WEurope telco incumbents: economies of scale of little help in financial performance

Thursday 13 April 2017 | 13:29 CET | Background

The incumbent operators of six Western European countries have a strikingly similar financial profile. The growth in revenues and costs are very close. This is notable given that the economies of scale at the big operators (Telekom Deutschland, BT UK, Orange France) don't result in particularly higher margins than the smaller operators (KPN Netherlands, Proximus Domestic and Eir). The reason may be that smaller companies focus more on cost management, helping to overcome their lack of scale. The question is whether this picture will continue. Geographic expansion in principle should bring economies of scale, even just on procurement of one of the most important 'raw materials' for telcos these days: content.

West Europe

Our analysis focuses on six countries and their former PTTs. Incumbents are multi-taskers - they have to serve a range of different markets. BT is probably facing this challenge the hardest at the moment, following the legal separation imposed by Ofcom on its wholesale and retail operations. BT is hoping it can still avoid structural separation. In the mean time, it needs to show a good performance, in both wholesale and retail. Investing in copper is not likely enough, so FTTP is getting increasingly more attention. The tough competition from Sky has forced BT to invest heavily in sports rights and added to that BT announced earlier this year an accounting scandal at its operations in Italy, which hit free cash flow by hundreds of millions. Add the ongoing integration of EE, and the picture of its underlying performance is muddy. 

The six countries covered in this analysis are:

  • Netherlands: KPN Netherlands, so excluding iBasis.
  • Belgium: Proximus Domestic, excluding BICS but including Luxembourg.
  • Germany: Telekom Deutschland, the German arm of Deutsche Telekom. Excludes its other European activities and T-Systems.
  • France: Orange France, excluding its foreign operations and Orange Business Solutions. Orange may be in the process of distinguishing itself from the others with the start-up of Orange Bank.
  • UK: BT, excluding Global Services.
  • Ireland: Eir.

It's important to note in this kind of overview analysis that markets do vary. For example, the number of mobile operators, investments in fibre and copper, whether there are cable networks as a second fixed infrastructure, the state as shareholder and the dynamics in the wholesale market. However, by limiting this to West Europe we assume the markets are largely similar, despite some cultural differences. 

  • Government. The German and French states still have controlling minority stakes in their incumbents. In Belgium, the state is majority shareholder. Eir has a more rocky past and is currently controlled by private equity.
  • Fibre versus copper. Ireland (Eir, Vodafone and ESB), France (Orange and the other big operators) and since more recently Belgium (Proximus) have big ambitions in terms of FTTH. In the UK (BT) and for some time the Netherlands (KPN), the incumbents' preference has been more advanced copper technologies, in combination with FTTH. Local and regional operators are also active in FTTH in these two countries. Germany (Telekom) has largely left fibre roll-out to city networks (such as NetCologne and M-Net) and Deutsche Glasfaser. Inexio is notably expanding, but is using FTTC.
  • Cable. Present in all six countries, but only in the Netherlands and Belgium does it have almost nationwide coverage. In the other countries, about half is covered, and satellite (Sky) plays a bigger role on the TV market. Cable operators have bought mobile operators in four of the countries, but not yet in the UK and Ireland.
  • Number of mobile operators (MNOs). The UK, France and Netherlands have four, Germany, Belgium and Ireland three. BT and Eir both sold their mobile operations (Cellnet/mmO2/O2 en Eircell), but then returned to the mobile market later (EE and Meteor).
  • Virtual fixed operators. There are bigger differences in this area, mainly on the consumer market. The UK and Germany have large virtual operators, listed on the stock market. This segment is smaller in the Netherlands, following a number of acquisitions by KPN (Tele2 and T-Mobile still play a small role). Belgium has opened its cable networks, and Orange has entered the fixed market as a result. In France and Ireland the role of access to the incumbent's network is changing as ADSL is replaced with FTTH.
  • MVNOs. Active in all the countries, MVNOs are most present in Germany, the UK and the Netherlands.
  • Content. Especially BT, Eir and Proximus have focused on sport by acquiring broadcast rights.

We look now at four important financial indicators:

  • Revenue growth.
  • Operating costs (opex). This impacts the operating profit (revenue minus opex = EBITDA) and the margin.
  • Investment (capex), which we also look at as a percentage of revenue.
  • Free cash flow, calculated as EBITDA minus capex and so also as revenue minus opex and capex. This is the final result of the first three indicators. We can consider free cash flow the 'bottom line', even though it's not a completely clean figure as opex comes in the profit and loss and capex from the cash flow statement. We use FCF as the main measure to compare the companies.


For all the operators, growth is low or often negative. Regulation, the contracting business market, and OTT and mobile services, with their falling ARPUs, are the most important causes.

  • KPN's revenue growth is negative for a number of quarters, but the decline is slowing. In 2013 revenue was falling by 10 percent, whereas at the end of 2016 the drop was just 0.7 percent.
  • Proximus has positive growth, but it slowed somewhat in Q4 2016 to 0.9 percent. In 2017 it expects this trend to continue, forecasting "nearly stable" revenues.
  • Orange has steadily falling sales, contracting  by around 1 percent on an annual basis.
  • Telekom Deutschland's revenues are currently falling too, by around 0.5 percent.
  • BT's reported revenues are affected by the takeover of EE. Only from Q2 2017 can we assess the figures on a comparable basis. The company sees underlying revenues stable in the fiscal year to March 2017 and the current year. 
  • Eir's revenue growth has slowed in recent quarters to 0.6 percent.

Operating costs

All the operators are embracing simplification. This is a necessity due to the falling revenues and an opportunity thanks to technology developments. An EBITDA margin of 40 percent has become the benchmark for this segment of operators.

  • KPN has worked for some time to cut costs faster than revenue, leading to an increase in its margin since early 2015. This followed a period in which the margin fell from over 40 percent to around 35 percent at the end of 2012. It's now recovering slowly to around 40 percent. This means it has largely met the target announced at its Capital Markets Day in 2016, for a 3 percent point increase compared to the 38 percent in 2015. A programme is underway to reduce costs by EUR 300 million by 2019, equal to 7 percent of costs in 2016.
  • Proximus's more or less stable margin shows it's keeping costs in check with sales. It's working on a 10 percent reduction in SG&A costs, which should lead to further improvement in the margin.
  • Orange's EBITDA margin is trending higher and recently moved over 40 percent (40.4%). So opex is falling. The company is working on a group-wide savings programme to cut EUR 3 billion in the period 2015-2018, of which around half was already realised in the first two years. This affects both opex (78%) and capex (22%).
  • Telekom Deutschland's margin is largely stable. The result in Q4 2016, 38.1 percent, was on the low end of what the company's achieved in recent years.
  • BT (excluding mobile) has historically had a high margin, well above 40 percent. It's been falling in recent quarters, to reach 38.7 percent at the end of 2016. For the fiscal year to March 2018, BT expects flat EBITDA for the entire group, excluding one-time items.
  • Eir has shown a somewhat lower margin recently, at 36.7 percent at the end of 2016, whereas in the past it has exceeded 40 percent. It's not surprising that a recent 'benchmarking exercise' has led to plans to reduce costs further. It targets low single-digit growth in EBITDA, which should be enough to grow the margin.



Investments mainly go to networks, both fixed and mobile. The capex at these operators is roughly 20 percent of revenues.

  • KPN is trying to reduce capex in order to grow free cash flow and subsequently dividends. Is this a good strategy? If a good return on investment is possible, the preference should go to re-investing profits, rather than taking cash out of the company. In the long term KPN's competitiveness could be undermined. Nevertheless, capex peaked in recent years at over 20 percent of revenue. The management now targets reducing this to around 15-17 percent. 
  • As for Proximus' capex, we assume the lion's share goes to its home market, and BICS reinvests just 1 percent of revenues. The Belgian operator's capex ratio has varied quite a bit and reached a peak of 28 percent in Q4 2016. In 2017, capex will increase somewhat due to the recently launched FTTH strategy.
  • Orange's capex is growing and recently reached a new height of 19.0 percent.
  • Telekom Deutschland is investing somewhat more lately, as its capex-sales revenue rose to 22.4 percent in Q4 2016.
  • BT's capex has historically been low without any mobile activities, when measured as a percentage of sales. It's now around 15 percent (14.4% in Q4 2016).
  • At Eir, the capex ratio hovers around 20 percent (24.8% at end-2016). This is in line with its target for 2017, of 19-22 percent.

Free cash flow


Free cash is used to pay shareholders (dividend), debtholders (interest) and the state (tax). The ratios of shareholders equity to debt and net debt to EBITDA determine the level of shareholder remuneration, as the bondholders and state take priority. Free cash flow at these operators is roughly 20 percent of revenues. One should note though that these are issues that play at the group level, not in terms of domestic operations. 

  • KPN Netherlands shows a largely stable ratio of FCF to revenue of 20 percent. If KPN succeeds in keeping opex stable (so an EBITDA margin around 40%) and reducing capex, this ratio can improve further.
  • Proximus Domestic's FCF ratio is not especially stable, due to the swings in its capex. In Q4 2016 it fell to a low point of 8.4 percent. The company has a strong balance sheet, with very little debt (net debt is around 1x EBITDA).
  • Orange France is able to keep its FCF fairly stable, at just over 20 percent. Its most recent figure is 21.3 percent, thanks to falling opex. Its net debt ratio is currently 1.9x EBITDA, with a goal of 2x. 
  • Due to the recently somewhat lower EBITDA margin and higher capex, free cash flow at Telekom Deutschland was at a historic low of 15.7 percent of revenue in the most recent period. Net debt is at 2.3x EBITDA, within the targeted range of 2.0-2.5x.
  • BT UK reports high free cash flow, thanks to low opex and capex. However the trend is lower, from a ratio of around 30 percent two years ago to 24.3 percent at the end of 2016.
  • Eir traditionally reports free cash flow at less than 20 percent of revenue. The latest figure of 11.8 percent is clearly on the low side. This is a consequence of higher opex and capex at the end of 2016. It has a high net debt ratio of 4.4x EBITDA, leading to junk rating for its credit. The company is profiting from the low interest rates. 

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