KPN: EUR 9 billion on share buybacks while FTTH roll-out stagnates

Thursday 16 December 2010 | 16:29 CET | Background

KPN completed this month a share buyback worth EUR 1 billion. Since 2004, the Dutch operator has bought back around 950 million of its own shares, or 38 percent of the shares it had in 2004, for a total EUR 9 billion.

Excess cash

For KPN, this was a way to give back to shareholders ‘excess cash’ in a tax-friendly way. The number of outstanding shares has fallen 38 percent since 2004 due to a series of buybacks and repurchasing part of the government’s shares in the company, going from 2.48 billion shares to 1.53 billion. This boosts earnings per share, which should also support the share price. This offers an advantage over dividends, as equities profits are often taxed lower than dividend income in many countries. Share buybacks also give companies a certain image: “we don’t do anything funny (read: takeovers) with our cash surplus”, which should reassure investors in general, and KPN’s especially. KPN’s wild adventures of around ten years ago are now a distant memory.

KPN’s vision in recent years has been all about ‘excess cash’: the cash leftover after all the bills are paid, and investments and takeovers are executed. Furthermore the company, as it said on 3 September 2007, has considered its share price ‘low’. Then it was hovering around EUR 12, which was reason enough to finish quickly a EUR 1 billion share buyback and start another EUR 500 million programme. Again in May 2010, KPN wanted to “profit from the low share price” and the buyback was accelerated. While investors don’t like to be hit with the benefits of hindsight, KPN reached a long-time high of EUR 13.45 in October 2007 and since then its share price has gradually fallen to EUR 11 now. This is slightly better than the benchmark AEX index, which over the same period has gone from 540 to 350. More to the point though, should management have an opinion about their company’s share price? Maybe not, as they are being paid with shares and options, so they are also investors. However, a company with a cash surplus does have to weigh the options: do we buy our own shares or lower the debt? KPN has a target of net debt at 2.0-2.5 times EBITDA and can manage its leverage with this decision.

This begs the question, what would the share price be if KPN hadn’t bought any shares? That’s difficult to say, and of course depends on what the company would have done with that EUR 9 billion: invested, left it in the bank or made acquisitions. It would depend mainly on the return on the chosen investment, both over the short and long term. This brings us back to the question of how ‘excessive’ this EUR 9 billion was. KPN has done dozens of takeovers in recent years, with little leftover to buy without running up against the Dutch competition regulator. If it tried to buy CanalDigitaal, KPN as ‘challenger’ on the TV market may have got away with this type of horizontal expansion. KPN has already been able to buy the broadcast company Nozema and the Digitenne DTT network.

FTTH biggest project

As far as investing (capex) goes, FTTH is the biggest project, and KPN’s strategy is centred on gradually replacing the copper network with fibre. One could even say this is the most dramatic change in the entire history of the almost 100-year-old KPN. Money is not quite the limiting factor here, that’s clear - it’s more the building capacity that can be mobilized in order to execute the project. But if we look at the figures, something doesn’t quite fit.

Reggefiber was able in Q2 and Q3 2009 (so before the winter period, another brake on the project) to add 127,000 homes passed, while in the same period in 2010, only 82,600 were added. In all of 2009, around 200,000 were added, while in 2010, it looks like it will be less than 150,000. And that’s even when there appeared to be some consensus on what was possible in a calendar year: roughly 400,000. This is also the figure we use in our annual FTTH report. At the current rate, Reggefiber will not realize its dream (80 percent of the Netherlands in 2020) and it will be a few decades before KPN has fibre across its entire network.

Back to the share buyback. One can ask: why over everything else give cash to shareholders? An investor holds KPN shares because he believes in the Dutch telecoms market, and whatever there is in surplus cash he would likely want to see first re-invested. Ok, it could be that there are no good investment opportunities available, but KPN admits openly that fibre is the future and all the xDSL solutions are merely interim. Here we come to another reason to slow down the roll-out of fibre: ‘sweat your assets’, try to get as much return as possible out of the existing network.

While it’s theoretically possible that the roll-out cannot be accelerated for ‘operational reasons’, in the mean time CIF has entered the market with EUR 1 billion and is busily deploying fibre. At the same time, cable is eating into the DSL customer base with its roll-out of Docsis 3. The cable operators will follow these developments with satisfaction, but KPN and Reggefiber need to have another good look at what was the cause of the slowdown in 2010 and whether they can still speed up the roll-out. Shouldn’t they have this down pat at Reggefiber after five years? If so, then the share buyback in 2011 could be scaled back to less than the around EUR 1 billion per year spent in 2004-2010. The capex budget can then be increased. An extra benefit from this is that the cash kept in the company allows for an increase in external debt, in order to keep the optimum leverage (the ratio 2.0-2.5 mentioned above). While this may not be good news for the short-term investor, over the long term it will add to the value of the company.

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