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Monday, 4 May 2015

CEO of Dutch telecom company KPN Eelco Blok expects a big shakeout at the European telco market within a few years. KPN is unlikely to survive this shakeout as an independent company.

Last weekend, the Dutch financial/economic newspaper Het Financieele Dagblad published an interview with the CEO of Dutch telecom company KPN, Eelco Blok. This became a very interesting interview about the future of the Dutch and European telecom industry.

By itself, the statements of Blok were not very surprising in nature. 

For the well-informed reader, they were rather a confirmation of the already started developments and trends in this industry, which stands clearly at the brink of strategic turnarounds and dramatically changed roadmaps for the future.

Nevertheless, it was good to read that the CEO of KPN had abandoned for good the flawed strategy of his predecessor Ad Scheepbouwer. Instead, Blok sketched a down-to-earth impression, with respect to the future chances of KPN. On top of that he had sensible ideas about the necessary investments in infrastructure, where his predecessor was mainly busy building a party for himself and his shareholders.

Here are the pertinent snips of this interview, which was held by Job Woudt and Jeroen Segenhout of the FD newspaper:

Blok: […] We have become a company which fully focuses on the Dutch market. We will deliver integrated services to our customers (i.e. telephone, television and internet in one service). You can only survive when you are able to do just that. You have to pamper your customers, by offering them excellent quality and service. We are doing that right now and made large steps in that process. In my humble opinion, this is the future of telecom providers in Europe.

I am absolutely convinced that there will be a new wave of mergers and acquisitions within this industry. We made an important first step by selling our subsidiary E-Plus to the Spanish company Telefónica. And now there is BT (i.e. British Telecom), which purchases EE from Deutsche Telekom and France Télécom. The next step will be that telecom companies find each other in cross-border contacts. Having the right scale, is definitely an important prerequisite in this industry in the near future.

Question: This consolidation wave has already been predicted for a number of years. Yet, the European telecom market is still a patchwork of relatively small companies.

Blok: When you compare Europe to for instance the United States, China and India, you will understand that the situation here is not tenable in the long run. Size does matter! Look at China, where China Mobile alone has 850 million customers!

Question: Are you not afraid that the industry gets into a new cycle, in which enormous debts are made for the purpose of expansion?

Blok: Are you referring to Altice? I wonder if that company chose for a viable business model. I am convinced that you have to invest sufficiently in your infrastructure, product portfolio, services and in your customers. Only by doing so, you will earn enough money in the long run to participate in the next wave of developments. The question is, however, whether that is really the business model of Altice or not.

Question: What is there to win for KPN in this new wave of mergers and acquisitions?

Blok: At short notice? Very little indeed! Our prospects look excellent; our balance sheet is rock-solid. When we look at the next few years, we don’t need a partner at all to persevere in following our roadmap for the future.

Question: Will KPN become a part of a bigger group?

Blok: In time, this is a logical consequence of the developments in the telecom industry. Nevertheless, this will happen from a position of strenght. And not from the weak position that we had just two or three years ago. In those days, our balance was weak and our achievements were below par. You can tell that. Now that situation has turned around completely.  

Question:: In five years, will there still be four players at the Dutch market with their own network?

Blok: No, I don’t think so. It is really unthinkable that you can make a decent profit on our domestic market, as a fourth player. It is already a drag to be the third player. You can see this today. 

Two years ago, Tele2 acquired a permit to deploy a 4G mobile network in The Netherlands at a really low price. Nevertheless, they are still struggling with the question how they should deploy that very network and how they can manage this commercially.

Fixed, analogue telephony is dead. When I look at The Netherlands and beyond, it is broadband, voice over IP- services all the way; both for the fixed and mobile networks. 

Look for instance at the available subscription forms nowadays: you take a 5 GB subscription for data and telephony and you will find that a large amount of SMS’s  and fixed telephony are enclosed in the deal. For us it does not matter anymore, whether you call through our network or by using Whatsapp Voice (i.e. part of Facebook).

Blok is right about a lot of things in this interview and I agree with most of his answers.

Classic mobile and fixed telecommunication – as we used to know it – seem as good as dead and so are old-fashioned "cash cow" services, like mobile phone calls and SMS messages. It won’t take very long until the “mother of all cash cows” roaming (i.e. calling and SMS’ing outside the territory of your telecom provider) will be gone too, under pressure of increasingly strict EU regulation against overpricing of services.

This means that broadband internet – both at home and in mobile form – will be more and more seen as simple utilities by the customers, like gas and electricity are. 

For mobile devices this utility approach means that a smartphone works everywhere, with all (free) internet services available and at the highest speeds possible. So simple is that. Although the possible speed of 5G mobile internet seems yet a shining spot on the horizon for avid downloaders, the moment is nigh that additional speed does not matter anymore for the average mobile phone and laptop user. Their service just has to work 24*7*52 without glitches and problems.

At home, this utility approach means that the service provider delivers ‘no thrills’ services like digital television, telephony and internet at one mouseclick. 
Every attempt to make such products more exciting will be in vain, I guess. 
In the near future, the customer will only pay a fixed subscription fee for a certain set of services at his home. Telephony, internet and television will be products with a fixed monthly price and free of surcharges for extra usage.

Outside, on the other hand, the customer only wants to pay for that quantity of bandwidth that he used during the previous month or quarter: no bundles, no tricks with data limits, no specially priced (read: expensive) services and no excess prices for out-of-bounds usage or roaming services. Just simple bandwidth.

The massive investments that it takes to uphold such utility-like services at a near 100% uptime level and at the highest possible speeds, can only be borne by very large and financially healthy, multinational conglomerates; especially as the excess cash flows from all “specials”  (SMS, roaming) will slowly evaporate during the next few years.

I expect that on the integral European market only 5 to 10 players (rather 5) will be able to survive this shakeout. The other suppliers will either disappear or will be taken over by one of their larger competitors. 

With an almost 100% certainty, KPN will not be among these 5 survivors as an independent telecom provider. The reason is that its territory and its customer base are just too small to compete with giants like British Telecom, Deutsche Telekom or Telefónica.

This means that KPN must continue its operations as efficiently, effective and customer-friendly as possible, until a large company with a big wallet drops by to take over the company for a fair price. Then the shareholders can receive the reward for their patience and confidence.

After Ad Scheepbouwer, who brought KPN at the brink of defaulting, it seems that Eelco Blok is the right man at the right place for KPN. I only disliked his side hit against Tele2 with respect to the future chances for survival, as the fourth telecom supplier in the Dutch market (see red and bold text).

As a former temporary employee of Tele2, I know that KPN not always made it easy for its competitors to deploy their own networks, to say the least. Especially in cases when these competitors had to use parts of the national telecom infrastructure, which are managed by former stateowned company KPN. 

One could say that KPN sometimes operated as a disappointed and envious monopolist in a post-monopoly world, trying to defend everything that they still had in hands.

Nevertheless, Blok’s strategic views seem spot-on.

However, I am not so convinced about the strenght of the balance sheet and the profit and losses of KPN, as Blok himself seems to be.

Profits and Losses statement of KPN
Data courtesey of :
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With €8 billion in revenues, the sales part is looking good, only slightly less than the €8.4 billion in revenues of 2013, as a consequence of discontinued operations (Base and E-Plus). With the operational costs being €600 million lower than in 2013, it seems that KPN became more cost-efficient than in the previous years.

However, the finance costs became substantially higher in 2014: €871 million, against €754 million in 2013.  And as a consequence of substantial losses on discontinued operations, there was still a loss of €584 million for 2014.

Balance Sheet (Assets) of KPN
Data courtesey of :
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Balance Sheet (Liabilities) of KPN
Data courtesey of :
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In the article, Blok stated that the solvability of KPN had improved, in comparison with 2013. That is true, but this is especially caused by an increase in the intangible assets; in particular for goodwill. 

Goodwill is a dangerous asset in my opinion, as it does not have a "fair value" and its value is only in the eye of the beholder: in this case KPN. So, when we take a look at the solvability, based on the tangible assets alone, the solvability actually declined: to 105% from 108% (see the following table).

Solvability of KPN
Table created by: Ernst's Economy
Data courtesey of :
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And with an increase of €2.6 billion (€2.713 million from €20 million (!)), the number of financial assets-available-for-sale of KPN soared. These are the 20.5% of the shares in Telefónica Deutschland that KPN received for selling E-Plus to Telefónica. Although these share represent a certain value indeed, their value is dependent on the achievements of Telefónica in Germany. 

KPN does not have a strategic voice in this company, according to the annual report, and has therefore almost the same influence as a normal, common shareholder. So it seems that the balance of KPN has not really improved so dramatically as Blok stated in the aforementioned interview.

Cash Flow statement of KPN
Data courtesey of :
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I am also not very satisfied about the development of the operational cash flow for KPN. In 2014, the net cash flow coming from operational activies was almost cut in half: to 1,554 million from €2,863 million. And also the influx of net cash and cash equivalents deteriorated since 2013: to €1,976 million from €3,946 in 2013.

The development in the latter is caused by a €4 billion payback of loans and derivatives, which took place in 2014: probably a one-off.  This is the reason that this figure may improve considerably during the coming years.

Nevertheless, this cash flow overview paints a mixed picture. Although it might be a good choice of the company to sell its subsidiaries E-Plus and Base, it is certain that the company will now miss a substantial part of its earlier cash flows. Big advantage, however, is that this divestment reduces the necessary reserves for future investments, which is not bad for such a capital-intensive company as a telecom provider. Still, the chances are quite dim that KPN will survive the big shake-out as an independent company. 

Therefore I believe that the strategy of Eelco Blok to turn KPN into a smaller, but healthy and well-financed company, is the right one for a company, that will undoubtedly get ‘for sale’ in a number of years.

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