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General

KPN Q4: results still weak

Monday 9 February 2015 | 13:08 CET | Background

KPN continues to suffer from negative growth, low margins and high debt. Its latest quarterly results show some recovery, but it's doubtful organic growth will be enough to turn around fully its results. A sale of its Belgian operator Base won't help the situation much, but it appears KPN is getting closer to exiting Belgium, as it announced plans to stop investing in Base. Selling the company's stake in Telefonica Deutschland could help turn things around. KPN is also looking at ways to reduce capex further through the use of new technologies.

KPN's fourth-quarter results showed signs of recovery, both in terms of revenues and costs:
  • The sales trend improved, with the exception of the Consumer Residential division, which saw sales fall 2.4 percent year-on-year. This was due to erosion in telephony (-EUR 13 mln), price pressure in broadband/VoIP/VAS (-10 mln) and TV (-2 mln), offset by growth in FTTH (+13 mln).
  • Costs are gradually falling. At the group level, sales, general & administrative costs were equal to 57.3 percent of revenue, versus 62.9 percent a year ago. Expressed differently, the EBITDA margin increased by 4.6 percent points year-on-year to 32.8 percent. At the divisional level though, it's clear the margins are still at a low level.

The balance sheet, given the company's liquidity, is still weak. Net debt was at 2.8 times EBITDA, whereas KPN targets a maximum 2.5. At the same time, the company still has assets it could sell (Base, iBasis). The downside of disposals is it also loses a piece of EBITDA, so the debt-to-EBITDA ratio doesn't necessarily improve. A more fruitful divestment would be selling the minority stake in Telefonica Deutschland, which could have a positive impact on the balance sheet. It appears KPN is instead hoping for dividends from the German holding, although these aren't for certain. A multiband spectrum auction is planned soon in Germany, and if it turns out expensive, Telefonica Deutschland could see its financial strength and shar price undermined.

Strategy

The response from KPN's management is a multi-facted approach:
  • Take the lead in 4G.
  • A pragmatic, hybrid approach for the fixed network.
  • Sell more services to each customer (multiplays). This lowers the churn.
  • Encourage customers to move to mobile subscriptions with larger data allowances.
  • Sell value-added services from third parties, eg Spotify.
  • Simplify at multiple levels: portfolios (reducing at the same time the need for hardware in the network), systems and IT, and the internal organisation (lay-offs).

Competition increasing

The management assumes that this all will lead to an improvement in results, through improved customer satisfaction, lower costs and less debt. But at the same time, the level of competition is increasing:

  • Ziggo's focus is internal at the moment but it is accelerating the integration with UPC. The harmonisation of their TV platforms is happening quickly. A new commercial offensive appears likely in the course of this year.
  • Vodafone has started FTTH unbundling to improve its competitive position on the fixed market. It will undoubtedly introduce a quad-play offer.
  • Tele2 will start in March migrating customers to its own mobile network. Later this year it will also likely start a new plan for the fixed market.

Missed chances

There are other risks as well. By focusing on multiplays KPN may be missing an interesting new market, for broadband-only and mobile-data-only. The pressure from OTT services is unending, leading to continuous erosion in traditional revenue sources. KPN could tie in with broadband-only services new customers who would otherwise switch to newcomers targeting this area. There is a risk it's falling behind the market trend. However, it's not too late yet. KPN has enough brands to try experimenting with standalone broadband or mobile data services.

The hybrid strategy for the fixed network is primarily a question of timing, but conflicts somewhat with the aim for simplification. 'Overbuilding' with FTTH takes time, so copper technology is seen as an interim solution. Setting aside the discussion about demand for faster speeds, FTTH has numerous benefits for operators, notably drastically lower opex. At the same, a high level of initial capex is required. The risk for KPN is focusing too much on the short term (reducing capex), leading to problems in the long term (rising opex). The focus on capex is currently resulting in tests of new technology, including 'super vectoring' and NG.PON (see below).

The likelihood that Base will be sold appears to be increasing. The operator has exited the fixed market and recently suggested it was halting investments in Wallonia. At the group level, KPN has lowered its annual capex budget by EUR 100 million. In our opinion this is due to the weak balance sheet and the reduced focus on Belgium. This increases the chances that another player will emerge that sees an opprtunity to create value with Base and makes a takeover offer. In other words, KPN is taking its chances with Base.

Fixed network

Turning back to the roadmap for the fixed network, KPN is targeting availability of 500 Mbps at 33 percent of homes by the end of 2016, versus 27 percent now. This means Reggefiber adding 450,000 homes passed in two years, a target Reggefiber originally aimed to realise in one year. Again, we see KPN trying to rein in capex, even when FTTH is the only part of the Consumer Residential division showing growth.

Also in terms of technology, KPN is working to reduce capex. On the copper network it's testing Alcatel-Lucent's Vplus technology, a type of 'super vectoring' that uses more spectrum than VDSL2 vectoring. This supports speeds up to 200 Mbps at distances up to 400m. KPN is thinking further about 400 Mbps, which requires a significantly shorter local loop. Vplus will in any event extend the reach of VDSL and make the new G.fast technology somewhat superfluous.

For the fibre network, KPN is testing NG.PON (next-generation PON). KPN is not yet using PON technology as that would result in a shared network, similar to cable. However, the advantage of PON is lower costs. New technology such as WDM-PON solves the problem of the shared network connection by providing each user with his own 'colour', but it is expensive. TWDM-PON is the latest version, which has the support of major vendors such as Alcatel-Lucent and Huawei. KPN suggests this technology offers more (>1 Gbps) than the current point-to-point technology (1 Gbps), but this is not completely correct. In theory P2P FTTH has no limits, it's merely a question of the equipment. In any event, KPN appears to be taking the first steps towards using PON in order to reduce the costs of rolling out FTTH.


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