The Telecommunications Sector in Times of the Corona Pandemic
The turbulence of recent years has not abated – the telecommunications sector is still confronted with elementary challenges. Almost all of the large companies are listed on stock exchanges and must regularly give an account of their operational and financial performance to their shareholders. How does the capital market assess the current situation, which is characterized by the coronavirus crisis, and what are the prospects for the future? What strategies and actions are regarded to be effective in achieving the objectives? Wolfgang Specht, Analyst at Bankhaus Lampe, answers these questions.
Mr. Specht, you have been involved with the telecommunications industry from the capital market perspective for two decades. What do you think about this sector at the moment?
The turbulences caused by the global coronavirus pandemic are the dominating topic in the telecommunications sector. Although usage of telecommunications services show a steep uptick since the beginning of the crisis, stock prices and thus valuations of most telecoms operators faced a sharp correction in recent weeks. Only a few stocks showed relative strengths vs. the broader market. Investors with holdings in the sector before the market started correcting mid-February thus lost a lot of money.
Wherever possible, companies are promoting to work from home. Shouldn`t that development improve the need for connectivity and thus be supportive for telecoms?
The need for solutions like VPN, collaboration tools and even telephony volume picked up materially, but that doesn`t necessarily increases revenues or earnings of telecoms operators. Large parts of the corporate contracts are based on flat rates and only a small proportion is variable, e.g. international calls or a required step up in bandwidth for the corporate network.
The employees that are forced to work from home usually use their existing broadband connection. Generating additional revenues is thus hard to achieve. If the pandemic is followed by a recession investors fear that the default of companies causes burdens.
And what about the residential segment? The need for communications services should have picked up materially?
The residential segment should hold up well during the crisis since the significance of telecoms services has improved materially. However, Government orders may allow deferment of payments for households that run into financial trouble.
A positive for telecommunications operators could be a reduced churn since customers are afraid of service interruptions in case of changing operators or service providers. Lower churn results in lower retention costs. Some households are probably also tempted to upgrade their broadband speed and/or top up subscriptions for content services. It is currently difficult to evaluate the net effect.
My best guess is that we will also see smaller negative effects from the residential segment once unemployment rates increase and households start adjusting their budgets.
Toput it in a nutshell: The corona pandemic will increase the traffic of operators, but hurt sales and earnings since the monetarization of the additional traffic is hardly possible?
Correct. The degree of negative impact will depend on the individual business model, duration of the shutdowns and the magnitude of the following recession. In order to maintain profitability, control of costs will be key. It is also helpful if parts of the capex can be postponed to preserve liquidity.
I believe that integrated operators with a good diversification of customers will be disproportionately affected. I also believe that the business models of lean telecommonications service providers serving the tail-end of the market will show a relative strength. The reason is that they have a natural inflow of customers which reduces their telecommunications budget.
What about the time after the coronavirus pandemic? Will the crisis force further consolidation? Will there be financing or leverage issues? And is the approach for regulation of telecommunications markets likely to change?
Weak capitalized operators and service providers who have problems to cope with the current challenges may run into problems over the next months. This calls for M&A opportunities. Leverage in the sector has increased in the past 3-5 years to an average of ~3x EBITDA. Given historically low interest rates, the coverage of interest payments by cash flows has however rather improved.
I thus regard most companies in the sector not as “over-leveraged”. The question on regulation is tricky: There are arguments that Governments and regulators will be more supportive to operators after the crisis while realizing the tremendous importance of building and operating networks. However, the general approach might not change significantly since politics also welcome a certain degree of service competition that is held up by the business model of service providers. I thus do not expect a post-corona privilege for infrastructure-based business models.
Will investors return to the sector and send share prices up again?
I see a good chance that well positioned or well managed companies in the telecommunications sector will be able to restore investors trust. The valuation levels of most listed German and European telecoms stocks are on a 10-year low. Companies that demonstrate resilience in the current environment should restore investors trust. In markets desperately seeking for save returns, sustainable dividend commitments are supportive to attract investors.
Wolfgang Specht is an Analyst at Bankhaus Lampe. Bankhaus Lampe is one of the leading as well as one of the few independent private banks in Germany.