Crisis-hit European telecom sector needs a reboot

During the summer months, when Europeans work on their global reputation for laziness and unproductivity, the bosses of the continent's big telecom companies retreat to the Amalfi coast or the south of France or perhaps to some opulent, solar-powered log cabin in Scandinavia, where they keep a lidded eye on emails between energetic bouts of water-skiing or similarly vigorous pursuits that befit the health-obsessed, twenty-first-century CEO. But the companies they temporarily leave behind have seen much better days.

After signing just about everyone up to mobile phone and broadband services, telecom operators have reached the end of one growth story without finding another. Prices continue to fall in the region's supercompetitive markets, and regulators are largely hostile to consolidation. National laws force big telco groups such as Vodafone to maintain country-specific systems for tiny markets when a core network for the continent would be far more economical. That stops them from achieving the scale of Chinese or US peers, they complain.

A rush to embrace all-you-can-eat tariffs also means revenues do not grow with usage, even if costs do. It's a problem that extends beyond European shores. "One thing I would say is the telco industry historically has had these all-you-can-eat business models and I think the world is moving more toward consumption-based business models versus all-you-can-eat business models and so we're going to have to adapt," said Jeremy Legg, the chief technology officer of AT&T in the US, at a recent European event.

But adaptation would be hard and risky. Data traffic growth has been slowing, and William Webb, an independent analyst, expects the curve to flatten by 2027. With improvements in video-compression technologies, traffic could even decline in the future, he thinks. Telcos that charge by the gigabyte would be in trouble.

Don't call us utilities

The sense of gloom can be exaggerated. The success of Amazon, Google, Microsoft and their ilk has made the Internet ubiquitous in every walk of life. Telcos, as the gateways to that Internet, have become even more critical than they already were. Average consumers are about as likely to give up telecom services as they are to abandon electricity or gas. That guarantees telcos a steady stream of revenues. Few other companies have such certainty.

Yet a comparison with similarly critical utilities, such as water and energy providers, carries negative connotations for telco bosses along with their shareholders and suppliers. Devoid of growth, many utilities are in poor health and struggle to fund improvements. Telcos, by contrast, have splurged billions on higher-speed network infrastructure and the spectrum to provide services.

In 2022, return on capital employed (ROCE) for European operators fell below the weighted average cost of capital for the first time in years, according to data from the European Telecommunications Network Operators (ETNO) association, a lobby group for the industry. Commenting on that development in a report, Deloitte last year warned of a risk that "the gradual decline in the industry's return on invested capital could soon go into free fall." The core problem it saw was that "overcapacity makes connectivity a commodity," said Deloitte.

All this would seem to bode catastrophe for capacity suppliers such as Ericsson and Nokia. Each year, the Nordic vendors pump about $9.5 billion into research and development. Most of that goes into network technologies, mainly mobile. The payoff comes when telcos rip out old technologies and upgrade to the newest generation, a refresh cycle that has happened roughly once a decade, albeit only for a few generations. There are now multiple signs this upgrade cycle is broken midway through the rollout of 5G.

For starters, the ROCE, overcapacity and traffic developments spotted by Deloitte, Webb and others have coincided with industry-wide cuts to capital expenditure. Spending by Europe's "big five" (Deutsche Telekom, Orange, Telecom Italia, Telefónica and Vodafone) fell from more than $49 billion in 2022 to about $43.1 billion last year, at today's exchange rates. This and a parallel decline in North America, blamed on earlier telco stockpiling, have torn into the revenues of both Ericsson and Nokia, which have responded by slashing thousands of jobs. More cuts are planned.

With the rollout of 5G on pause, while telcos question the reasons to invest, Europe's big telcos show little appetite for 6G, promoted by parts of the industry as a 2030 standard. A paper from the Next Generation Mobile Networks (NGMN) alliance, another group of prominent telcos, said "6G must not inherently trigger a hardware refresh of 5G RAN [radio access network] infrastructure," calling for it to be about "software-based feature upgrades of existing network elements."

'No cyclical uplift'

For vendors that make most of their money from expensive new radios, this was rather like the world's biggest meat eaters telling chefs to serve just the salad garnish in the future. None other than Börje Ekholm, Ericsson's CEO, now seems to realize 6G is in danger, and his company with it. "If we cannot generate the extra revenues from the features of the network, it's very hard to justify the future investments in later generations as well," he said on his company's recent earnings call for the second quarter.

Ericsson and other G stakeholders are desperately trying to monetize 5G by reaching out to software developers. The plan is to use industry-standard application programming interfaces (APIs) to expose 5G features to those developers. If all works out, new applications, impossible without 5G, could become available to any telco. Revenues would surely follow from developers accessing those APIs and 5G customers paying for a quality-of-service boost. Right?

Analysts are unconvinced. In 2022, Ericsson justified its $6 billion takeover of Vonage, a communications platform-as-a-service specialist, as a facilitator of this strategic expansion into network APIs. Since then, it has booked impairment charges against Vonage of nearly $4 billion, prompting one equity analyst to accuse it of "value destruction" on the second-quarter call. Since the Vonage deal was announced in late 2021, Ericsson's share price has fallen 45%.

Analysys Mason, a consulting and analyst company, is seemingly among the skeptical. By the end of the decade, capital intensity (spending as a percentage of sales) will fall to between 12% and 14% for the world's biggest operators from about 20% now, it said in a recent paper. Among its forecasts was the message that there will be "no cyclical uplift" with 6G.

The prognosis is bleak unless telecom experiences some kind of dramatic and unforeseeable reboot. Besides cutting capex, operators are lopping off parts they would once have described as strategically important, including the towers that host mobile network equipment. Telecom Italia has gone as far as divesting its entire fixed-line network, a move that will reduce its headcount by nearly 20,000 employees, to 27,067. In 2012, it had three times as many.

Big Tech retreat

Private equity is advancing into this infrastructure space vacated by telcos just as Big Tech takes responsibility for IT and software systems provided through hyperscaler clouds. Most operators still resist putting their telco as opposed to IT workloads in a public cloud, worried as they are about security, control and the impact on network services. But the bigger danger, perhaps, is that Big Tech cools on telecom.

Microsoft has recently made cutbacks at its Azure for Operators business after struggling to win deals. Chipmaker Intel, whose general-purpose silicon powers most data center servers, last week said it would cut 15% of jobs – a figure that equates to more than 18,000 roles, based on December reports – following a disastrous run of results. Non-core units often suffer during such retrenchment. In Intel's case, that could mean the small telecom unit. It would be a setback for telcos that see general-purpose compute and the cloud as an answer to cost problems.

There is an optimistic take on all this, although maybe not for the average worker. Staff numbers have fallen dramatically at the world's biggest telcos outside Asia in the last decade with the outsourcing of jobs, sale of assets, focus on efficiency and slow creep of automation. In the US, where laying off staff is easier, AT&T finished June with 146,000 employees, down from about 280,000 in 2017. Verizon's headcount has fallen from 155,400 to 103,900 over the same period. In the UK, BT thinks it can finish the decade with between 75,000 and 90,000 workers, compared with 130,000 last year.

Such drastic cuts, combined with plummeting capital intensity, could theoretically boost profitability to well above today's levels. But with neither sales growth nor consolidation, the intense rivalry so characteristic of the European industry could fast erode those gains. And if the network upgrade cycle lengthens from ten years to 15 or even 20, as several analysts have surmised, the region's kit vendors will be hobbled. For some of those waterskiing CEOs, it's a frightening thought.