Strategy & Operations » Leadership & Management » Telco CFOs striking a balance between stakeholder interests

“IN THE TELCO INDUSTRY, maybe flat is the new up,” says Timoteus Höttges. A quick glance at the share price performance of the sector’s major players proves the validity of the Deutsche Telekom (DT) finance chief’s opinion.

His own company’s share price has flat-lined between €8.87 (£7.60) and €8.51 over the last year; similarly, Telefónica’s share price dipped from €13 to €11.47 over the same period, while Vodafone rose from £170.80 to £187.80.

Speaking at the Economist CFO Summit earlier this year, Deutsche Telekom CFO Höttges said it is a “tough environment” for telecoms companies. His own business reported that adjusted earnings before tax fell 3.8% to €18bn last year, but DT’s issues are mirrored across the industry.

Finance chiefs in this space are contending with high debt levels and large financial rations, an overcrowded market, a shrinking traditional fixed line business, overlapping products, tough European regulations and the ever-present recession.

Against the sector’s indebtedness – a total of £15bn gross debt in the UK alone according to figures provided by CompanyWatch – telcos are balancing a capital intensive and long-term investment cycle to keep pace with an industry that is undergoing dynamic transformation.

“The way consumers are using telecoms is changing,” says Ewan Parry, partner at OC&C Strategy Consultants. “Wireless is everywhere and the devices people are using are increasingly going to be consumer devices. It is all being driven by the consumer market.”

According to Höttges, the rapid change is evidenced by the continuously shorter product lifecycles of the industry. To gain 50 million users, TV needed 38 years, the first PCs took 13 years, internet programmes four years and tablet computers less than two years.

“It’s a very capital-intensive industry. We build networks nobody sees. We have low capital turnover and a long investment cycle,” he told delegates at the Economist conference. “It is a long-term investment industry, but at the same time you have to make the right bets.”

Investment race

For major players like Deutsche Telekom, Vodafone and Telefónica, the conundrum for finance chiefs is balancing the cap-ex costs of investing in traditional fibre infrastructure and building new 4G capabilities.

“It’s a big dilemma,” concedes Höttges, who said that out of €60bn revenue Deutsche Telekom invested €8.5bn every year in cap-ex. With reductions on retail prices and depleting revenues from traditional business, network operators are feeling the squeeze.

“It’s very difficult to keep the same level of revenue as we had before,” Höttges says. “At the same time, a lot of cap-ex is needed to participate in the game in the future.”

There are two distinct ways in which operators are trying to gain a share of that all-important infrastructure. The first is through traditional merger and acquisition deals.

In July last year, Vodafone bought Cable & Wireless Worldwide for £1.1bn in a deal that doubled its business with British companies and provided Vodafone with a 20,000-kilometre fibre network allowing it to carry more mobile internet traffic at a lower cost.

According to Vodafone’s chief technology officer Steve Pusey, the opportunity to provide combined telecom and IT services to companies was one of the main rationales for the deal.

“We are seeing many customers from both companies knocking on our door for a converged fixed mobile-hosted application offer,” Pusey told Reuters last year.

In April 2010, Deutsche Telekom completed its own deal to merge its UK T-Mobile operation with France Telecom, the parent of Orange, to form the UK’s largest mobile phone operator at the time, Everything Everwhere.

However, Höttges says FDs need to be cautious when deciding between mergers and investment in existing infrastructure. The UK deal provided Deutsche with an advantage in terms of “yield management” because it improved the company’s “capacity for investment”.

Nevertheless, he sounds a note of warning; M&A should not be outside of the company’s core footprint and should come within the sphere of prudent portfolio management.

“If you want to modernise your infrastructure don’t mess around with other things,” he says. “We stay in markets where we hold the most modern infrastructure and hold a number-one position.”

On the spectrum

M&A is not the only way to gain mass and cut costs. More recently, operators have taken the unusual tack of sharing their networks. Last year, the UK divisions of Telefónica and O2 agreed to pool their basic network infrastructure to create one national grid running each operator’s independent network spectrum.

This coalition approach – the infrastructure, including towers and masts, will be transferred to a 50/50 joint venture company – poses tantalising questions about how companies can work together, while at the same time remaining in direct competition. Though they share the infrastructure, the spectrums that carry their own customer traffic will remain fully independent.

“The biggest thing historically is that they wanted to have their own networks. Now they are up for sharing,” says OC&C’s Parry. “They share investment costs and keep their brands.”

In terms of the customer benefits, they will not be able to roam between the two networks but should benefit from more coverage than before in terms of geographic reach and indoor penetration.

Ronan Dunne, CEO of Telefónica UK, said the partnership is about “working smarter as an industry. “One physical grid, running independent networks, will mean greater efficiency, fewer site builds, broader coverage and, crucially, investment in innovation.”

The deal, recently granted permission by the Office of Fair Trading and Ofcom, should also allow the operators to roll out 4G services more quickly.

The telecoms regulator raised £2.34bn from its auction of the 4G mobile spectrum, which promises mobile broadband speeds roughly five to ten times faster than 3G networks. Yet despite its seeming importance to the digital future of the sector, the winning bidders – which included Vodafone and Telefónica – spent much less than the government had expected, and much less than the £22bn raised from the 3G auction in 2000.

OC&C’s Parry says this is a sign that the businesses have got smarter about using the spectrums they have.

“When 3G came out they thought the business would collapse and die without it,” he says. “In a 4G world they want it, but they already have the other spectrums and are sharing what they have.”

Balancing act

Spending big on spectrum auctions and merger deals is all well and good, but Höttges says it is the FDs job to balance this against stakeholder interests. Entrepreneurs in the business, capital markets and customers all require different outcomes from the finance function.

“The art of balancing is the balancing out of these different interest groups,” he says.

Entrepreneurs want sufficient funds, planning security and room for innovation. “Entrepreneurs in the business need money,” he says. For instance, a large-scale roll out of fibre cables across customer homes could take between ten and 15 years with a €70bn outlay to build the infrastructure.

The second group of stakeholders are the debt and equity holders. But equity holders are not looking to invest over a 20 year time horizon. They want return on investment, a sustainable dividend and sound balance sheet ratios. “They want to know the money is coming back,” he says, while seeing a return of capital that is above capital costs.

At the same time, customers are looking for the lowest costs and the highest quality. They want state of the art products, seamless connectivity and coverage anytime, anywhere. But how do you manage that balancing act as a CFO? Höttges’ advice is to avoid surprises and be focused on what you do.

Avoiding surprises all comes down to risk management. Sometime this can be driven by what “executives read in the paper” and is “not always built on the fundamentals” of the market.

“We introduced early warning indicators,” Höttges says, and adds that a leading indicator concept means the company can identify whether the industry is improving or worsening before pressing ahead with an investment.

Another element is building a risk cockpit that can measure around 50 key performance indicators for the business markets. If risks occur, what is the impact on EBITDA and what are the FX impacts?

Secondly, the FD must prudently manage the company’s portfolio by focusing on what it does well. This harks back Höttges’ point on staying within the businesses’ footprint, which in turn creates a “safe haven” for investors.

“Our equity is less risky than the profile of our peers,” he says. In turn, this reduces refinancing costs. And by having a predictable portfolio, the performance of the business is reliable.

“You always know we are in a position to clear our dividend commitments,” he says. “We need a liquidity reserve that covers our [debt] maturity for 24 months.” This is important, says Höttges, because there are question marks over whether governments will use the bond markets to refinance.

“If this happens, it could be difficult for us to tap the bond market,” he says. “If the market is closed, Deutsche Telekom is never sweating.”

Timoteus Höttges was speaking at the Economist CFO Summit in January 2013