European telecoms: mixed signals | Financial Times

A cynic may view Ericsson chief executive Borje Ekholm’s warnings about low returns as a self-serving jab at regulators. Ekholm’s description of Europe’s telecoms market as “non functioning” is linked to the idea that companies cannot cover their costs of capital and so are not investing in 5G. He is right that Europe’s rollout of faster wireless technology is lagging behind but it is not stagnant.

Consolidation would support profits, however. Rulemakers in the US and European telecoms markets have shaped their respective markets. In Europe, where lower consumer prices are the priority, there are typically four operators per major market. In the US there are three. Mobile price wars in Europe have lowered returns. Average revenues per mobile customer in Europe were less than half those in the US in 2019, according to Analysys Mason.

Rattled European investors have dragged down valuations. At 12 times two-year forward earnings, the European telecoms sector is about as cheap as it has been for seven years. This sets the scene for dealmaking. Low valuations already attract interest. Last year Spain’s MasMovil was purchased in a private equity buyout. Cheap debt offers private buyers the chance to boost leverage and returns. A buyer paying a 20 per cent premium on current European average sector multiples, and lifting leverage to five times ebitda, achieves an internal rate of return of almost 15 per cent over six years, thinks Barclays.

European telecoms investors want to see a green light for consolidation. Hopes were raised last year when an EU court rejected the European Commission’s veto of Hutchison’s 2016 bid for UK mobile operator O2. The deal has not been resurrected. But tie-ups between O2 and broadband operator Virgin Media, and Iliad’s bid for Poland’s Play, suggest regulatory appetite for combinations will be tested later this year. 

Yet even without M&A the 5G rollout is under way. Plus, telecoms tariffs appear to be joining in the reflation trade. Demand for 5G services should add to pricing power and profits in the sector.