KPN's new strategic plan builds on its plan from 2016. In short, the focus is on cost savings, investing in technology and convergence. This should result in a higher margin and growth in EBITDA and free cash flow, leading to dividend growth as well. The biggest risk, according to the company at its Capital Markets Day, is execution risk: will the company be able to realise all its plans in the timeframe targeted? Other risks include weaker-than-expected revenues, underestimating the competition and an expensive spectrum auction.
Growth still the goal
The motto for the forecast period 2019-2021 is 'organic sustainable growth', which follows the 2016 aim 'simplify, grow, innovate' and 'strengthen, simplify, grow' from 2014. Growth is the constant in KPN's ambitions. It may be time to let this go though, as telecom is a saturated market and a utility, where only price increases can generate growth.
In its normal usage, growth refers to the topline, so revenues, or even customers and market share. With growth in these areas appearing difficult, the new CEO Maximo Ibarra has decided instead to focus on EBITDA and free cash flow. This brings a risk, over which his predecessor Eelco Blok would have something to say. When he issued targets for the dividend, without guidance for revenues, the company's credibility was undermined. How can you predict the bottom line when you have no idea about the top line?
Cost savings essential but not especially ambitious
Ibarra seems aware of this. Not only does he explain the understanding of growth, but he's joined a team well-versed in implementing cost savings. If the stagnation in revenues does not prove too horrible, he can still more or less guarantee growth in EBITDA and free cash flow (assuming stable capex) by cutting costs. CFO Jan-Kees de Jager added a boost by noting that cost savings are not limited to the current forecast period, but can continue for "at least a decade". The EBITDA margin may even over time reach "cable-like levels". This is important for a company like KPN, as paying a 'progressive' dividend is an essential part of being a utility.
Ibarra said execution is the biggest risk - everything must go to plan. This raises questions especially over the company's plan to relaunch the FTTH roll-out. At the same time, KPN has been very successful in lowering the costs of the roll-out, pushing the cost per home passed down to EUR 650 from over EUR 1,000. The company said it has also lined up "eight or nine contractors" for executing the plan.
A focus on "value over volume" should take account of the weak revenue outlook, while limiting the impact on EBITDA. KPN shows it has much within its control:
- On the large corporate market, where tenders are in play, KPN can evaluate whether it is worth deploying fibre, and with FTTH, the company can choose the most attractive areas. If the result ends up being the loss of a customer, revenues may be affected, but EBITDA much less so.
- KPN clearly has the capex under complete control, helped in part by good internal procedures for vetting investment projects. 5G could still be a risk, if the mobile network requires extreme densification. This is one of the elements of 5G, but KPN sees 5G mainly as a business technology: "4G connects people, 5G connects society". We note as well that the cost of spectrum is not included in the capex budget but is factored into the leverage target (<2.5 compared to 2.7 now). This means an expensive auction is another risk.
- The opex is also well in hand. Implementing new technology and bundled services already lead to lower costs, as KPN has shown in recent years. Only the timing and switching costs are risk factors.
The question is what kind of impact opex savings of EUR 350 million by 2021 will have. Results in recent years show KPN has been able to reduce costs by around EUR 100-200 million per year. In this light, the company's new target is not so ambitious. As for the number of FTEs, KPN has been shedding around 500 per year on average, after correcting for acquisitions (such as QSight in 2017, with 250 employees).
Is KPN underestimating the competition?
One factor over which KPN has much less control is the competition. The impact of T-Mobile's merger with Tele2 and the open cable regulation will be small in the short term. KPN even thinks having a bigger and more stable number-three player will be good for the market, as it will act more rationally than a smaller player. However, if T-Mobile lives up to its "invest and disrupt" motto, KPN faces some risks. Open cable will be a factor only in the longer term, once the management of VodafoneZiggo faces up to the new reality. Competition on the wholesale market will provide challengers with more healthy margins and more room for lower prices.
Cord cutting and the general competition with internet services are also outside KPN's control. Of course it wants to hold on to customers and sell them more services, including OTT services, but if more and more people cancel their fixed lines and traditional pay-TV, KPN may end up being needed only for the broadband connection. That market is competitive, and will become more so as VodafoneZiggo plans to offer gigabit broadband nearly nationwide in 2020. VZ is also using exclusive content, something KPN doesn't seem to think is necessary: "We are the best, so we don't need exclusive content", said Jean-Pascal Van Overbeke, the new consumer market chief. Pride before the fall?
And there shows the risk of underestimating the competition. If there is a risk of disappointing revenues, this is the most likely cause.
