Can consolidation move the dial on European telecoms?
Telco economic returns remain poor and European telecoms is seen as fundamentally flawed by many investors. But can widespread consolidation – if it happens – change this picture?
The sector's four long-standing challenges remain:
- The industry remains fragmented in Europe relative to the US and Korea/Japan.
- Mobile Average Revenue Per User (ARPUs) downside risk as frontbook prices are below backbook ARPUs.
- Growing fibre overbuild with challenger fibre covering around one-third of European homes.
- Leverage is still high, with a 1x increase in net debt/EBITDA since the global financial crisis. If we capitalize the cost of as-yet unbuilt fibre deployments, leverage would be 1x higher than current levels.
The EU's competitive landscape limits the ability of its operators to scale up. Using HOLT® we find the leading European telcos generate returns below the cost of capital – and have done so for more than a decade. Major telcos would need to increase free cash flow (FCF) by ~75% to reach a level where the sector no longer destroys economic value.
However, the sector has also changed in two crucial ways. First, the sector is increasingly moving to a netco/serveco model, with traditional telcos renting infrastructure. Second, telcos do appear to be moving toward consolidation, as they position for a more dovish antitrust stance following the pandemic.
We build a standardized framework for measuring the financial impact of potential in-market consolidation in seven of Western Europe's 15 major markets. Jakob estimates a rise in incremental Free Cash Flow (FCF) if consolidation occurs across Europe. Consolidation would be positive and reduce the value destruction gap but is unlikely to eliminate it.