US ahead whilst Europe struggles in global telecoms, says Rogge Group’s Eiremo
Annika Eiremo, global credit analyst at Rogge Global Partners, says investors in the telecoms space should be looking to the US.
Since the end of 2012, event risk has increased significantly in the global telecommunications sector. The increased risk is driven by several key factors: weak growth outlook in European domestic markets, cheap access to financing for high quality issuers and increasing competition in major markets. M&A is on the rise in an effort to stem revenue declines in Europe and LBOs have once again become a legitimate concern with the recent takeover of Virgin Media by Liberty Global.
Ratings downgrades, which were largely avoided in 2012, have become a much larger risk as the European downturn takes its toll on balance sheets.
On the other hand the US mobile market has remained very healthy, with competition expected to increase as a result of recent M&A activity.
In light of all this, investors should have a cautious outlook for the global TMT sector and be positioned in telecom credits with solid balance sheets and good diversification between mobile and fixed assets. Another area offering attractive opportunities is European high yield cable bonds, which could benefit from being takeover candidates.
The overall picture is somewhat mixed. Telecom revenues have been under pressure for some time now given EU regulation on Mobile Termination Rates (MTRs). In many European markets, competition has become increasingly aggressive as new low cost operators drive down pricing and existing operators reduce pricing to retain their existing customer bases. As a result of the gradual shift in consumer trends, revenues from mobile voice and text services are no longer a growth driver. Mobile operators will eventually need a new way to drive the top line and retain customers. This trend increases the risk that incumbent fixed and mobile telecom companies will acquire assets in the cable space.
Looking at Europe, there are several key factors and trends driving the sector. After a mad dash to diversify revenue streams and gain access to high growth emerging markets over the past several years, European telecoms are being forced to return home and focus on defending their position in domestic markets. As the domestic markets usually provide the bulk of mobile operators’ EBITDA (earnings before interest, taxes, depreciation and amortization) and cash flow, this has become increasingly relevant in ensuring ratings stability. The fundamental and operational health of incumbent telecoms’ domestic markets is increasingly being highlighted by rating agencies as one of the most important factors in ratings decisions.
The sectors’ efforts to enhanced liquidity is also being challenged, as many companies may be running out of options.
Over the past year, operators’ focus has been on cash preservation and liquidity enhancement in the form of cutting dividends and selling off non-core assets. In 2013, there are very few dividends remaining in the European telecom space which can be cut, and the majority of easily divested assets have been sold or IPO’d. Running out of obvious options, telecoms must look elsewhere to raise the liquidity needed to preserve credit ratings. Year to date the trend has been hybrid debt issuance, which is a viable option as the rating agencies typically account for hybrid as being 50% debt and 50% equity.
However, the rather dubious situation in Europe is not characteristic for companies on the other side of the pond. The North American mobile industry has dramatically outperformed Europe for the past several years. Despite the US recession, the average monthly spend per customers has steadily increased for AT&T and Verizon who combined control nearly 70% of the US mobile market and have maintained extremely solid balance sheets. This has been largely due to increased smartphone penetration and monetization of mobile internet usage.
This near-duopoly could change in the next couple of years, however, given that Japanese operator Softbank has entered the US market through their acquisition of Sprint in 2012. Given Sprint’s historically lower price point and unlimited data usage plans, this could dramatically increase competition in the market.
Overall, increased event risk suggests a cautious approach to investing in telecom securities. In 2013, disciplined security selection will be the key to outperforming in this sector. Security selection will be manifested primarily in two different ways: first, avoiding companies that have high event risk even if spreads are wider than the industry average. Therefore, preferred holdings should be those that have large liquidity cushions and that have flexibility within their current ratings to withstand near term pressure such. Finally, US mobile operators have better growth prospects versus European which makes it a much more compelling investment.