By Craig Mellow
European telecommunications providers are merging and acquiring like it's 1999. That won't return their downtrodden stocks to the glory days. But it may churn up value in particular companies.
Within the past few months, Swisscom agreed to buy Vodafone's Italian business for eight billion euros ($8.7 billion), French champion Orange merged its Spanish operations with local operator Masmovil at a 19 billion euro valuation, and Telecom Italia sold its fixed-line assets to private-equity giant KKR for 22 billion euros.
The companies are trying to consolidate their way out of ruinous competition. Growth in their core cellular and broadband services has slowed to a crawl, while too many players -- from an industry point of view -- keep prices down.
"Overcapacity makes connectivity a commodity, and customers don't care anymore," Deloitte consultants concluded in a recent report.
Debt from building 5G networks has risen with interest rates. Remaining state stakes in former monopolies constrain cost-cutting, as governments want to maintain employment.
Stocks reflect these concurrent calamities. "Returns on most of these companies have been negative over the past 10 years," says Javier Correonero, an equity analyst covering the sector at Morningstar.
The holy grail for telecom dealmakers is a "four to three" transaction. Having three rivals in a given national market offers a fair shot at profitability; quartets not so much.
Regulators tend to like competition, however. Even where they have permitted mergers, they take steps to bring in new market entrants. Spanish authorities cleared the Orange-Masmovil tie-up on condition that Masmovil yield spectrum to Digi Communications, an aggressive outsider based in Romania.
Not all European telecoms are equally afflicted, though, Correonero says. A few smaller markets do offer less ruinous three-way competition. These include the Netherlands, where he likes market leader KPN, and Sweden, where he favors Tele2. He's also bullish on Deutsche Telekom, which retains exceptional brand loyalty in its native Germany, while its T-Mobile US unit gains market share in the U.S.
Fabio Caldato, an equities portfolio manager at AcomeA, sees broader positive trends in European telecoms. Capital expenditures should ease as the 5G build-out nears completion, and an expected fall in rates lightens debt burdens. Enough pricing power is returning to at least keep up with inflation.
"I think telcos will be a sector trade for the next year," he concludes.
One of Caldato's top picks is former U.K. monopoly BT Group, which has told investors it can cut capex by 35%, doubling free cash flow. He also flags Telecom Italia as a deep value play once it unloads debt through the KKR divestiture. The shares have lost half their value over the past five years.
Wheeler-dealer in chief on the European telecoms scene is Margherita Della Valle, an Italian who took over as chief executive of U.K.-based Vodafone last year. She is looking to exit both Spain and Italy, while pushing a four-to-three merger in the home market with CK Hutchison Holdings (brand name Three).
London's Competition and Markets Authority may have other ideas. The combination "could lead to mobile customers facing higher prices and reduced quality," it sniffed in a preliminary report. Caldato gives Della Valle an "A" for effort nonetheless. "Vodafone is finally focusing on efficiency, not an acquisition binge," he says.
Investors haven't quite gotten the memo; Vodafone shares have slumped another 20% since Della Valle took the reins last April.
A lesson for today's market stars: No one stays hot forever.
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
May 31, 2024 03:30 ET (07:30 GMT)
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