Dutch telecom market Q1: free cash flow under pressure in transition period

Wednesday 15 June 2016 | 13:44 CET | Background
The Dutch telecom market underwent some small shifts during the first quarter. As in the previous quarter, we look here at the profitability of the major operators, based on revenues and costs (opex and capex). Ziggo is still performing best, and KPN showed some improvement. Vodafone NL and T-Mobile NL posted weaker results, and Tele2 NL's cash flow is deep in the red. 

CanalDigitaal is not included in our analysis as it does not report financial results. We also leave aside the international business operators and smaller players in the cable, fibre and MVNO markets. 

Margins stable at KPN, Ziggo, Vodafone

Tele2 is the only operator showing revenue growth, at 3.7 percent in Q1. The drop in revenue reached 3.9 percent at KPN, 3.3 percent at Ziggo, 3.8 percent at Vodafone and 6.4 percent at T-Mobile. KPN showed a stable EBITDA margin (slightly higher if looking only at the Netherlands and excluding iBasis), but Ziggo's margin is structurally much higher, at 55 percent versus 33 percent for KPN. Vodafone's margin was also stable, at 33 percent, while's T-Mobile's margin fell to 27 percent from 38 percent a year ago. Tele2's margin eroded further in Q1 and was negative for the first time, at -2.1 percent versus +10 percent a year ago. The drop in T-Mobile's margin is due to declining wholesale revenue from Tele2 (which carries a high margin) and investments in LTE and new services (business market, Knippr). Tele2's parent company targets an EBITDA margin of 35 percent. 

Free cash lower across the board

Looking at capex and free cash flow, KPN showed a small improvement (14.3 percent of revenue), while Ziggo was slightly lower (34%). This ratio at both Vodafone and T-Mobile has fallen to just over 10 percent, while Tele2 is sharply negative, at -38 percent versus -19 percent a year ago.

Based on KPN's targets (EBITDA margin up by 3 points, capex down to 15-17% of revenue), further improvement can be expected. However, it's questionable whether KPN can achieve the levels of other big European incumbents. This may drive shareholders to push for consolidation (e.g. a takeover by Deutsche Telekom) in order for KPN to gain scale. 

The proposed joint venture between Ziggo and Vodafone is aimed at cost savings. While Ziggo's margin will be diluted by Vodafone, it will still be well above that of KPN.

T-Mobile is under pressure to play the challenger and is actively seeking new revenue sources. The problem is all its new services carry low margins. Tele2 meanwhile is bleeding cash and lacking scale. This points strongly to a merger of the two operators. Acquisitions of smaller players could also help them achieve economies of scale. 

Transition puts sector under pressure

Since Q1 2016 we can compare the sector on an annual basis, as the merger of Ziggo and UPC is no longer a distorting factor. Some small acquisitions aside, the top five operators lost together EUR 124 million in revenue on an organic basis compared to Q1 2015 (-3.7%). KPN, Ziggo, Vodafone, T-Mobile and Tele2 together can be seen as an indicator for the health of the Dutch telecom sector as a whole. They also suffered a combined loss of EUR 76 million, or 6.3 percent, in EBITDA in Q1, while capex increased by EUR 27 million or 4.3 percent. Free cash flow, the bottom line, was down by EUR 103 million or 18 percent for the top five operators together.

We use free cash flow (EBITDA minus capex) as a proxy for measuring profitability. The operators have in principle three main choices for using the free cash flow: shareholder remuneration, extra investments and price reductions.

All of the above leads us to conclude that it's not going well with the telecom sector in the Netherlands. The question is whether this is the result of the current transitional phase or the changes underway are more 'business as usual'. At the very least, the sector is in a multi-year transitional period, impacted by trends such as the rise of the OTT sector, structural changes on the enterprise market, the roll-out of 4G networks and the addition of a fourth mobile network (Tele2), and the deployment of fibre increasingly closer to the customer. In addition, customers are becoming more demanding, whether consumers or businesses, and competition is intensifying, putting pressure on prices. This will all lead in the end to lower free cash flow. 

The sector's answer has two parts:

  • Increase revenues, through new services and migration to services with higher margins.
  • Reduce costs, through consolidation, simplification and virtualisation.
The financial situation has only gotten worse at the top 5 in Q1 2016. It's too early to say whether this is the bottom. The operators will continue working to optimise their revenues and costs, and the question is whether consolidation can play a role in this. The most obvious pair-up is T-Mobile and Tele2, while KPN could also be swallowed up in Deutsche Telekom's plan to build a pan-European, all-IP network.

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