Europe's telecoms: fading charms

Whoever said telecoms stocks were safe? Having generally outperformed since the 2008 global financial crisis, Europe's telecoms sector has become one of the smelliest dogs this year. While the Bloomberg European 500 Index has been flat in price terms, a sub-index for telecoms constituents is down 9 per cent, ranking the sector 33rd out of 37.

Behind this underperformance lies a growing awareness that the vice-like squeeze on telecom companies' finances is unlikely to be loosened soon. Revenues are declining - down for three consecutive years, to about €270bn in 2011, according to industry estimates, and likely to fall further in 2012. Fixed-line revenues are tumbling fastest, but mobile voice markets are also saturated and regulatory pressure is pushing down termination rates. Mobile data growth only partially offsets this. In addition, investment demands are rising - for example, to fund network upgrades, fibre rollouts and spectrum auctions. The sums invested are increasing - up about 5 per cent last year - but the revenue share devoted to investment is still only about 12 per cent. Moody's thinks it should be nearer to 18 per cent.

These dynamics have obvious knock-on effects. One is to turn the spotlight back on to costs and efficiency. Network-sharing deals - such as Vodafone/Telefonica's recent agreement in the UK - make sense; the opportunities have not been exhausted. Corporate consolidation is another: synergies among the big incumbents are limited, but there is scope for further restructuring within specific markets, regulators permitting - witness the talks between KPN and Telefonica about merging their German operations.

None of this bodes well for yield-hungry investors, who have become used to telecom stocks distributing more than half of their free cash flow. The number of reliable cash cows among European telecoms groups is declining fast. And that may tarnish further the sector's fading charms.

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