Debt-ridden VMO2 reports loss and sale of towers stake

Back in the 1990s, the telecom sector was notorious for vendor financing. Equipment vendors like Huawei would effectively lend money to a service provider, which in turn would spend that money on Huawei's products. A bubble took shape as operators splurged on underused networks. Eventually it burst, as is the fate of all inflating bubbles.

Vendor financing might not be the serious problem it was in those days, but it hasn't disappeared. That's evident from the latest earnings report of Virgin Media O2 (VMO2), which booked £2.7 billion (US$3.3 billion) under the vendor-financing category in September this year. For many large companies, it would be a relatively trifling sum on its own. But VMO2's various other debts are huge.

Unsurprisingly, then, it would rather exclude vendor financing from the total when calculating its net debt and the ratio of this to annualized adjusted earnings (before interest, tax, depreciation and amortization). That came to about 3.7 in September, said VMO2 today. But when vendor financing and a few other items were included, VMO2 was looking at a ratio of nearly 5, it conceded in its report. What it calls "total third-party debt and lease obligations" added up to nearly £21.9 billion ($26.6 billion).

Most of Europe's big telcos have, for a long time, reported net-debt-to-EBITDA ratios of between 2 and 3. But as sales growth has dried up, and costs have risen, the pressure on them has grown to reduce their debts. And so a ratio of around 4 or 5, depending on the calculation, is clearly not the best shape to be in when inflation remains high and interest rates are being cranked up.

Job cuts and divestment

Despite a pretty good operational performance for the recent September-ending quarter, VMO2 is also unprofitable. Around this time last year, it enjoyed a £2 billion ($2.4 billion) boost in finance income and managed to report a £677 million ($821 million) net profit. With finance income falling to just £62.5 million ($75.8 million) this time round, and VMO2 racking up £754 million ($914 million) in finance costs, the operator this year instead booked a quarterly net loss of £311.5 million ($377.8 million).

Accordingly, VMO2 is cutting jobs and selling assets. It reportedly plans to cut up to 2,000 jobs altogether, which would represent about one-tenth of the current total. That is an especially gloomy development for telecom-sector workers because other UK-based operators are doing the same.

In May, Philip Jansen, the soon-to-be ex-boss of BT, reckoned his organization could lose up to 55,000 of 130,000 jobs (including contractors) by 2030. Worldwide, Vodafone plans on cutting 11,000 (it reported exactly 98,103 for its last fiscal year). A merger between its UK arm and Three, if approved by regulators, would inevitably result in layoffs.

The VMO2 divestment, announced with results this week, raises £360 million ($437 million) from the sale of a 16.67% stake in Cornerstone, the mobile masts joint venture that VMO2 co-owns with Vodafone's Vantage Towers. It has been snapped up by GLIL Infrastructure, a group of UK pension funds. That lowers VMO2's stake to about 33.3%, although it insists it still has co-control with Vodafone of the important asset, which boasts about 20,000 UK towers.

Mast sales have been all the rage in Europe's telecom sector as operators try to improve their financial health. That trend has given rise to the phenomenon of the "towerco," a company that rents out space for basestations and other electronics on its mobile masts. It has also prompted concern that traditional operators could ultimately lose control of valuable infrastructure. Cellnex, Europe's largest independent towerco, has gone from renting out passive infrastructure to leasing the use of active electronics as well.

What makes UK developments even more interesting is that possible merger between Vodafone and Three, which is currently involved in a similar joint venture with BT called MBNL. Dealmaking could leave a merged Vodafone and Three with stakes in both Cornerstone and MBNL and raise competition concerns. A possible resolution would be Three's withdrawal from MBNL.

Full-fiber diet

Reporting customer growth in both fixed broadband and mobile markets, VMO2 said its quarterly revenues were up 7.2% year-on-year, to roughly £2.77 billion ($3.36 billion). But this improvement was largely thanks to controversial price increases based on a formula also used by other UK telcos. Its adjusted EBITDA also grew 5.6%, to about £1.05 billion ($1.27 billion).

The financial plight of VMO2 is exacerbated by its ongoing investment in network expansion. Overall capital expenditure came to £563 million ($683 million) for the recent quarter, representing about 20% of revenues. But if it spent less VMO2 would risk losing out to BT, which aims to extend fiber to about 25 million properties by 2026 and had already reached more than 11 million by the end of June.

VMO2 is less transparent about coverage. Around 16.7 million homes were "serviceable" in September, it claims, and the figure is a decent improvement on the 16 million it had a year before. Yet most of these properties are connected to aging cable technology. VMO2 insists connection speeds of "up to" 1.1 Gbit/s are available across the entire network. But it evidently thinks cable will not stand the test of time. By 2028, it aims to convert the whole network to fiber. Juggling that with its financing commitments won't be easy.