Wednesday, April 27, 2005

Use your illusion

I often use musical references here, and I genuinely and sincerely apologize for the Guns-'n'-Roses reference, but it somehow seems appropriate, at least for telcos, in the short term. The past three days have been somewhat unprecedented, at least as far as I can recall, in terms of EuroTelco carnage. On Monday we had a bombshell from Tele2 (first in the sector to report), which demonstrated that it appears to be competing credibly in a number of key markets, but missed market expectations by a significant margin. The share price is down 8.6% in three sessions. Yesterday, TeliaSonera breached the low-end of consensus (EBITDA in Finland fell by over 50% YoY) and got hammered, and today was another world of pain: two day decline - 8.9%. Today, Telenor shocked and awed with the underperformance of its domestic fixed business and margin softness in emerging markets, and the market drove its shares down 9.4%. That's a helluva lot of value wiped off the sector over three days, but only at the mid-cap end of the market.

Tomorrow we have numbers from large-cap name France Telecom, and if it drops a poo-bomb on us, then I really am going to start to think that maybe all these disruptive influences I've been writing about for nearly three years have at last become undeniably evident. One thing France Telecom has going for it is that the company will be reporting based on a radically revamped organizational structure. Yes, the analysts have some pro forma restated historicals to work from, but I am always skeptical when companies change reporting lines (as has repeatedly been the case over the past three years, usually justified on the basis of a "more accurate representation of operations"). I am particularly skeptical when the structural change coincides with significant shifts in market dynamics. My cynical nature leads me to conclude that companies are buying time, but I didn't say that, and you didn't hear it.

We analysts generally like to portray ourselves/be portrayed as "industry experts," and no doubt there are a lot of very bright and talented people out there. I do not seek to denigrate their work. However, when I stand behind a podium and speak frankly to people who work in, live, and breathe this industry on a day-to-day basis, and I come away with a sense that we are living on different planets, I worry even more. Maybe it's I who am deluded, but if it's the case that the misguidedly orthodox views of the industry are filtering down to the analysts through multiple generations of spin (as I think is almost certainly the case), with all the distortion inherent therein, no wonder we see such aggressive share price targets, and accordingly see such massive share price falls when things go wrong.

Periods like the past three days bring me back to recurring conflicts I have had with our sales team from time to time, and the vague sense of incomprehension I sometimes encounter from colleagues covering other sectors. "Surely there must be something you can recommend within the sector?" is a common refrain. "Well, actually maybe not," is my typical reply, and though it concerns me, developments like we have seen over the past three trading sessions only lend support to this view. To my colleague covering utilities I typically say, "Where would power companies be if there emerged a technology for competitors to supply energy at virtually no cost?" To my automotive colleague I say, "What is the value of the auto industry if we crack the secret of teleportation?" These are patently ridiculous propositions for the industries in question, but in a telecoms context are all too relevant, if slightly exaggerated. Maybe a more salient question generally is, "What if your powerful national brand has its face ripped off by global internet players, device makers, and people you've never even heard of?"

I have often made the point to our sales force and clients that traditional telco valuation is a dangerous business in the IP world. We can cling doggedly to comfortable traditional methods, or in a pinch, desperate last-ditch bastions like multiples of net PP&E and other such relics - or we can do the right thing and admit that any valuations we attempt are speculative at best. My feeling is that investor expectations are so low that it only takes one quarter's disappointment to reset expectations to a much lower level, and ultimately this process can be repeated down to near zero. Analysts who might have felt confident in valuing Telenor at NOK 68 - 70 a few weeks back are adjusting to a new reality today, with the share price struggling to hold NOK50. Finding your feet may be increasingly challenging in the world to come, if you have failed to board the ClueTrain. No doubt we're going to see a lot of complicated gymnastics in the quarters ahead, and a lot of smoke and mirrors employed to place a brave face on a fairly grave situation. However, my sense is that the gloves truly are off as of this week, and we may be entering a new phase. For the sake of investors in the sector, and the thousands of people employed in the industry, I hope I'm wrong.

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