KPN and its brand-new CEO Eelco Blok have issued a profit warning. The company points to the rapid changes in consumer behavior, such as substitution of mobile voice and SMS with apps like Ping and WhatsApp (especially but not limited to young people), as well as the price pressure in the business market. Both are trends limited to its operations in the Netherlands.
To fix the Dutch activities, KPN proposes:
- The launch of data-centric mobile bundles and volume-based pricing. The challenge is to design the bundles and conditions (caps, out-of-bundle prices and speeds) in such a way that heavy users are prompted to upgrade to a more expensive tariff plan.
- Extra investments in VDSL and use of new technologies, namely bonding (2011, good for roughly a doubling in speeds), vectoring (also 2011 and again a doubling) and phantom mode (2012, for a gain of 30-40%). (For more on this see our background article ‘Network upgrades far from over’.) What this all means in the end for VDSL speeds is not yet totally clear.
- Cutting personnel by 4,000-5,000 FTEs (20-25% of the Dutch workforce) by 2015, mainly through outsourcing and offshoring the back-office. The restructuring will cost EUR 250-300 million.
- Service bundles over FTTH networks will also be adjusted to make them more competitive with cable.
The effect on the company’s guidance is minimal: the extra investments (EUR 100 million) and EUR 200 million less in EBITDA (excluding the restructuring costs) will be offset by a tax benefit this year of EUR 300 million. This is the result of a lowered tax rate of 5 percent applied to R&D work in the Netherlands, helping to reduce KPN’s tax rate to 21 percent, from 24 in 2010, and 20 percent thereafter. For the period after 2011, KPN said it will maintain its leading position in shareholder remuneration (dividends and share buybacks). More details will come on 10 May, when KPN reveals its targets for the coming years during its Investor Day.
The timing of the profit warning is surprising, as at the end of January it seemed nothing was different and the guidance was maintained. Smartphones and apps are nothing new, and Telefonica said already in January that use of such apps had cut SMS revenues by 19 percent. The question is why aren’t Base and E-Plus suffering from this trend? OK, smartphone penetration is lower there, but that means the impact of over-the-top services such as Skype and WhatsApp is still hanging over KPN’s head in Germany and Belgium. Questions like this helped push KPN’s share price 8 percent lower, despite the fact that the market was already expecting EBITDA for 2011 lower than the company’s previous guidance of EUR 5.5 billion.
The profit warning can be seen in another light. First, it’s not unusual for a new CEO to draw a line under the previous management and lower the expectations, a phenomenon know as the ‘big bath’. Blok has limited room here though, as he was of course partly responsible for the previous regime under Scheepbouwer. The warning could also be aimed at regulator Opta, which is currently working on its plans for the coming years. KPN has every interest in making business look as bad as possible in order to try and ensure an easier regulatory environment (and tighter regulation of cable operators).
Looking more closely at the two problem areas, we can see the following:
- NL consumer mobile: services revenues down 8.1% to EUR 399 million due to regulatory effects (-4.4%), the shift away from prepaid (around -2%) and the mentioned change in behaviour (around -2%). The last factor represents around EUR 9 million in revenues. Data’s contribution to ARPU has risen to 37 percent, and among the postpaid subscribers, 42 percent have a smartphone and 51 percent a data bundle.
- NL business fixed: sales down 7.2 percent to EUR 346 million, affected by one-time income of EUR 22 million in Q1 2010, while Q1 2011 profited from the takeover of Atlantic Telecom (EUR 12 million). Organic growth was a drop of EUR 17 million or 4.8 percent.
Adding up all the negative items, we get an impact of EUR 26 million at the sales level, on total quarterly sales at KPN of EUR 3.235 billion – so, less than 1 percent. EBITDA totaled EUR 1.269 billion in Q1, down 4.1 percent, while according to the previous outlook EBITDA for the full year was supposed to be at least unchanged. EBITDA at the consumer activities in the Netherlands actually rose 5 percent, but business revenues were down 13 percent.
Conclusion
Blok is laying a heavy hand with this (early) profit warning, given that the actual effect on results is limited. Of course it makes sense for Blok to intervene quickly, otherwise the negative sales developments could accelerate. The proposed changes can only make KPN a stronger company, so that within a few quarters, and certainly after 2012 (when the effect of MTA cuts should largely be over), the company can come with some positive news. The lower tax rate will also help in the coming years. There are likely also political motivations at play: deregulation at KPN, regulation of the cable and a major round of job cuts need to be justified by deteriorating results.
In comparison, the European incumbents fell on various stock markets all around 1 percent, while KPN was down 8 percent. For more clarity and details on the fixed network (VDSL, Reggefiber) we will have to be patient and wait until 10 May.
