Capex in fibre and 5G limits European telecoms’ free cash flow
European telecoms operators continue to invest heavily in rolling out fibre and 5G networks, keeping capex high and limiting free cash flow (FCF) generation in the short term, Fitch Ratings says.
The impact will be the greatest on incumbent operators’ FCF as they need to deploy both networks simultaneously and, in some cases, rapidly. Alternative operators with cable assets will be less affected, reflecting the existing hybrid fixed coaxial network structure that will lower the cost of deploying fibre in the ‘last mile’ of the network. Operators will seek alternative ways of financing deployments, including monetisation of access to local infrastructure.
The pace of fibre-to-the-home (FTTH) deployments in Europe varies by country, primarily due to differing costs of deployment, competitive dynamics and regulatory or political factors that incentivise deployment.
Incumbent operators, such as Deutsche Telekom in Germany and BT Group in the UK, are at an early stage of rollout, which will accelerate over the next two to three years and result in weaker FCF compared to Telefonica in Spain, which already has high coverage.
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FTTH penetration levels of over 60% in Spain and Sweden are encouraging for the rest of Europe. These two markets achieved a high level of FTTH coverage relatively early and their higher penetration rates are important for the return economics of fibre deployments as they could facilitate higher average revenue per user, reduce churn and cut operating costs. As penetration rates increase, incumbent operators begin to consider switching off their copper-based networks.
We expect operators will continue with a measured pace of 5G deployment, aimed at improving coverage in high and mid-density areas using recently acquired 700MHz and 800MHz frequencies.
The low level of 5G device penetration and a lack of applications in the B2C segments that specifically demand 5G capability are likely to restrain the take-up of 5G services and ARPU growth in the segment over the next 12 to 18 months. However, the use of 5G in the B2B segment could gain traction as businesses begin to embed the technology into their workflow processes.
Limited scope for full-vertical consolidation in most markets and the sector’s constrained FCF mean that inorganic projects are likely to focus on network infrastructure and bolstering of capabilities in the cloud and security services for the B2B sector. There will also be greater focus and emerging appreciation of longer-term cost benefits of full-fibre and all-IP networks within stable market structures. This could lead to a revision of investor risk appetite and improving sentiment towards longer-term investments.
Some infrastructure, pension and private-equity investors have a different perspective on the sector’s risks and returns to existing equity shareholders of listed telecom operators that often value short- to medium-term FCF and dividends. These investors can have lower project hurdle rates and longer-term return horizons, and would be willing to forgo dividends in the short term for capital gains in the longer term. Such investors would also have a higher tolerance for leverage and securitised and structured forms of debt.
As a result, we expect telecoms operators will explore ways to optimise or monetise the value of local access infrastructure. The rationale and outcomes are likely to differ by incumbent and alternative operators. Non-listed alternative operators may be more willing to fully separate their networks from their retail operations, while incumbent operators may opt for stake sales or focus on joint ventures in less dense urban and rural areas.
Stability and visibility of revenues of telecom network assets can have greater leverage capacity within their respective rating levels than their integrated counterparts or operators without network ownership.
