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UK Large Cap Telco’s in change mode
Telecommunications is a complex industry experiencing significant change as operators seek to expand via “bundling” the provision of mobile, data, broadband fixed line and TV to consumers and high speed/ digital and data/ information services to business customers. This transition is a multi-year plan with some companies more advanced than others, but the investments and costs involved is causing some pressures on profitability in the short-term. Longer term these investments should deliver.
“Bundling” is observed in IT consumer and business markets. Broadly it comprises:-
a) “2 Play” Internet + Fixed Voice or TV + Fixed Voice or Internet + TV
b) “3 Play” Internet + Fixed Voice+ TV or Internet + Fixed Voice + Mobile and
c) “4 Play” Internet + Fixed Voice + TV + Mobile
Telecom operators are expanding capabilities to meet a multi-tier EU market where the combined tariff package paid by the end user, be it a consumer or business, is significantly cheaper than buying these services individually. The positive for operators is the significant lessening of competition in some areas such as the ability to offer “4Play”.
Old challenges remain. Firstly the need to pay exorbitant sums to governments for spectrum i.e. the bandwidth required for the delivery of high speed “4G” the delivery of high speed internet to mobile devices. The recent auction of 4G spectrum in India earned the government $9.7bn. Other governments in key emerging markets are now lining up to tap telecom operators for 4G. Another recurring theme is the need for telecom operators to consider mergers and acquisitions as a rapid means of achieving full service capability. Larger operators have their pick of potential cable TV targets as an alternative to starting a cable TV business from scratch.
New challenges include the proliferation of new competing technologies providing alternatives, such as broadband via satellite “satcom” and the increased use of VOIP (voice over internet protocol) for voice traffic. Recent initiatives at both Skype (who rely on a private network) and Google Talk which connect users between two domains could draw traffic from mobile telephony. The overall context remains the industry requires heavy investment spending to maintain relative competitive positions. Competitive pressures and new technology have led to significant pressure on ARPU (“average revenue per user”) for mobile operators hence the need to diversify the service offering.
1 Year relative performance between Vodafone / BT/ UK 100
BT Group (BT.A) BUY
Post the February 2015 acquisition of mobile operator EE (formerly the UK operations of Orange and Deutsche Telekom’s T-Mobile) BT Group is in the midst of a transformation that will combine EE’s 4G mobile capabilities with BT’s traditional strength in high speed broadband, BT TV and business communications. However as FY15 results showed, BT Wholesale, BT Openreach, BT Business and BT Global Services all saw revenue declines.
|52 Wk Hi/Low||470/360|
|Avg Daily Volume||26.7m|
BT faces a key challenge improving revenues and cash generation over 2016 in the face of significant regulatory pressures. However recent acquisitions and investments in BT Sport, whilst expensive, will restore top line revenue growth.
BT has guided towards a 10%-15% hike in the annual dividend alongside a £300m share buyback (c.0.8% of share capital). In our view BT earnings per share are likely to meet 2016 forecasts of 30.93p after 26.5p in 2015.
Source; Fidessa plc
Key Risks to Price Target
i) Significant £7.6bn pensions liabilities, these can increase due to factors outside of BT’s control
ii) BT’s acquisition of EE for £12.5bn is significantly relative to BT net assets of £19.5bn.
iii) Ofcom, the UK’s communications regulator has proposed via the Business Connectivity Review a) controls on BT Business Line Wholesale prices b) opening up BT’s “dark fibre” network enabling competitors to access BT’s fibre optic cable network. Both measures could impact BT’s profitability.
Vodafone (VOD) SELL
Following FY 2015 results, concerns have emerged regarding low growth in the EU, “Project Spring” costs (a three year initiative to increase capital spending by £6bn for Vodafone network improvements) and a strategy amounting to heavy expenditure now for standing still. The guidance provided by the board suggests Vodafone moving to significantly higher debt c.(£28bn) alongside a reduced ability to generate cash, particularly in Europe. Post the Verizon spin-off, EU revenues fell 4.7% year on year with Germany, Italy, Spain, Greece and Romania all lower. It is unnerving to see revenues lower, and costs and debt sharply higher. It appears Vodafone is a possible dividend cut candidate.
|52 Wk Hi/Low||255/184|
|Avg Daily Volume||45m|
Vodafone responded to speculation concerning a takeover of Liberty Global, following supportive comments about a tie-up from John Malone, Liberty CEO. The Vodafone board is examining an asset related transaction but not an acquisition of Liberty.
Vodafone is thought to be considering media acquisitions with possible candidates including Virgin Media, Ziggo and Unitymedia. Acquisitions are likely to be positive if equity funded.
Source; Fidessa plc
Key Risks to Price Target
i) Vodafone debt levels are expected to rise to near £28bn over FY16. A rights issue to reduce debt / fund acquisitions would alter the debt trajectory and would be positive.
ii) A US acquisition of Vodafone is possible and would likely to be a premium to the share price.
iii) A change of strategy possibly to spin off Vodafone’s emerging markets businesses from the EU business could be taken positively by investors.