Falling market caps, blocked mergers and low return on capital have put European telecom operators at a disadvantage to global peers—but 5G could turn the tide.
With a wave of new entrants and challengers, the European Telecoms sector has seen substantial fragmentation in recent years, triggering a significant disadvantage in scale vs. peers in China, the U.S. and Japan. However, the tide may be turning on industry regulations and blocked mergers, which could lead to more consolidation that can help telecoms cut costs, compete more effectively and absorb costly 5G build-out.
Consider: The combined market capitalization of the European Telecoms sector now stands at just €300 billion, a 75% drop since 2000. This decline is due to rising competition and a drop in unsustainably high returns on products such as SMS (texting), visitor/traveler roaming and international traffic. Recent regulations and new technologies, such as the rise of international calling and texting apps, have eroded these profit centers.
Since 2000, European Telecoms have also spent enormous amounts on 3G, 4G and 5G spectrum leases, the rights to which they must repurchase every 15-20 years.
Wireless Scale Dynamics
Perhaps the largest setback, however, has been the European Commission’s decision to block various mergers and acquisitions, citing the need for competition. Some 20 years ago, the U.S. wireless space operated at a similar competitive intensity, with 13 different network providers, most of which were regional players. Now, only three large wireless operators remain.
In contrast, Europe has seen a wave of fragmentation over that period, with a score of challengers, new operators and commercially aggressive virtual-network operators, which don’t even lease their own wireless network infrastructure.
This lack of scale has resulted in a significant drop in pricing power. European wireless remains among the most deflationary sectors anywhere on the globe, with the average price per unit (GB of data) falling by 33% on a year-over-year basis. Essentially, this deflation has canceled out robust data volume and traffic growth, leading to an overall drop in net revenues.
A Changing Tide for Consolidation
The largest European Telecoms’ returns on capital expenditures remain below their cost of capital—and regulators may have finally taken notice. Without a favorable return on their investment, these companies may hesitate to spend more to upgrade their networks.
That could put a damper on 5G expansion. We believe the European Commission will be keen to ensure a faster launch of 5G, given its potentially critical role in ramping factory production, autonomous vehicles and smart cities. The value of telecom networks has also been evident during the COVID-19 pandemic, stressing the need for network reliability and the ability to handle increased data consumption from consumers, corporates and governments.
The political will to accelerate 5G rollout, plus the importance of telecoms in the connectivity-strapped COVID era, may give the sector more leverage to secure a “New Deal” from the European Commission. We see this new deal as having four parts:
1. More M&A and less restrictive competition laws: The EC could approve more “4 to 3” wireless mergers, which would lower the competition bar from four companies in a region to three, similar to the U.S. In a rare approval from 2018, the European Commission suggested its openness to telecom-sector consolidation, saying there is no “magic number of operators” per market.
2. Premium wholesale fiber access rates: Fiber coverage across Europe varies greatly, from roughly 5% in the UK to about 80% in Spain. Telecoms could be incentivized to invest in fiber through higher regulated wholesale rates, which would ultimately bring more consistent speeds, ultralow latency, and solid connectivity, even on congested networks.
3. A shift to freehold wireless spectrum: European telecoms typically acquire spectrum for 15-20 year cycles and need to re-purchase this spectrum. National regulators could shift to selling permanent rights, as is the case in the U.S.
4. A potential return of the Net Neutrality debate: At present, wireless consumers pay for downloads, but tech and media companies don’t pay for their transmission. The COVID-19 pandemic has highlighted streaming media’s intense use of European networks. This congestion could trigger higher capital intensity needs. We believe this could result in a renewed push for looser rules on net neutrality, which the telecoms industry has long advocated, as a way to boost revenues and stimulate increased network investment.
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