenues and profitability, rising capex bills and consequently falling free cash flow.
Cable players enjoy best overall financial performance
Based on 2013 data, incumbents and mobile players faced revenue declines of between 4–5% (see Figure 1), mainly due to regulatory-driven reductions in mobile termination and roaming rates. In contrast, cable grew on average by 1%, helped by greater exposure to growing TV revenues and lower exposure to mobile termination rates. Altnets’ revenue increased by nearly 6% on average, mainly because they are typically smaller and more agile and can find growth from market share gains in a stable market, whilst significant, “needle-moving” M&A (Merger & Acquisition) is also generally easier to achieve. Even so, there are wide variations in financial performance among altnets, not all of which can be attributed to country, market segment or age of company.
Indeed, many of the early altnets now face the same risk in business model as the incumbents, insofar as they risk losing revenues from traditional services, alongside needing to invest in new services. This is particularly true for altnets in Germany (e.g. M‑net, QSC, Tele Columbus, Ecotel, NetCologne and 3U Holding), Tiscali in Italy, and multi-country network players (such as COLT, Interoute, and euNetworks). In this regard, Jazztel’s performance is notable. Despite being at the Euro 1 billion revenue level, the company is growing organically at 15% in the highly competitive and economically challenged Spanish market, by leading with a triple-play consumer offering. The only European telco to outshine Jazztel in size/growth terms is Iliad in France, which saw revenues rise by 19% to Euro 3.2 billion in 2014.
Aside from beating incumbents and mobile on revenue growth, cable players are also performing well in terms of margins, with EBITDA margins (Earnings Before Interest, Tax, Depreciation and Amortisation — a measure of cash earnings favoured by analysts) of around 45%, compared with 34% for incumbents, 26% for mobile and 21% for altnets. The relatively stable EBITDA margins for incumbent and mobile players actually represent a fairly impressive performance, given the loss of high margin mobile termination and roaming revenues, with the negative impact on EBITDA mitigated by cost savings in areas such as customer service, sales and marketing, and networks.
In terms of change in EBITDA, trends are also more favourable for cable, with average growth of 2% versus average declines of –5% for incumbent and mobile players, mainly reflecting underlying revenue trends. EBITDA for altnets is in fact increasing by a surprisingly strong 12% (see Figure 2).
In order to monitor another vital measure of company financial performance — free cash flow (FCF) — we also need to consider capital investment (we use EBITDA minus capex as a proxy for free cash flow). Cable companies have the heartiest capex diet, at 18% of total revenues versus 14–16% for mobile players and incumbents and 8% for typically asset-light altnets. Capex for cable, incumbents and mobile is also rising by 7–9% as they invest in broadband (see Figure 3). Taking into account EBITDA and capex margins, cable comes out on top in FCF terms, with an FCF margin of 26% of revenues, versus 16–17% for incumbents and mobile players and 14% for altnets. The altnet average is particularly impressive, given that many altnets are often resellers of business communication services. They therefore take relatively little, if any, technology or product risk, yet often still manage to generate returns not far removed from their much larger incumbent and mobile peers. Despite pressures on their FCF margins, cable, incumbent and mobile players are still generating large amounts of cash from leveraging their networks to pay dividends similar to companies in the utility sector.
How are cable players generating the best combination of returns and growth among European telecommunication players? Overall, cable networks are more technically advanced than their fixed-line incumbent peers, particularly in terms of broadband capabilities, and they enjoy greater exposure to growth areas (such as video). They are also at the forefront of new converged, triple/quad-play business models. It is hardly surprising that incumbents and mobile companies are fighting back in these areas, particularly broadband and convergence.
Incumbents and mobile companies fight back with broadband
All of the major players are now investing heavily to capitalize on rapid developments in broadband technology, with 4G mobile, very high-speed digital subscriber line (VDSL)+ vectoring, DOCSIS 3.0 and fibre-to-the-premises (FTTP) and fibre-to-the-cabinet (FTTC) technologies all offering significantly faster speeds than hitherto. Whilst 4G and DOCSIS 3.0 are relatively straightforward “no-brainer” technology choices for mobile and cable operators, incumbents face more complex choices between the more expensive, but “future-proof” FTTP and FTTC, with a rather mixed picture across Europe in terms of technology choices.
LTE/4G represents perhaps a huge technology step forward, bringing true broadband speeds to mobile devices of up to 300 Mbps, with15–20 Mbps commonly available. Mobile network operators are also moving to realize the positive impact of 4G in terms of their ARPU (Average Revenue Per User), leading to an acceleration in roll-out plans. Having lagged behind the United States market by a considerable margin, European mobile network operators are fighting back, with EE in the United Kingdom closing 2014 with 7.7 million 4G subscribers, or about a quarter of its base, smashing its original target for 2014 of 6 million 4G subscribers. This increased investment is being supported by an improving outlook in regulatory impacts and company-specific factors — for example, Vodafone’s windfall from selling its Verizon Wireless stake.
Technological upgrades are less straightforward for fixed-line broadband providers, where incumbents have multiple choices — for example, between fibre to the premises (FTTP) and fibre to the cabinet (FTTC)/VDSL — and where choices are often based on factors including housing density, the regulatory environment, and so on. While major operators such as BT and Deutsche Telekom have opted for the lower cost VDSL, markets such as Portugal and Sweden are seeing strong growth in FTTP penetration. One contentious issue, of course, is how much bandwidth typical consumers actually need, with some arguing in favour of the 0.5–1Gbps of FTTP, while others claim that the 20–200 Mpbs of various VDSL models are more than adequate. One ISP (Internet service provider) in Sweden in 2000 (Bredbandsbolaget) considered that its (then) market-leading offer of 10 Mbps supplied over its fibre network offered more than any household would ever need! The lesson is perhaps that supply often creates its own demand.
A converging battleground
Another key industry theme is convergence, with most major consumer-focused players now pursuing a Triple or Quad Play strategy combining fixed-line telephony and broadband with mobile and video. Convergence is not just about common branding, a single unified bill, and discounts — convergence is also technological. For example, Deutsche Telekom uses a hybrid router to combine 4G and VDSL, while Liberty Global uses Wi-Fi in its cable networks to provide better in-home mobile coverage and save backhaul costs on its MVNO arrangements. In general, convergence has broadly helped reduce churn and improve ARPUs. While cable companies have engaged with convergence for some time, incumbents are looking to in-home mobile coverage and video to sustain the need for their fixed broadband services.
The current market structure in most European countries lends itself to convergence, with major players strong across two or more sectors of fixed, mobile and pay TV. The United Kingdom is an exception in this regard, as most major players are focused solely on fixed or mobile services, partly as a result of BT having hived off O2 in 2001. BT’s decision to re-launch mobile services through an MVNO agreement with EE has triggered major strategic rethinks among competitors, with BT now pursuing a full takeover of EE, 3UK talking about a merger with O2, and Vodafone, Virgin, Sky and Talk Talk also considering their options. The “for sale” signs put up by the owners of EE (Deutsche Telekom and Orange) and O2 (Telefonica) in the UK are a clear sign of the perceived challenges facing mobile-only businesses in a converging world.
The move to convergence has also been reflected in mobile/cable mergers in Spain, Germany and France, among others. Mobile consolidation is also accelerating, with a move from four to three players over the last 1–2 years in Austria, Germany and Ireland. Similar moves are being proposed in Norway, and may possibly happen in the United Kingdom, France, Italy and Spain. While such mergers are usually associated with stringent regulatory caveats (for example, new MVNOs or a requirement to divest spectrum), these mergers are a rational move in highly competitive and turbulent markets.
Prospects for 2015
Despite the rather gloomy financial performance of incumbents and mobile players in Europe revealed by our analysis, there are some reasons for hope for the major European telecommunication players in the outlook for 2015, driven by growing demand for superfast broadband, both fixed and mobile. In particular, the payback for 4G/LTE investment is turning out to be much quicker than initially expected (“Long-term Evolution” is something of a misnomer in this regard), with initial expectations partly tempered by the mixed experience of 3G. At the same time, reducing regulatory impacts and an increased acceptance of consolidation from competition authorities are also improving the outlook for mobile players. Incumbents need to work out how best to leverage their 4G networks without threatening the cash cow of their copper access network, while also keeping an eye on their often financially strong cable TV competitors.
Philip Carse is Lead ICT Analyst for Megabuyte.com.
He has 25 years of experience in telecommunications, as a city analyst for UBS, Citigroup and Commerzbank and as a consultant for PA Consulting and NERA, as well as his own company, Teleq Consulting. Megabuyte is a United Kingdom-based company, offering analysis and information services focused on the financial, corporate and strategic activity of telecommunications, IT and software companies, both public and private.