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General

KPN faces the choice: expansion or dividend

Friday 21 November 2014 | 11:12 CET | Background

KPN is buying out Reggeborgh and acquiring all of Reggefiber. The acquisition, plus paying off external debt at Reggefiber, will take a good portion of the cash received from selling E-Plus. Reggefiber will have negative cash flow for some years to come, as capex clearly outstrips EBITDA. KPN still has around EUR 3 billion left over though from the EUR 5 billion cash plus around EUR 2.4 billion stake in Telefonica Germany it received for E-Plus. The company faces a strategic choice what to do with the money. 

Reggefiber is not expected to generate cash flow in the next few years. The free cash flow (EBITDA minus capex) was negative EUR 327 million in 2012 and negative EUR 276 million in 2013. We estimate an outflow of another EUR 128 million in 2014 and EUR 90 million in 2015. This means KPN will need to invest a few hundred million more in FTTH in the coming years before this business becomes self-financing.

We have discussed previously the opportunities for KPN to use the proceeds from selling E-Plus to take a new strategic course. Other operators are doing the same, selling assets in order to re-invest in growth activities. The choice is invest in expansion or invest in existing networks. We leave aside the possibility of spending the money on an extraordinary dividend.

  • Vodafone is using the proceeds from its stake in Verizon Wireless for Project Spring (infrastructure).
  • Tele2 will likely spend what it receives for Tele2 Norway on its activities in the Netherlands (accelerated LTE roll-out).
  • Telstra has sold network assets to the state and is using the proceeds for reorienting its Asia strategy and acquisitions.
  • BT is facing pressure from some shareholders to sell BT Global Services, which could raise around GBP 10 billion. However, BT has resisted this step.

If we focus on acquisitions, where are the opportunities? We have seen several examples in recent months:

  • Geographic expansion: Colt has bought KVH in Japan. This company is active in a similar market, but in the Far East.
  • Vertical and geographic expansion: Telstra has bought Ooyala, a global online video specialist. Telstra is taking a position in the extended value chain (video), while at the same losing a piece of the chain (network).
  • Horizontal and geographic expansion: Vodafone has bought cable operators (KDG in Germany, Ono in Spain). America Movil has acquired a majority stake in Telekom Austria, which is expanding in eastern Europe. AT&T is buying satellite TV provider DirecTV and a mobile operator in Mexico.

Back to KPN. Looking at each of its divisions and their ability to generate cash, we conclude:

  • Base and iBasis generate minimal cash. They could be sold to another player able to create more value.
  • Business and NetCo contribute the most cash, making them stable assets.
  • Consumer Mobile and Consumer Residential, the two retail organisations, are much more volatile. Mobile is suffering from difficult market conditions, and Residential is dealing with the start-up phase still of developing TV and fibre services.

Conclusion

KPN can choose to invest aggressively in networks, expansion or both. It still has billions left from the sale of E-Plus and could raise more with the divestment of Base, iBasis and the stake in Telefonica Germany (the lock-up expires 01 April 2015). In the Netherlands, the company is already doing everything it can to ramp up its LTE network. Other options include:

  • A new impulse to FTTH, with KPN taking a clear choice on the balance between copper and fibre.
  • Rather than selling Base, strengthening the Belgian operations.
  • There are opportunities to expand in the value chain or abroad, but this has not figured in the company's plans.
  • Continuing on the same path is of course also an option. The market will recover sooner or later. And the extra cash could be paid out to shareholders.


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