Tuesday, August 09, 2005

From the Q2 results front

Spent all of today working through the rather good results from KPN, which surprised everyone (yours truly included) with some subscriber mix improvements and better margins in the mobile division. However, looking at it from the disruptive angle there was a lot of fairly negative stuff to get excited about too. I've got a negative rating on KPN, for many reasons which I've documented exhaustively here in the past. But stepping back from the situation, it certainly is an interesting case study of the pressures facing telecom.

On the one hand, we have here a company which is well on its way to returning over EUR2bn cash to shareholders in the space of a year - that's roughly 12% of its current market value, and it seems to feel confident that it has the headroom to take on bolt-on acquisitions, such as Telfort (a sizeable one) or the 60k DSL subs bought from Tiscali.

On the other hand, we have a management team which seems to have no qualms about speaking frankly on issues of market turmoil and lack of visibility. One great question from the audience today to CEO Ad Scheepbouwer: "Do you think your voice lines could go down by 6 or 8% next year?" "Yes, quite possibly, no one knows." (I'm paraphrasing here.) Another classic question was, "Do you expect the fixed line margin to continue to decline?" "Maybe, but not in huge increments. However, if we begin mass-market migration to VoIP, then we would see a profound effect." Here is a man who is publicly embracing the fact that many of the key value drivers of his core business may have huge swing factors in them, even over the next 12 months. It's an unenviable position to be in, but I like his style.

Looking under the hood, there are some true signs of strain. This quarter KPN began reporting its fixed line results in three segments: Consumer, Business and Wholesale. This affords us a lot more clarity on what's happening in the various segments - and it ain't that pretty. The line loss in the Consumer segment in the quarter, annualized (i.e., multiplied by four), was 5.3%, which is a real step-change from the 2.4% seen a year ago. Also, because we now have the line bases broken out clearly, we can see that the rate in Q1 was 5.1%, and moreover, that there has been a steady acceleration in line loss over the past year. We knew it was happening, but we couldn't see it in such clarity before. The other interesting shift here this quarter was that previously, some of this line loss could have been passed off as ISDN-to-DSL migration; however, this quarter ISDN lines were flat and all the pain came from people ditching their PSTN lines, plain and simple. Business line loss is not as linear as Consumer, but this quarter was sufficiently ugly at 4.3% annualized, and the ARPU number I calculate was down 7% YoY. One other disturbing trend was that the uptake of discount calling packages, both in Consumer and Business, hit a wall this quarter. This is one of the key defensive weapons of the legacy telco, and it's worrying to see previously very strong growth grind to a halt so suddenly before penetration has even hit 30%.

So here we come to the dilemma for everyone who cares about our beloved sector: how long does the cash thrown off by the business continue to allow the kind of payouts seen so far to compensate investors for risk, how quickly does the situation deteriorate from here, and at what point do things really start to go wrong? We can play with spreadsheets and flex assumptions until we're blue in the face, and the analysts tried to do that today verbally, but management weren't willing to show all their cards, if indeed they had even seen them.

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