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Tuesday, 24 January 2012

KPN shows disappointing figures for 2011Q4 and 2011Y. Dutch telecom behemoth struggles with its earnings model in the smart-phone market and with diminished results in fixed telecom and the corporate market.


Today, the Dutch Telecom giant KPN presented its Q4 and annual figures for 2011. As already could be expected from the earlier profit warnings last year, the figures were clearly disappointing. Nevertheless, the company still makes a healthy profit of more than €1.7 bln (before taxes) in 2011.

First, I show the pertinent snips of the official KPN press release, combined with the most important annual results. Afterwards I print a translation of an interview of the Dutch financial newspaper Het Financieele Dagblad (www.fd.nl) with chairman Eelco Blok of KPN

Annual results KPN (Press release English) (Direct link to the PDF-file)

Highlights
·         Financial results in line with full-year outlook
·         The Netherlands overall performance not meeting our expectations
·         Positive trends in IPTV [internet television – EL] and Fibre to the Home [internet, telephone and television services through glass fibre- EL]
·         Continued strong performances in Germany and Belgium
·         Outlook 2012 lower, reflecting transition year

Message from the CEO, Eelco Blok
"In 2011, we have achieved our Group outlook. We have seen positive trends in IPTV and FttH [Fibre to the Home – EL] and our international businesses continued showing strong underlying profitable growth. However, some aspects in the performance of The Netherlands did not meet our expectations.

In order to strengthen our domestic businesses in response to the challenges they face from the changing external environment, we will further expand and accelerate our investment strategy beyond the measures we announced in May 2011. This means 2012 will be a year of transition in The Netherlands, as we aim to bottom-out our broadband market share and to stabilize our market share in Consumer wireless.

The investment strategy will ensure a sustainable level of profit for The Netherlands going forward, combined with a focus on quality and simplification to drive customer satisfaction and reputation. In 2012 we will continue to balance revenue growth and EBITDA margins of our international businesses and keep investing in mobile network roll-out in Germany and Belgium. Group profits and cash flow will be lower in 2012 while The Netherlands is in transition, which is reflected in the 2012 Group outlook.

Furthermore, the overall macro environment is unsettled. At such a time, we must strike the right balance between investments, including possible strategic investments (e.g. spectrum and fiber), shareholder remuneration and a prudent financing policy. I have full confidence that KPN will come out of this transition year a stronger company."

Here are the most important data taken from the annual results in figures (link points to file in XLS-format):

Revenues

Consolidated revenue overview
All data courtesy of KPN (www.kpn.com)
Click to enlarge
Although Belgium and Germany showed some improvement in Q4, the overall revenues over the year 2011 are in two words: mostly disappointing. The international mobile phone business showed disappointing results with lower sales in Germany and Belgium. 

The fact that International Mobile in the end still shows increased revenue, is probably due to eliminations in the rest of the world. These eliminations improve the overall negative picture, but are probably one-off. The core business did disappoint, however.

The consumer market decreased by 5%, probably due to diminished fixed phone usage (cheap per minute of calling, but expensive for fixed costs) and the usage of free apps on the smart-phone. The decreasing results on business and wholesale show that companies are also busy diminishing the costs of phone usage one way or another.

I’ve written a number of articles on the changing business model in the Telecom market. This article explains largely the disappoint revenues that KPN reports today.

In my opinion fixed internet and mobile internet will become normal utilities in the near future, just like electricity is a normal utility. You don’t think about it, you don’t compare it often with the offers of other providers (maybe only once a year when the contract expires)… It just needs to be there, when you plug it in; at the highest quality and against the lowest possible price.

Currently, there are lots of tricks and stunts that telecom providers pull to keep customers under contract, while paying lots of money:
·         exclusive phone contracts (Apple(!)) with high subscription and usage fees;
·         cheap or free smartphones (non-Apple) with high subscription and usage fees;
·         opaque contracts and subscription forms that are impossible to comprehend for normal citizens;
·         contract-limits for data usage;
·         very expensive data usage beyond the contract-limits;
·         pinched-off access to free apps that substitute dearly paid telecom services;

I think this business model will disappear to be replaced with a business model that treats fixed and mobile internet as a utility. The customer buys a phone and pays a very limited fee per month for internet bandwidth. All ´classic´ telephone actions (calling, SMS-ing) will go via IP connections, as there is no need anymore to use the classic digital voice or data connections.

Now, there are still big differences in quality between the individual telecom providers (especially where it concerns countrywide coverage). I think these differences will disappear soon as all providers are reaching the maximum coverage and maximum possible speeds in ADSL (twisted copper), cable (coax copper), glass-fiber and wireless connections.

Profits and Losses
Consolidated P&L
All data courtesy of KPN (www.kpn.com)
Click to enlarge
You could say that in 2011 KPN lost almost €600 mln in profit before taxes, when compared to 2010 and then you are right.

But you can also say that KPN still earned €1.7 bln before taxes in 2011 and then you are also right. In my opinion, this table shows that the telecom business is still extremely lucrative for KPN, with a net margin of 11.7% in 2011. Compared to last year’s net margin of 13.4%, however, there is a considerable loss of 1.7% in margin.

Balance sheet

Consolidated balance sheet
All data courtesy of KPN (www.kpn.com)
Click to enlarge
There are two remarks that I want to make on this balance sheet:
·         In my opinion, KPN is extremely leveraged for a non-bank company: 7.64 times
·         More than one-third of the assets exists of goodwill, licenses and software. I can understand that these kinds of intangible assets are common at a telecom company, but I think that the combination of little tangible assets with the highly leveraged equity is quite dangerous, when you look at corporate risk.

The Dutch financial newspaper Het Financieele Dagblad printed today an interview with CEO Eelco Blok, who had a very tough rookie year as CEO in 2011. Here are some snippets of this interview:


This Tuesday, 24 January 2012, the CEO of KPN Eelco Blok came with a tough message for its shareholders. The profit and cashflow will diminish strongly in 2012 and the company will not buy back its own stock anymore.

`The free cashflow will possibly diminish with 30% in 2012. How is that possible? Last year (2011), we had a one-off benefit of €250 mln, which we won’t have in 2012. On top of that there are additional investments, for mobile telephony in Germany and glass-fiber in The Netherlands. Due to pressure on prices, the profitability of the business market is simply diminishing. And then there is the mobile market where we are losing market-share. We expect that the market will bottom-out this year.´

´And how do we explain to our shareholders that we stopped with our buy-back program for shares? Our shareholders saw the €1 bln buy-back program as a privilege. But we decided to invest in our company. You can only spend a euro once. I wish it would be different. And we are here to serve all our stakeholders´

Looking at the increased leverage of KPN in 2011 and the increased risk that is the result of it, I think that Eelco Blok´s decision to stop with buying back shares, is a wise one. A utility company like KPN should not gamble with leveraged money.

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