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S&P Sees Euro Rebound

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News Analysis
Light Reading
4/29/2004

Europe's main incumbent carriers have largely recovered from the financial hell of the telecom downturn and continue to improve, according to the telecom team at ratings agency Standard & Poor’s.

The operators' new management teams have dragged their companies from the debt chasm created by reckless international expansion and a €100 billion splurge on 3G licenses in the late 1990s and the first few years of this decade.

"The old management indulged in an M&A frenzy and didn't take care of their domestic markets," said Guy Deslondes, head of S&P's European telecom and technology team, at a seminar in London today. It was up to the new blood to sort out the 3G mess and withdraw from overseas investments. "I can't think of any [of the investment-grade European incumbents] that didn't change their senior management teams, and that's been a major factor in the turnaround," he told the gathering.

The new head honchos have also slashed capex and successfully improved operating performance, which has led to a growth in free operating cash flow and reduced debts. Deslondes said the aggregate capex of the five largest carriers had been reduced by 42 per cent between 2000 and 2003.

Those measures have resulted in a greater number of positive ratings actions by S&P during the past two years, he added (see Telekom Austria Looks Positive, Deutsche Telekom Gets Credit Kudos, and France Telecom Raised to BBB+).

S&P expects more of the same for this year and next, as cash flows are expected to remain at their current high levels. In 2003, BT Group plc (NYSE: BTY; London: BTA), Deutsche Telekom AG (NYSE: DT), France Telecom SA (NYSE: FTE), KPN Telecom NV (NYSE: KPN), Telecom Italia SpA (NYSE: TI), Telefònica SA, and Vodafone Group plc (NYSE: VOD) generated a total of nearly €43 billion (more than US$55 billion at today's rate) , with Vodafone and Deutsche Telekom contributing nearly half of that total between them.

That cash generation will help the carriers cut their debts further and will not be eaten away by a massive ramp-up in spending, which is unfortunate for the vendors. S&P predicts only a modest increase in capex by the Euro incumbents -- an 8 percent increase in 2004 followed by a 3 percent hike in 2005, with the majority spent on wireless gear as the 3G network rollout gathers pace.

The S&P team sees some merger and acquisition activity that might not damage the carriers' credit ratings. Acquisition was a dirty word this time last year, said Deslondes, but now even shareholders and creditors can see the appeal of some merger activity, particularly cross-border deals for mobile operator assets.

Other credit rating risks include regulatory pressures regarding tariffs and network access. Carriers have consolidated and restructured their finances and will compete aggressively in the voice and broadband markets this year and next. Deslondes noted in particular the growth in local loop unbundling that will help alternative operators pick up market share in the growing DSL markets.

What about VOIP? "It's clearly a long-term threat that will impact traffic levels and prices, but [VOIP] shouldn't be overplayed, as there are reasons for the incumbents to be optimistic," said Deslondes. European incumbents dominate the broadband market, do not face a major challenge from cable operators in the same way the U.S. majors do, and have the financial muscle to adapt their business models and their technology bases.

Of course, VOIP is a "big headache" for the regulators, "but they'll have to make some sort of decision," says Deslondes. "And if they come out with some unexpected decisions, then we'll need to assess the impact on the incumbents' business plans and cashflow potential."

— Ray Le Maistre, International Editor, Boardwatch

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