Deleveraging is set to be a key theme across all industries for the
immediate future, as the global economy enters uncharted waters.
However, among incumbents, there will be a sense of déjà vu, given
that as recently as 2002 telecoms experienced its very own liquidity
crisis. What has been an unprecedented shock in other sectors
should, therefore, be more familiar in telecoms. Indeed, the
incumbents may be looked to by governments as a potential bedrock
of calm, and be called upon to do their bit for the economy by investing
in fibre next generation access (NGA) network upgrades – with more
enlightened regulation acting as a quid pro quo. We see NGA as a
competitive weapon that will reassert the scale-friendly characteristics
of the industry. But if the economy worsens, incumbents can still cut
capex right back to maintenance levels, giving themselves a large FCF
buffer – while standing back to allow the macro environment to have
the effect that their investing in NGA would otherwise have had on
sub-scale domestic rivals. Either way, in-market scale wins.

Deleveraging déjà vu
In a sense, the telecoms operators have seen it all before. In the aftermath of the bursting of the dot com
bubble, the industry experienced its very own liquidity crisis. While the major incumbents were capable
of covering their interest payments, many had become over-dependent on short-term debt which proved
difficult to refinance. As a result, operators had to undertake a rapid and painful deleveraging exercise.
Managements seem to have learnt something from these dramatic events. The first point to make about
the current difficulties is that the incumbents are in a far stronger financial position, generally having
lowered their leverage, significantly reduced their reliance upon short-term funding, and put in place
much larger and longer-dated backup credit facilities.
Another lesson that operators may want to draw from their past experience relates to the flexibility
provided by the capex line. One widespread response to the liquidity crisis was to slash network
investment – some incumbents effectively halved their capex/sales ratios. The temptation may well be to
repeat this exercise. However, while we would acknowledge that this is possible as a last resort (and
would provide the sector with a good deal of resilience in terms of FCF generation), we believe that a
measured approach would be more appropriate.

For one thing, in the wake of the seismic shock that is the deleveraging phenomenon, governments are looking
for sources of fiscal stimulus, but are themselves already resource constrained (having bailed out banks and
automotive manufacturers). In this context, telecoms infrastructure upgrade projects could become particularly
appealing – representing fiscal stimulus with the bill footed by private companies rather than by the tax payer.
But to facilitate such investment, regulators will have to adopt a more sympathetic approach to the
incumbents. The capex required by projects such as next generation access (NGA) fibre upgrades is very
considerable. So, even though we believe that NGA will benefit incumbents (because the technology is
intrinsically scale-friendly), operators will be looking for reassurance before deploying such fibre. Hence
we foresee a reassertion of the traditional relationship between capex and regulation: when more capex is
needed, regulation retreats. In fact, telecoms could behave rather like (for instance) the UK water utilities
in the middle years of the decade, once regulators had decided to adopt an easier line in recognition of the
investment required. Such a scenario would be very supportive for the telecoms sector’s performance.
Capex conundrum
But investors remain nervous of capex. This is hardly surprising, in view of both the massive sums
wasted in the bubble and the mercurial nature of regulation. Fortunately, while projects like NGA
upgrades are clearly big-ticket items, they are also phase-able. In other words, while the total bill might
be large, the period of time over which the money is spent is under the control of the incumbent.
Moreover, investment in NGA in a sense merely represents the latest project an incumbent is focused
upon – generally following on from core network upgrades and 3G/HSPA. As a result, it is not
necessarily the case that capital intensity (the capex/sales ratio) need rise enormously – something borne
out by those operators that have taken the most extensive build (eg, AT&T).
But what if economic conditions worsen? This report also examines capex/sales ratios at their depths
following the bursting of the dot com bubble, to see how far hard-pressed operators could cut their capex
in the last exigency. The reassuring news is that this analysis suggests that incumbents have the ability to
offset significant top-line pressure with capex economies, if need be. And in this scenario, ironically, the
economy would simply take over NGA’s role of weeding out some of the sub-scale domestic competition.
However, the gap between past capex/sales floors and present levels of spending also suggests that there
should be scope for at least some NGA investment, even in a tough macro context – especially with
appropriate phasing (something that can obviously be tailored to the severity of the environment).
It might be supposed that a phased NGA upgrade would substantially delay the positive impact of the
investment. However, as demonstrated by the cases of France Telecom and KPN, this is not necessarily
the case, as the mere presence of a clearly articulated intention to invest in fibre access can cause a shake
out of ULL players suddenly confronted with the impending obsolescence of their business model.
Theory of relativity
Any discussion of capex must make reference to the impact of the credit crunch and deleveraging. Capital
is becoming considerably scarcer and hence more expensive – even for large incumbents, let alone for
smaller competitors. Indeed, some incumbents are struggling in the face of their leverage, and will likely
have to refocus domestically. And, not surprisingly, speculation about the consolidation process in
Europe continues (even if the credit crunch makes the practicalities of implementation more difficult).

This all suggests that the capex of competitors will be under greater pressure than that of the incumbents,
thereby further bolstering the domestic scale advantage of the latter. This report therefore examines which
incumbents face the rivals most and least able to continue to invest in capex. The crucial point here (a key
tenet of HSBC Telecoms research) is that it is not the absolute amount of capex that is important, nor the
number of new pieces of equipment that an operator purchases, but rather how a given operator’s
spending compares relative to that of its competitors. In other words, capex is a competitive weapon.
Hence some incumbents may be in the position where they can spend less, out-invest their smaller
competitors more, and still retain sufficient flexibility to be able to phase in a NGA deployment (so as to
reassert the importance of scale). If the macro situation deteriorates to the extent that this proves
impossible, then it will also doubtless also take care of many of the rivals that the NGA investment was
originally intended to counter. And, in such a scenario where capex was brought down to historical lows,
the savings that would result would imply resilient cash flow generation.
Spectrum speculations
Capex is not the only capital outlay operators face – nor the only one that may be subject to downward
revisions. Suitable spectrum is also crucial to mobile operators, and one reason why HSBC Telecoms
research has always employed relatively high capex/sales ratios is to reflect the cost not only of building
and maintaining networks, but also of purchasing the necessary radio frequencies.
A further round of spectrum auctions are upcoming, and this is not surprisingly causing some disquiet,
given the crippling expense of the 3G auctions at the start of the decade. However, times are much
changed, courtesy of the credit crunch, and it is difficult to see such wild bidding being repeated.
In a sense, now is an ideal time – so far as established operators are concerned – for the auctions to take
place, given that the credit crunch will severely curtail the ambitions of new entrants. This could persuade
certain administrations to postpone the auctions until more prosperous times return, but we suspect that
most governments are in need of all the funding they can lay their hands upon, and hence we would
expect the auctions to proceed.
Winners and losers
The goal of the present report on capex in a deleveraging environment is to highlight those incumbents:
􀀗 that have the financial strength to continue investing – but face rivals without the same strength to invest
􀀗 that have made more progress in deploying NGA than their domestic rivals
􀀗 that also have the most scope to sustain FCF generation by cutting capex if the going gets really
difficult – yet face smaller rivals without such flexibility (implying that the incumbent’s capex cuts
can be made from a position of relative safety)
We assess the incumbents on three sets of criteria, which aggregate into a score from +1 to +5; we then
assess the incumbents’ local rivals on similar criteria to produce a score from -1 to -5. Deducting the latter
from the former gives the incumbent’s total grade: a combined measure of its own position against the
position of those against which it must compete. In more detail, we make:

.. an assessment of the incumbent抯 degree of financial strength, measured in terms of factors like its
financing requirements, its gearing, and so on ?and we compare this with its competitors?relative
level of threat, measuring the extent of their investment in capex and ability to sustain this spending
.. an assessment of the incumbent抯 NGA progress (future spending needs are lower if some of this work is
already done, or well underway) ?and we compare this to the NGA progress of its domestic competitors
.. an assessment of the extent to which the incumbent can offset negative revenue impacts by capex
cuts (giving a measure of the operator抯 ability to respond to an extremely poor economic
environment with capex economies if there is no alternative, thus providing a gauge of the company抯
resilience) ?and we compare this to the resilience of the principal domestic competitor
Relative winners from among the list of our preferred incumbents include Swisscom, KPN, Telefonica and
FT. Swisscom benefits from its decent financial position and the fact that it has already built out majority
coverage of FTTN/VDSL, whereas its competitors lag materially in NGA coverage. Although KPN抯
progress in NGA deployment is not as well advanced, it has still convinced some rivals to exit, thereby
leaving the incumbent facing a lower level of competitive threat. KPN also boasts a strong balance sheet.
FT does relatively well, in particular having the advantage of a good balance sheet. However, it does face
several well financed and ambitious competitors (its weaker rivals having already exited the market in
anticipation of the expense of fibre builds). Meanwhile, Telefonica benefits from its own financial
strength, and also from the relatively modest threat that its domestic competitors represent.
Of the operators that we rate negatively, we would highlight TI抯 and PT抯 poor performance on these
assessment criteria. Both are disadvantaged by their relatively weak financial positions (high leverage), and
both also face aggressive local competitors. DT does fare somewhat better. The company has a strong
financial position, but some of its domestic competitors are likely to prove determined.
Of names where we are Neutral, it is worth pointing out the poor positioning of BT and TeliaSonera. BT
obviously has issues with gearing (given the size of the pension deficit), and faces a cable operator that has
been particularly rapid in its deployment of NGA. In the case of TeliaSonera, its domestic competitors are
comparatively strong, and are making reasonable headway with NGA programmes of their own.
On the parallel issue of spectrum costs, according to our assessment, Vodafone, DT and Telefonica face
the greatest absolute risk, while Telenor is the most exposed relative to its market capitalisation. But, as
the companies with the largest exposure, these are also the stocks that benefit the most from the fall in
estimated spectrum costs since our previous report on this subject (Money for nothing, February 2008).
For the sector overall, we believe that the dominant determinant of 2009 performance will surely be the
macro environment. Telecoms may suffer during periodic beta-driven rallies, but we believe the market
will continue to return to the sector, on account of its attractive cash flows and dividends.
In this report we have implemented two changes to target prices. With regard to Deutsche Telekom, we
reiterate our Underweight rating, with the addition of a volatility indicator, and lower our target price to
EUR9.0 (from EUR10.4) on reduced earnings forecasts in the US and Eastern European operations. And with
respect to Portugal Telecom, we maintain an Underweight rating, with the addition of a volatility indicator, and
lower our target price to EUR5.5 (from EUR5.8) on the back of an increased pension fund deficit.

目录

A friend in need is a friend
indeed 6
Affordable luxury 13
Theory of relativity 28
What a difference a decade
makes 36
Defensive now offensive? 46
Winners and losers 54
Company Profiles 61
Belgacom 62
British Telecom 64
Deutsche Telekom 66
France Telecom 68
KPN 70
Portugal Telecom 72
Swisscom 74
Telecom Italia 76
Telefonica 78
Telekom Austria 80
TeliaSonera 82
Disclosure appendix 85
Disclaimer 88