KPN, bonuses and the FTTH dilemma

Friday 21 May 2010 | 12:20 CET | Market Commentary
Het Financieele Dagblad has reported some turbulence in KPN about the company's bonus structure for the period 2008-2011. Forty directors could see their annual salaries double or triple if certain cash-flow targets are met, assuming they stay on until 1 May 2011. The company has reportedly set aside EUR 60-70 million for the plan. KPN is working on a new structure for the period after 2011, which according to the paper takes account of a new strategy under development this year and the current public debate over top salaries.

Two issues are at play here: the end of CEO Ad Scheepbouwer's contract on 1 July 2011 and the Back to Growth strategy from early 2008. The latter runs until the end of 2010, so we're eagerly anticipating the new above-mentioned strategy for 2011 and beyond. The company has given a few targets for 2011, but we can expect within the next few quarters a strategy update. The queston is when exactly the update will be presented, and if it will be Scheepbouwer or his successor behind the podium.

As for the top remuneration, everyone can have their own opinion. KPN is not a state-owned company and is more or less free to develop its bonus structure. It's up to the supervisory board and shareholders meeting to set any limits on this. There is a question though about whether short-term targets are good for the company. With short-term bonuses and stock and options remuneration packages, directors and managers will start acting like shareholders, with their similar short-term view. In a defensive sector, that may not be a bad idea. There are not as many technological challenges there as in the telecoms sector - every year the company just needs to sell more ice lollies. (could that be why KPN's former CFO Marcel Smits went back to the food sector with his move to Sara Lee in 2009, where he's now since a few days also interim CEO?)

In reality, KPN has a difficult phase ahead. The copper network has served for 100 years and in the coming years it needs to be replaced with fibre. This puts the company in a unique phase and dramatic transition. However, the transition to FTTH is being implemented only very gradually. Reggefiber, KPN's FTTH vehicle, has even been referred to the European Investment Bank for external funding. KPN is doing everything it can to avoid dipping into the cash flow, probably partly due to the bonus plan. The target has been EUR 2.4 billion for a few years already, even though the company is contracting (in terms of sales, access lines and employee numbers). A smart performance on the face of it, but now would be just the right time to justify a dip in the cash flow. The shareholders will undoubtedly vote with their feet, but one would expect from a good management that it could bring the company adequately though this unavoidable and dramatic development in the company's history (namely FTTH).

Private equity investors are often accused of bleeding a company dry. Assets are sold, the company is saddled with mountains of debt after self-financing its own takeover, and resources are further depleted by the pay-out of exorbitant dividends. TDC (Denmark) is a notable example. The KPN management should watch out for being accused of the same. The company has already spent EUR 8 billion on repurchasing its own shares - all in the name of increasing EPS. In the dramatic phase the company finds itself in, underlined by the contracting DSL market, there should be better ways found to spend the free cash flow. A capex spike and a free cash flow dip would then be no great shame.

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