#5 – A new category of operator owners arise with focus on sustainable cash generation rather than revenue growth

It has taken half a decade to get here, but with Europe on the doorstep of the next generation of mobile communications, we believe regulators’ arguments for sustaining four-player mobile markets in the interest of consumers have finally become too weak. Consolidation is a must in order to create sustainable operators with capital available to invest in technologies that may benefit consumers more than even lower prices would. Besides the wave of telco mergers that would be resurrected due to this development, one of the consequences would in our view be the increasing presence of a new category of owners. These owners value a stable business environment and the sustainable cash generation of operators much more than any hopes of significant revenue growth from digital services. Not usually ones to be late to the party, we also see financial investors such as private equity funds picking up targets of a suitable size with the intention of separating the network operating business from the customer facing, and selling to a more long-term investor in due time.

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One of the beliefs that Northstream has long argued for is that a more liberal approach to in-market consolidation by European regulators would be the key to create a long-term sustainable market environment, where operators continue to be willing and able to invest in future mobile communications technologies. Due to the fragmented market, low ARPU (compared to other developed markets in North America and Asia), and high debt levels, we see a risk that by having regulators solely focus on ensuring high competition and low prices for European consumers, the price we may all have to pay in the long run could be that Europe ends up far behind leading regions in the usage and benefits of future mobile communications technologies.

It is well established that our view has not been shared by the European Commission, who since the appointment of the current Commissioner for Competition, Margrethe Vestager, has until very recently blocked every single attempt of an in-market 4-to-3 merger, or demanded severe concessions. We have also noted recent developments in Belgium and Germany, where regulators are considering using the upcoming auctions of 5G spectrum to open up for a new mobile entrant, effectively executing a reverse 3-to-4 play. We firmly believe that in most markets, the position of the #4 operator (either the existing one or a new entrant from concessions or acquired spectrum) is unprofitable, as customers need to be won over from competitors, typically with non-sustainable price offers, and one will always run a subscale operation compared to the competitors. Hence, consolidation should not be a question of if, but when.

A possible trigger is the fact that the merger of the #3 and #4 players in the Netherlands was recently approved without concessions by the European Commission. It remains to be seen whether this in fact marks a step change in regulators’ view of in-market consolidation, something that would set off a wave of similar transactions in other European countries, no doubt to both operators’ and investment bankers’ delight. The alternative and devastating scenario is that this was an exception that was allowed purely due to the limited market impact of these smaller players, and that larger transactions in other countries will face a continued demand of concessions which effectively rule out most of the benefits. Regardless of what the future holds in this matter, we expect the pressure on the EC to continue increasing as commercial 5G becomes a reality in other regions, and that it will loosen its grip on the 4-player mobile markets.

Assuming this happens sooner rather than later, a next step is to think about what other changes the consolidations could lead to. One trend we have been observing is a new category of owners approaching operator businesses; one that prioritizes stable long-term cash generation over growth, and treats the business much like a classic infrastructure or utilities investment. The most apparent example is right next to us in Denmark, where the incumbent TDC in 2018 was bought out off the stock market by a consortium of pension funds and an international infrastructure fund.

The consortium aims to separate the network operating business from the customer-facing business and make the network open for use by all telecommunications brands and retailers. In short, it appears the priority of the new owners lies with the network operation and ensuring maximum utilization and return on the physical assets, while the future of the customer-facing business driving the service innovation is less known.

We see this as a sign of the times – as mobile communications is no longer a growing industry in terms of revenue, operators have a less natural place in the public stock markets, where they will be subject to short-term volatility and under constant pressure of cost cutting. Instead, long-term investors such as pension and infrastructure funds will consider taking them private, spurred on by new hopes on consolidation and a presumed increased ability to invest in the communications networks for the next decade to come (providing the highly coveted stable returns at low risk in the process). We also see a possibility of increased presence of more short-term financial investors, such as private equity, activist and buy-out funds, trying to get ahead of the general trend by acquiring suitable targets and executing the spinoff of the network operations themselves. These investors are not completely new to the mobile industry, but the change we see is that the investments are not made in #3-4 operators with an aggressive growth agenda, but rather in the #1-2 players that have the most extensive infrastructure and can be the primary beneficiaries of a consolidation trend. This will likely happen first in small to midsize markets where the leading players are not part of a group operation. And then the rest will follow suit…

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