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General

KPN in Q4: FTTH adding more than LTE

Friday 8 February 2013 | 12:43 CET | Background

KPN's results showed a further deterioration in the fourth quarter. In the end, 2012 as a whole came in at the low end of the Dutch operator's reduced targets. KPN expects the weaker profitability to continue (lower margins), forcing the company to also address its balance sheet through a rights issue worth EUR 4 billion. The leverage, net debt divided by EBITDA, was at 2.7 at the end of 2012, higher than KPN's targeted range of 2.0-2.5. If the planned buy-out of Reggefiber from Reggeborgh is included, the ratio rises to 3.2. The rights issue will reduce the leverage by 0.9 points, with the proceeds used for both investments and debt reduction. Over the longer term, KPN aims to stabilise if not slightly increase its market shares in the Netherlands, as well as expand its shares in Germany and Belgium.

The deterioration in results is the result of a number of trends: 
  • The weak macro-economic climate, which impacts consumer confidence and business customers’ willingness to invest. 
  • Intensifying competition. This is primarily visible on the mobile market, where Tele2 has just acquired its own mobile frequencies. Growth is also slowing in Germany, and competition is tough on the business market. KPN is facing competition from the cable operators, other mobile operators and over-the-top (OTT) providers; the latter are especially driving reduced demand for traditional services. 
  • Regulation of termination and roaming rates. 
  • The transition to next-generation access networks: FTTH, LTE and Wi-Fi (as well as VDSL in the Netherlands and HSPA+ in Germany as interim measures). Reggefiber is leading KPN’s FTTH strategy. KPN aims to increase its stake in the company to 60 percent, likely in the second half of 2014, before eventually going to 100 percent. At 60 percent, Reggefiber will be consolidated in the results, weakening the balance sheet further. 
KPN is taking a number of steps to address these trends: 
  • Job cuts. By the end of 2013, around 5,000 lay-offs are planned, but this will not likely be the end of job cuts. 
  • The dividend has been drastically reduced. 
  • Various assets have been sold, and part of the Corporate Market division has been integrated into KPN Business. The rest of CM will continue as IT Solutions (data centres, consulting, desktop management). More divestments can be expected, especially property assets. A sale of the German or Belgian operations failed, but the fact that there is no integration of the mobile activities across the three countries suggests that Belgium and Germany are actually still up for sale. 
  • New markets. TV is the new growth market in the Netherlands, and in Belgium KPN has launched an attack on the fixed market (as a Belgacom reseller). The quad-play offerings (Compleet in the Netherlands, Snow in Belgium) can also be seen as a new market. Machine-to-machine markt (M2M) is another growth area. 
How bad was it though, at the division level?

Consumer Residential 

The sales trend is improving. Underlying sales fell 1.7 percent, less than in the previous quarter. KPN is growing in the FTTH and TV markets, but this is putting pressure on EBITDA, which showed an underlying drop of 18 percent (in line with the contraction in previous quarters). After an increase in capex, free cash flow has turned negative. The company is profiting from the takeover of some of the Reggeborgh assets. The organic performance was also good, with 44,000 FTTH connections and 123,000 digital TV additions, while growth at rival Ziggo came to halt. 

For the first time in a long time KPN was able to grow the total number of access lines, after a string of quarters in which the net line loss reached the tens of thousands. The organic growth reached 4,000 lines, and including takeovers, 130,000 lines. While TV is driving the growth, in the end it’s about the broadband market ("... with the objective to further reducing churn in broadband ..."). Revenues from TV, despite the company’s significant market share of 23 percent, were just EUR 53 million (11 percent of the division’s sales). 

Revenues from traditional telephony, at EUR 94 million, now account for just 20 percent of the division’s sales. While KPN does not disclose the total number of customers, this can be calculated from the number of RGUs per customer. This shows that after a long period of contraction, growth has returned, even if this is mainly due to takeovers. KPN now has 3.49 million customers on the fixed market, up from 3.37 million in the previous quarter. 

In short, growth has returned, but it’s not yet translating to improved profitability.

Consumer Mobile

Underlying sales were still down sharply (-8.6%), but EBITDA was up 10 percent thanks to price increases and the new handset lease model. Increased capex led to a 63 percent decrease in free cash flow. Net additions were just 3,000. Minutes of use were flat, while SMS declined further, down 39 percent year-on-year. ARPU was down 4.5 percent, mainly due to a 8.3 percent drop in postpaid, while prepaid stabilized and was unchanged year-on-year. 

In summary, there wasn’t much change in the operational performance, and the dependence on traditional services (voice, SMS) remains high. The handset lease model is at least giving a boost to EBITDA, but this is likely only a temporary effect.

Business

The sales trend is worsening, with a drop in underlying revenues of 4.8 percent. The decline in free cash flow is also accelerating, down 8.9 percent. KPN said it is satisfied with its challenger brands, Telfort and Yes Telecom. 

The number of traditional lines fell by 12 percent year-on-year, and the number of minutes per line was down 8.6 percent. In terms of data lines, there was a small decline in DSL and leased lines and a small increase in the VPN market. Net additions on the mobile market were high, at 76,000, but usage per customer declined, with minutes down 8.3 percent and SMS falling 20 percent. ARPU declined 12 percent. 

Revenues from internet and voice showed some improvement, with a drop of just 2.7 percent. Revenues from data services showed marginal growth of 1.1 percent, the same as last quarter, after a long period of contraction. Mobile revenues however were weak, down 5.8 percent with a 3.1 percent fall in services. 

Corporate Market

Underlying sales fell 4.4 percent, worse than previous quarters. EBITDA was also weak, down 20 percent, leading to negative free cash flow again. CM has problems with overcapacity, delayed investments by customers and heavy price pressure, which all lead to a writedown of the division’s value. The charge resulted in a net loss for KPN as a whole in Q4. 

Germany

Organic sales growth was weak for a second quarter, at just 1.0 percent, and service revenues were down 1.0 percent. Underlying EBITDA plunged 26 percent lower, and capex increased, resulting in a 56 percent drop in free cash flow to EUR 58 million. The company also lost market share in terms of revenues. 

KPN attributed the weak performance to increased competition in prepaid, where it’s market leader, and price pressure in postpaid. The company did add new subscribers, but at the same time E-Plus did a clean-up of its base, resulting in a net loss of almost 600,000 customers. Usage per customer was weak, with minutes down 7.7 percent. At the same time voice fell to 58 percent of sales. 

Belgium

Sales growth slowed to 1.0 percent, but on an underlying basis growth was a solid 6.2 percent. Service revenue rose 2.8 percent. EBITDA was still down 12 percent due to the costs of adding new customers. Free cash flow dwindled to EUR 4 million, down 91 percent. 

Minutes of use per customer rose 16 percent, and voice remains relatively important for Base, at 75 percent of sales. Base also did a clean-up of its customer base, resulting in a quarterly loss of 286,000 lines. On an organic basis though, it added 7,000 postpaid customers and 41,000 in prepaid. 

Conclusion

Consumer Residential is well on its way, with just 20 percent coming from traditional telephony. Mobile is another story, both in the consumer and business segments. The dependency on traditional services (voice and SMS) is still high at around 70 percent of revenues, and these revenues are increasingly at risk. A recovery will take much longer. 

Germany appears unable to avoid the same problems, while Belgium is still doing well, although the OTT providers will do their damage eventually there too. This makes the attack on the Belgian fixed market sensible and raises the question whether E-Plus should do the same and start a partnership with a fixed operator, in order to offset the slowdown in mobile. In the mean time, TV is providing KPN with some growth, but revenues from this are still relatively small, and the margin is likely very low. Due to the poor economic conditions, the business market remains weak. 

All together, there are a few positive points (broadband, TV), but many areas of concern still, spreading now also to Germany and probably soon to Belgium. At the same time, FTTH is providing some growth thanks to the targeted efforts of Reggefiber, allowing FTTH to distinguish itself from the xDSL market. LTE cannot be exploited in the same way though, meaning a quick investment in LTE will not solve the operator's problems in the mobile market. 




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