Telco mergers could put end to harmful phone subsidies

Mobile phones subsidies are a thorn in the side of European telecom operators because they result in lower margins and increased revenue volatility, says Fitch Ratings. As much as companies would like to end handset subsidies, fierce competition in some European markets prevents individual operators from acting unilaterally.



Mobile phones subsidies are a thorn in the side of European telecom operators because they result in lower margins and increased revenue volatility, says Fitch Ratings. As much as companies would like to end handset subsidies, fierce competition in some European markets prevents individual operators from acting unilaterally.


Conventional wisdom says operators have to offer subsidies to retain their customers and increase smartphone penetration, as this will in turn increase revenue through greater data use. However, Europe’s only smartphone penetration rates of greater than 50% of the population are in the Nordic markets – and these have moved away from subsidizing the latest technologies.


The high subsidies offered – which can account for as much as 15% of revenues – among competing rivals in fragmented markets are probably unsustainable in the medium term because of the drag on operating margins. So we would expect to see operators kick their addictions to subsidies and focus on price and network quality if mergers between operators in the same country were to happen. Evidence for this again comes from Scandinavia where the two large regional mobile operators, Telenor (Fornebu, Norway) and TeliaSonera (Stockholm, Sweden), dominate. Both players have actively sought to cut subsidies as well as having some of the most technologically advanced networks in Europe.


Meanwhile, the more competitive and fragmented markets, such as France, Germany or the UK, continue to push on with destructive subsidies and this has cut margins down to the low 30% range. In contrast, operators in Italy and Russia do not subsidize their phones at all and they have higher margins of around 40% and above.


France has the worst short-term outlook of the major European mobile phone markets when macro-economic factors are disregarded. The operators have traditionally offered high subsidies, but only about a third of the population has smartphones and the recent entry of a fourth competitor means tariffs have fallen by 20%.


Without consolidation, margins in countries like France will drop to levels that could start to affect operators’ credit profiles. However even in France we would consider a strategically sensible merger between third-placed Bouygues Telecom (Paris) and the fourth-placed new entrant Iliad Telecom (Paris) to be difficult to achieve in practice. This is due to likely differences of opinion over valuation multiples and/or possible regulatory and anti-trust issues over consolidation, given that Illiad has just received the fourth operator license. These sorts of domestic issues are prevalent across much of Europe and will likely slow the pace of consolidation.


Even in countries where subsidies have increased smartphone penetration rates, there is no guarantee that this feeds through to increased profits. The high tariffs needed for the subsidies means phone usage may drop as customers use Skype and other VOIP services to circumvent the tariff. This has already started to happen in Spain and the Netherlands, where approximately 40% of the population have smartphones, and whose populations are undergoing austerity programs.