Sector Spotlight: Dialling up the Positivity on Telecoms

European Telecoms

European telecoms have turned a corner operationally and are in the best financial health for many years. This has led us to upgrade this investment grade sector as an investment proposition, reflecting that its fundamental credit quality is expected to improve in the next few years.

Telecoms remains a capital-intensive business, but after several years of increases peak capex for 5G and fibre in Europe is now behind us (Figure 1) with 5G spending to fall. This will boost businesses’ cash flows and support debt reduction and lower leverage.

Figure 1: Deleveraging driven by falling capex driving stronger cash flows
Source: Company accounts, March 2024. *estimated figure

In addition, consumers now consider telecom services essential to everyday living and are prepared to pay more for them, particularly given their share of wallet spend remains low. Telecom services are essentially commodity-like (with few differentiating factors), but given the importance of networks post-Covid perception has changed and bills which are typically less than 5% of household budgets can absorb higher prices.

The mergers and acquisitions (M&A) landscape looks eventful for 2024, with two-thirds of European markets still having at least four players within the telecoms sector and the landscape remaining competitive. In-market deals could boost returns on the expectation of lower remedies compared to the past, which will support fundamentals. Merger remedies are used by competition authorities to maintain or restore competition in the market and involve divesting assets (spectrum1 and/or sites), offering capacity from the merged entity to the mobile virtual network operators, and in more negative scenarios allowing a new entrant to the market, which can be disruptive. Italy is one of the best examples where remedies were too harsh and all operators lost market share to the new entrant, Iliad, and lessons have been learnt.

The impact of consolidation should lead to better outcomes for the players involved in more competitive markets, and not be to the detriment of customers. We look to examples in the US where prices didn’t go up and better networks were created for the combining companies following the merger of Sprint Corporation and T-Mobile US. In the Netherlands and Germany, which have more rational markets, consumers got a good deal from T-Mobile and Tele2 (Netherlands) and Telefonica Deutschland and E-Plus (Germany) and profitability has improved for the operators.

Long-term anchor shareholders will play a positive role in firms executing their strategies well, including successful M&A, and overall we see European telecoms as a solid investment.

1 Ofcom, What is spectrum? 6 April 2022

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