Although European telcos are struggling, they are not easy to buy

Emeka Obiodu, Principal Analyst, Industry, Communications and Broadband

Europe’s telecoms market is in a state of difficulty. Weak operational performances and uncertainties over their short-term profitability have dampened valuations of EU telecoms assets, and even raised questions about the long-term survival of the region’s telecoms players.

However, potential suitors should be wary. America Movil’s withdrawal of its offer to acquire KPN is just one example of how difficult it is to buy European telecoms assets, especially former incumbent telcos.

Despite these players’ uninspiring performances, European governments have a number of strong incentives to block any takeover bids, especially from non-EU players. These include a desire to retain control of the national broadband infrastructure, concerns about national security, straightforward protectionism, and national pride. It is not impossible for outsiders to acquire these assets, but they must be prepared to pay over the odds.

The problems of Europe’s telecoms market are clear

The telecoms industry is heavily reliant on economies of scale, and one set of statistics in particular helps to illuminate the plight of the European market. In China, the three mobile operators will each serve an average of 400 million subscribers and generate approximately $40bn in annual revenues in 2013. In the US, the four main mobile players control approximately 94% of the market. In 2013 they will each serve an average of 87 million subscribers and generate approximately $50bn in annual revenues. In contrast, Europe has more than 180 operators that will each serve an average of 6 million subscribers in 2013 and generate $1.2bn in annual revenues.

And therein lies the challenge. Although many things are blamed for the woes of Europe’s telecoms market, this lack of economies of scale is a problem across the board, affecting the fixed and mobile telecoms markets, the telecoms equipment market, and the digital content market across the continent. The result is that the mid-term prognosis for the industry is bleak. For example, Ovum forecasts that mobile services revenues in Europe will decline by a CAGR of 1% between 2012 and 2018.

The responsibility for this situation is shared among various parties. OTT players can be depicted as the big bad guys, intent on damaging the telcos’ business model, while regulators get a share of the blame, too. Their populist quest for lower consumer prices, though admirable to us as consumers, further weakens telcos’ revenue streams. Meanwhile governments add to the pressure on stretched telco cash flows with their demands for exorbitant spectrum fees. The result is job losses, profit warnings, slashed dividends, sapped morale, and a frantic scramble to find a savior.

Despite the gloom, European governments will not be easily cowed

European governments were supposed to have surrendered the “Golden Shares” they own in their former nationalized industries. However, the emergence of “Foundation Preference Shares B” as an independent foundation that could exactly replicate the Golden Shares mechanism in KPN suggests that governments still hold sway. Similarly, uncertainty around the future of Telecom Italia is a reflection of the reality that any solution must be politically palatable. Even sub-scale domestic champions such as Belgacom and Swisscom will remain independent for the foreseeable future because their respective governments will not countenance their sale.

Things are unlikely to change soon. Governments have many reasons to make it difficult for foreign suitors, especially non-EU ones, to acquire Europe’s main telecoms assets. They include concerns about national security (especially given the recent spying scandals), a desire to retain control of the national broadband infrastructure, and national ego. However, determined suitors can still succeed if they are prepared to pay over the odds, either to directly purchase telecoms assets, or in support of Europe’s macro-economic stability.

Could Europe benefit from a cyclical upturn in the long term?

Given the challenges facing Europe’s telecoms market, it is puzzling why telcos from outside the region are even interested. America Movil has just withdrawn from its attempt to buy KPN, but it still has sizeable stakes in the Dutch telco, and in Telekom Austria. Orascom Telecom has also looked into Telekom Austria. AT&T is rumored to have approached the Spanish government to talk about acquiring a stake in Telefonica, a nimble yet debt-laden telco. Telecom Italia rejected a reverse takeover from Hutchison Whampoa, and limps on with the politically contrived “Telco” majority shareholding (Hutchison Whampoa has had more success with smaller purchases). Even Vodafone, stripped of its Verizon Wireless cash cow, is now rumored to be in the sights of suitors.

What could these suitors possibly be seeing? AT&T has exhausted domestic opportunities and can be presumed to be seeking new growth markets. America Movil will be rightly worried about changes in the Mexican telecoms market, but its European foray is driven mostly by the dictates of Carlos Slim. Hutchison Whampoa has set aside its “for sale” tag and become an acquirer itself.

Judging by how the US market went from being a laggard in 2G to a market leader in 4G, it could be that the structural changes that Europe will be forced to implement in the next five years will lead to an upturn. Telcos and EU authorities are already talking about changes such as a single EU telecoms market, a single regulator, a more activist consolidation agenda, increased network sharing, co-building of new infrastructure, increased government subsidies for new infrastructure, a stay of execution on further imposed cuts in termination rates, regulatory/tax holidays for telcos, early work into 5G, and innovative tariff strategies.

While none of these changes could save Europe’s telecoms market individually, together they could lead to a renaissance in the European telecoms market beyond 2020. Such an outcome, however, depends on Europe’s politicians and telcos making all of these changes happen.

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