Europe's Long Walk to 5G

Iain Morris
Prime Reading
Iain Morris, International Editor
7/11/2019



Visitors to the UK, lapping up cheap beer and pub grub while its currency plummets, can also witness some of the slowest 5G connections in the world. For anyone cash-rich enough to buy an early 5G smartphone, and station themselves near one of the few mobile sites providing 5G coverage, speeds max out at 569 Mbit/s, according to data from OpenSignal.

That might sound impressive, but it's less than 5G customers can expect in the US, Switzerland, South Korea, Australia, the UAE, Italy and Spain. It is, at least, some 128 Mbit/s faster than maximum 4G speeds -- unlike in Australia, where the top 5G speed is 158 Mbit/s slower than the zippiest 4G connection. But when the "old" tech can deliver as much as 950 Mbit/s, who needs 5G anyway? (At least for faster mobile broadband...)

Discounting Switzerland (so often Europe's outlier), European countries fare poorly in OpenSignal's comparison of 5G speeds. But speed is only a part of the story. While US and Asian operators work on extending their 5G reach, many European countries have yet to introduce a commercial service. And in some that have rushed 5G to market, rollout could be a long and painful business. Operators spend years deploying any new network technology. The worry is that 5G rollout will take even longer than usual.

This matters for two reasons. The first is that 5G could turn out to be far more economically important than it might currently appear. If those, ahem, lightning-fast connections give rise to new services, developers will probably flock to the countries with the best 5G infrastructure. One might turn out to be the next Google, and Europe could do with a digital giant of its own. New services might also boost industrial productivity (factory automation is a focus area). Should Europe lag the US and China, its companies might struggle to compete on a global stage.

The second reason is that a long walk to nationwide 5G could exacerbate the "digital divide" -- the gulf between the digital haves and have-nots -- in individual countries. For governments trying to reinvigorate deprived areas and stop rural communities sliding into economic irrelevance, this long walk looks awkward. It also comes amid a surge in populism, fueled by a growing wealth gap between rich and poor and a sense that established elites have ignored the concerns of ordinary people. Operators that have chosen to focus their early 5G efforts on places like London's Canary Wharf, where Oxbridge-educated lawyers sip grande soy caramel frappuccinos opposite pinstriped bankers, could provoke further discontent.

Europe's 'Live' 5G Networks

Source: Operators, regulators, various news outlets, Light Reading.
Source: Operators, regulators, various news outlets, Light Reading.

The spectrum squeeze
But why is Europe struggling to get its 5G act together? In countries yet to launch 5G, it is often because new spectrum has still not been made available by government authorities. Most countries in eastern Europe fall into this category, but France does, too. In markets such as the UK, meanwhile, operators are being spoon-fed new 5G spectrum in successive auctions, as if the government is worried about the dangers of an overdose.

The effect is twofold: fragmentation -- a kind of digital divide across the European region -- as different countries fall out of sync; and higher costs. By restricting the amount of spectrum sold at any one time, authorities have driven up prices, say critics, as operators fight over scraps. Toss a thin slice of meat into a pit of hungry predators and see what happens.

Operators that have fought hard for their 5G concessions are now mewling in pain. After spending nearly €2.2 billion ($2.5 billion) on new 5G spectrum, Deutsche Telekom said the money could have been used to build approximately 50,000 mobile sites instead. It soft-launched a 5G service in Berlin and Bonn this month but does not expect to have more than 300 5G antennas in operation by the end of the year. Across Germany, Deutsche Telekom currently maintains about 28,000 mobile sites.

Opponents are unsympathetic. Operators always bleat about regulatory unfairness, and yet competition forces them to invest, they say. Another argument is that operators would simply pocket the money, if spectrum were given away, and not use it for network rollout. Many shareholders with an eye on short-term dividend payments would undoubtedly approve. France's Orange, one of Europe's biggest operators, is understood to have encountered shareholder resistance to its splurge on all-fiber networks in recent years.

Regulators have an alternative, though. In the "beauty contests" favored by the likes of Ericsson, a Swedish mobile network equipment maker hoping to profit from 5G network spending, authorities have substituted stringent coverage obligations for high spectrum fees. Fail to meet these and you could lose your license, is the ultimate threat.

Germany, however, plumped for both high fees and stringent obligations. Its auction design was clearly intended to maximize returns, according to Ericsson. "There were about 450 rounds and after 100 rounds, with the price at €2 billion [$2.3 billion], the allocation of spectrum didn't change," says Gabriel Solomon, Ericsson's head of European government affairs. The eventual proceeds were roughly €6.5 billion ($7.3 billion). At the same time, license winners are supposed to hit a 98% coverage target by 2022. Outraged operators took legal action against those rules and were rebuffed by the Cologne Administrative Court in March. That seems unlikely to be the end of the dispute.

Price per MHz Pop ($) for 3.4-3.8GHz Spectrum
Source: Regulators, operators, Light Reading.
Source: Regulators, operators, Light Reading.

Elsewhere, authorities seem to have prioritized a short-term windfall over long-term 5G benefits. In Italy, the other European country whose 5G auction proceeds well exceeded forecasts, the coverage obligations attached to the critical "midband" spectrum do not seem very onerous. According to a presentation given last year by Mauro Martino, the head of the spectrum office for Italian regulator Agcom, operators are required to cover a relatively small percentage of Italian municipalities, and some rules do not apply to licensees with less than 80MHz of spectrum. That would seem to excuse Wind Tre and Iliad, but not Telecom Italia and Vodafone.

In any case, Telecom Italia aims to provide a 5G service to just 22% of the population by 2021. Operators in other countries have been far cagier about rollout targets, preferring to identify cities where 5G will show up. "We've said 25 cities by the end of 2019, but there is not necessarily blanket coverage -- it is a presence," says Mike Eales, the head of network services strategy and architecture for Three, the smallest of the UK's four mobile network operators.

A few other details have slipped out, though. BT, the UK's biggest operator, wants 5G at 2,000 of its 19,000 mobile sites by May next year. Deutsche Telekom, before its costly spectrum outlay, said it would cover 99% of Germany's population by the end of 2025. Swisscom, remarkably, is targeting 90% coverage by the end of this year, even though a government requirement is for only 50% of people by 2024. Its hope, perhaps, is that authorities will relax legislation on radiation limits -- which could hinder 5G services -- if it shows it is a good citizen.

Next page: Balancing the books



Balancing the books
But something will have to give. Excluding its large US business, Deutsche Telekom's capital intensity (capital expenditure as a percentage of revenues) has soared from 14% in 2013 to about 20% last year. Orange's has risen from 14% to 18% over the same period. Telecom Italia's domestic business has seen the most dramatic increase, with capital intensity rocketing from 18% in 2013 to a possibly record-breaking 37% in 2018, including fees for spectrum licenses. Those figures cannot rise interminably.

What makes them harder to stomach is the lack of any immediate sales opportunity for telcos building 5G networks. If mobile telecom history is a reliable guide, customers are unlikely to pay more for a 5G service than they do for a 4G one. And there is little scope for pricing innovation. The UK's Vodafone hopes charging for different connection speeds and unlimited usage will draw consumers away from plans based on monthly data caps. But if its move proves popular, rivals will eventually respond. Its competitive, SIM-only rates have already sparked concern about a "race to the bottom," says James Crawshaw, a senior analyst with Heavy Reading.

Table 1: Capital Intensity in Europe (€B)

2013 2014 2015 2016 2017 2018
DT non-US capex 5.9 6.2 6.6 6.8 7.5 7.8
DT non-US revenues 41.6 40.3 40.3 39.4 39.2 39.1
DT non-US capital intensity 14% 16% 16% 17% 19% 20%
Orange capex 5.6 5.6 6.5 7.0 7.2 7.4
Orange revenues 41.0 39.4 40.2 40.9 41.1 41.4
Orange capital intensity 14% 14% 16% 17% 17% 18%
Telecom Italia (domestic) capex 3.0 2.8 3.9 3.7 4.6 5.6
Telecom Italia (domestic) revenues 16.4 15.3 15.0 15.0 15.4 15.2
Telecom Italia (domestic) capital intensity 18% 18% 26% 25% 30% 37%
Source: Operators.

Trying to justify the move to reporters at the 5G launch, Vodafone executives said profits would accrue partly from the "spectral efficiency" of 5G compared with 4G. The basic argument is that sending one data bit over a 5G network is much cheaper than transporting it on 4G. But the difference is a point of contention. 5G costs four to five times less, said Scott Petty, Vodafone UK's chief technology officer (CTO), during the 5G press conference. At the end of 2017, Johan Wibergh, Vodafone Group's CTO, reckoned it would be ten times cheaper.

Whatever the actual figure, investors do not seem convinced that fatter profit margins lie ahead. Vodafone's share price gained 2% on the day of the 5G launch but has lost 15% of its value this year. Rival BT, which also recently introduced 5G services, is down a fifth over the same period.

Skepticism that spectral efficiency will boost earnings seems warranted. Operating costs are unlikely to budge significantly without staff reductions or other measures to cut overheads, such as the sale of real estate. The 4G standard was similarly touted as a more cost-efficient technology than its 3G predecessor, and yet the margin for earnings (before interest, tax, depreciation and amortization) at Vodafone Group has risen just two percentage points in the 4G era, from 29.9% in the fiscal year before Vodafone UK's 4G launch to 31.9% in the most recent one. Spectrally efficient technology seems like a mechanism for coping with a spike in data traffic rather than a route to bigger profits.

"5G doesn't change the overall cost structure for an operator to run the network," says Bengt Nordström, the CEO of Northstream, a consulting company. "It significantly reduces the cost of introducing higher data speeds and adding more capacity. But if operators want to increase profitability it is going to be through their digital transformation programs."

The debt profile of some large European operators makes all this a bigger worry for investors. Telecom Italia's net debt last year was equal to about 3.3 times its earnings, a high level by comparison with most peers. With a ratio of 2.65, Deutsche Telekom is skirting a comfort-zone limit of 2.75. "Our numbers don't indicate that we're going to leave the corridor … but there is going to be very little wiggle room," said Timotheus Höttges, the German operator's CEO, during its last earnings call.

Squeezed
Deutsche Telekom's Timotheus Hottges says his company's balance sheet gives it little 'wiggle room.'
Deutsche Telekom's Timotheus Höttges says his company's balance sheet gives it little "wiggle room."

All together now
What Europe desperately needs is more consolidation, according to some analysts. The US, a market of 330 million people, has four big mobile operators, and that number could fall to three if T-Mobile eventually merges with Sprint. In China, three operators serve a population of 1.4 billion. With about 510 million people, the European Union (EU) is home to several big telco groups -- including Deutsche Telekom, Orange, Vodafone and Spain's Telefónica -- as well as numerous sub-scale operators that compete alongside the giants. Many of the small players struggle, says Ericsson's Solomon. "The fixed cost base is similar to an operator with larger market share and it is much harder to sustain and generate returns," he says.

In this worldview, everyone is worse off as incumbents settle for a smaller market share and competition drives down prices. Solomon thinks an operator needs an EBITDA margin of 38% to achieve "optimal levels of investment" and says the European average is much lower. Vodafone's adjusted EBITDA margin was 31.6% across its European markets last year. Deutsche Telekom's was 30.8% after adjustment for special factors.


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Unfortunately, for the investor community, European regulators have continued to oppose merger activity, arguing it would lead to price inflation and hurt consumers. In the less competitive US market, customers have tended to pay much higher rates for telecom services, note fans of the European approach. Yet this means European operators face spending constraints, according to Nordström. "The biggest challenge for Europe compared with the US is that our revenues per user are much lower, and so our starting point is that we have less money to spend if you break it down to investment per user," he says. "That is fueled by resistance to consolidate markets in Europe."

When regulators did allow Hutchison and Orange to merge their Austrian operations in 2012, the deal led to a 20-30% improvement in network coverage and higher connection speeds, according to analysis carried out by the GSM Association, a lobby group for the mobile industry.

As the EU selects new leaders -- to the annoyance of critics who see it as an undemocratic and byzantine institution -- the telecom industry is waiting to see if a more investor-friendly regime will emerge. But a more relaxed attitude toward in-country takeover activity would not solve the problem of European fragmentation or aid the development of a cross-border market for telecom services. Even Deutsche Telekom's efforts to build a single network across multiple European countries have been somewhat frustrated by national regulators' demands for local data facilities -- to prevent information from being stored in another European jurisdiction.

Those objections will not easily be addressed in today's political climate. For populists throughout the region, the EU is an unaccountable, Kafkaesque monster that has stripped nation states of their rightful sovereignty. UK voters chose to leave the EU during a referendum in 2016 (triggering the currency devaluation that explains why beer and food are now relatively cheap for European visitors). With or without a deal, that "Brexit" is due to happen in October. And it could spur demands for referendums in other member states.

The arguments for and against more European integration will rumble on. But as China and the US flex their 5G muscles, it is hard to find anyone in the industry who doubts the need for a new approach. "Thinking about connectivity as the bedrock for a new industrial strategy is vital, and I don't see the EU doing that right now," says Solomon. "If we remain fragmented, other superpowers will accelerate forward into the digital domain."

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— Iain Morris, International Editor, Light Reading

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