Telefónica entered into an exclusivity agreement with Hutchison Whampoa regarding Hutchison’s potential acquisition of the Telefónica subsidiary O2 UK for £10.25 billion in cash, valuing the deal at an estimated 7.5 times 2014 EV/EBITDA. The Hutchison-O2 UK deal — should it complete — will entirely redraw the telco landscape in the UK in terms of market shares. The acquisition of O2 UK will transform Hutchison from the smallest mobile operator with 7.5 million customers to the largest with 31.5 million customers and reduce the number of mobile operators in the UK from four to three.
This development follows on the heels of the announcement by Orange and Deutsche Telekom that they have entered into exclusive negotiations with BT Group regarding a potential divestment of 100% of their shares in EE, their joint venture in the UK. The increased merger activity is not surprising, and we predicted as much in our report Predictions 2015: Telecoms Will Struggle To Align To The CIO's BT Agenda. Still, these deals raise important questions for the European telecoms markets:
At its annual Energy Analyst And Sourcing Advisor Event in Berlin, Deutsche Telekom/T-Systems re-emphasized its commitment to service the energy sector with a dedicated offering. Over the last three years, Deutsche Telekom has spent significant resources in building up expertise to become a platform and service provider for the utility sector. Our main observations during the event were that Deutsche Telekom:
Henning Dransfeld, Ph.D., Clement Teo, and Brownlee Thomas, Ph.D.
We recently attended T-Systems' Analyst And Sourcing Advisor Summit in London. T-Systems has made some progress since its last analyst summit, not least of which is the development of a clearer overall market message and further developments of its portfolio. Its overall market message centers on what Forrester calls “the age of the customer.” The vendor emphasizes enhanced network/solution performance, innovation, and execution. Our key takeaways were:
The deepening the relationship between T-Systems and parent Deutsche Telekom is sensible. During the keynote, and in the breakout sessions, there were several references to how T-Systems’ assets complement Deutsche Telekom’s. T-Systems is moving ever closer to its parent Deutsche Telekom, in particularly in the B2B2C space. T-Systems can provide solutions to its business customers that are brought to market through Deutsche Telekom's consumer customer base. Such an approach is limited to Deutsche Telekom's footprint. However, this strategy could also be extended to other carriers as white-label solutions, where no competitive conditions exist (e.g., in Spain or the Nordics). This approach clearly makes sense for both Deutsche Telekom and T-Systems and is reflected in T-Systems "zero-distance" marketing message.
Dan Bieler, Frederic Giron, Brownlee Thomas, Ph.D., Stefan Ried, Christopher Mines, Pascal Matzke, Jennifer Belissent, Ph.D.
T-Systems hosted its 2012 analyst and sourcing advisor event recently. To be sure, T-Systems remains one of the most advanced true ICT providers in the European market. But T-Systems ought to demonstrate more clearly how it can support and enhance business process for its customers and improve the customer experience for its customers’ customers. Of course T-Systems is not alone. The ICT industry needs to emphasize proven capabilities in delivering enterprise-grade ICT solutions ranging from co-management of infrastructure resources to full outsourcing.
T-Systems, like many of its competitors, is busy making sure that it does not bleed too much in what T-Systems calls the red ocean, i.e., the highly competitive market segment of legacy services. That's a good start. At the event, T-Systems communicated very clearly the progress at its internal production factory. This aspect is critical for streamlining and standardizing the portfolio, boosting margins, and developing products and services that the revamped sales team then can actually sell. One tangible outcome of this effort shows through in the high customer satisfaction level and deal wins like BAT, OMG, and Georg Fischer. Importantly, T-Systems also has put in place a rigorous certification framework for ensuring quality of service with suppliers.
However, T-Systems still needs to convince in areas of the blue ocean, i.e., the emerging innovative market segment. Like many of its competitors, T-Systems is not finding this easy. Why? Because T-Systems continues to prop up its legacy business: selling technology solutions.
Deutsche Telekom is leading its daughter T-Mobile USA down the aisle for a second time in less than two years after the previous marriage attempt with AT&T collapsed in light of regulatory objections (see http://goo.gl/hgCrm). But T-Mobile USA will not leave the house altogether. Should the deal go through, Deutsche Telekom will own 74% in the NewCo. The NewCo will operate as one company with two brands, similar to how Everything Everywhere was run. MetroPCS Shareholders will own the remaining 26%.
The financial plan is that scale effects will translate into $6-7 billion of cost synergies from enhanced scale and scope. Deutsche Telekom pitches the deal as creating a wireless value leader in the non-contract (pre-paid) segment, with the goal of targeting a growing market segment. The ambition for the NewCo is to generate compound annual growth rates of 3-5% for revenues, 7-10% for EBITDA and 15-20% for free cash flow over the next five years.
The deal raises several issues for me:
Targeting a market opportunity requires ongoing investments. In my view, the goal for growth looks ambitious based on the proposed value proposition. Whilst I do see a market opportunity for unlimited data plans (i.e. NewCo’s value proposition), I believe that ongoing investments beyond the existing ones are required to ensure QoS and customer experience. The completed network modernization to the tune of US$4 billion LTE investment including site upgrades and spectrum re-farming provides a good starting point. But more capex is required in the years ahead as data traffic continues to explode. In turn, this could undermine free cash flow growth ambitions.
Several weeks ago I toured Friedrichshafen, Deutsche Telekom’s T-City — a smart city demonstration project launched in 2006 to test the use of ICT across a real city with real people. The project began with a competition in which the cities themselves proposed a concept for how they’d use ICT and work with Deutsche Telekom (DT); 52 cities competed, 10 were short-listed, and Friedrichshafen was ultimately chosen.
Friedrichshafen is a relatively small city of 59,000 — not one of the megacities that have garnered so much attention from large technology vendors and the media. It is also not a greenfield city with a clean slate; it has an industrial history, with the Zeppelin Museum holding a place of prominence on the shore of Lake Constance.
The T-city project began with the installation of fiber to the curb and upgraded 3G mobile technology. This networking backbone powered more than 30 projects, from health and assisted living to education to home networking to smart grid. Some were simple citizen services applications — like the Flinc ride-sharing application or a kindergarten registration application — while others were more extensive infrastructure projects.
Corporate CIOs should not ignore the network-centric nature of cloud-based solutions when developing their cloud strategies and choosing their cloud providers. And end users should understand what role(s) telcos are likely to play in the evolution of the wider cloud marketplace.
Like many IT suppliers, telcos view cloud computing as a big opportunity to grow their business. Cloud computing will dramatically affect telcos — but not by generating significant additional revenues. Instead, cloud computing will alter the role of telcos in the value chain irreversibly, putting their control over usage metering and billing at risk. Alarm bells should ring for telcos as Google, Amazon, et al. put their own billing and payment relationships with customers in place.
Telcos must defend their revenue collection role at all costs; failure to do so will accelerate their decline to invisible utility status. At the same time, cloud computing offers telcos a chance to become more than bitpipe providers. Cloud solutions will increasingly be delivered by ecosystems of providers that include telcos, software, hardware, network equipment vendors, and OTT providers.
Telcos have a chance to leverage their network and financial assets to grow into the role of ecosystem manager. To start on this path, telcos will provide cloud-based solutions that are adjacent to communication services they already provide (like home area networking and machine-to-machine solutions), such as connected healthcare and smart grid solutions. Expanding from this beachhead into a broader role in cloud solutions markets is a tricky path that only some telcos will successfully navigate.
We are analyzing the potential role of telcos in cloud computing markets in the research report Telcos as Cloud Rainmakers.
I attended Trend Forum 2012 last week in Bonn, effectively an analyst day where Deutsche Telekom presented its innovation strategy. There was no focus on overall group strategy. Still, innovation matters greatly as part of the repositioning efforts of telcos. As the role of telcos in the value chain is weakening, largely due to increasing competition by over-the-top providers (OTTPs), telcos need to differentiate themselves increasingly via service provision and their ability to innovate quickly and prolifically. Failure to do so will cement their status as transport utilities for OTTPs.
Deutsche Telekom’s Core Beliefs focus on: a) building its platform business by partnering with software firms; b) leveraging the cloud by providing high QoS and secure connectivity; and c) leverage differentiating terminals through device management and customer experience provision. These Core Beliefs form the basis for pursuing its focus growth segments in digital media distribution, cloud storage, cross-device digital advertising, classified marketplaces, and mobile payment in addition to the core telco business. These targets match up well against our evaluation of best cloud markets for telcos.
A defining characteristic of next-generation network (NGN) infrastructure and the move towards cloud-based business models is openness. As a consequence, OTTPs increasingly deal directly with end customers across the network. Relationships between telcos and other members of value chain become more complex. Emerging cloud services by telcos need to become network agnostic to deliver cross-network solutions and ensure cloud interoperability. Deutsche Telekom has made significant progress in the recent past to adapt its strategy to these new telco realities.
It does not come as a real surprise that the deal aimed at merging AT&T's and Deutsche Telekom's US wireless operations got nowhere. We were expecting as much back in autumn. In our view, there are no winners as a result of this dropped deal, not even the US consumer. The US consumer can look forward to poorer network infrastructure and a weakened T-Mobile as the low-end market provider. Hence, the Federal Communications Commission and Justice Department attained somewhat of a Pyrrhic victory.
Whilst the collapsed deal is a major irritant for AT&T, it is a disaster for Deutsche Telekom, as it leaves T-Mobile US in a very difficult position. With about 10% of the US wireless subscribers, T-Mobile US remains subscale. Its image is increasingly trending toward cheap rather than good value, given its patchy network coverage, especially in rural areas.
The reluctance by Deutsche Telekom to prepare for a "no-deal scenario" leaves T-Mobile without a clear strategy. This lack of direction is very risky and only pushes T-Mobile further down a slippery slope toward increasing churn and revenue and margin challenges. Deutsche Telekom needs to communicate its plans for 4G roll-out, spectrum purchases, partnerships for network sharing, and device portfolio. Above all, Deutsche Telekom needs to decide soon whether to pursue an IPO, a sale to another operator or a financial investor, or target a merger with the likes of Dish, Leap, Clearwire, Sprint, or even LightSquared. Ultimately, we expect Deutsche Telekom to opt for a merger scenario.
T-Systems’ Analyst Summit 2011 in Frankfurt was dominated by updates on the progress the company made regarding its restructuring projects. As a result of these efforts, T-Systems has created the basis to become a more efficient and agile ICT services provider going forward. Still, in our view, the period between mid-2010 to mid-2011 was a lost year for T-Systems — despite the obvious progress T-Systems made in addressing its past challenges.
In some respects, T-Systems had become a victim of its own success in 2009 and 2010. T-Systems was clearly overwhelmed by its multibillion deals (with clients including Linde, BP, Shell, E.ON, MAN, Continental, etc). Delivery capacities were stretched to the limit, manifesting in serious transition and transformation challenges. T-Systems was forced to allocate more capacities to big deals, thus depressing margins to just over 2% in Q3 2011 (see chart below). T-Systems still aims to reach the peer-group average EBIT margin.
Source: company reports
About a year ago, T-Systems began to restructure its entire operations in a mammoth project, effectively redrawing the entire organisational structure and reshuffling the top management team, except for the CEO and CFO. The Analyst Summit provided some insights that these efforts are beginning to bear fruit: