Tag Archives: consolidation

European Telecom Frenzy

After many years of forecasted telecom consolidation in Europe, the recent uptick in M&A activity in the European communications sector is turning into frenzy. The catalyst includes European regulator’s agreement to allowing consolidation from four to three operators in mobile markets in Germany, Ireland and Austria. Declining mobile revenues & ARPU, the capital expense required to upgrade networks to 4G and buy spectrum, and the popularity of the quad play (bundled mobile and fixed telephone, broadband & TV) in certain markets are other catalysts. The graph below from the Wall Street Journal highlights the trends in the European mobile market.

click to enlargeEuropean Mobile Telcom Revenues

BT is a central player in the frenzy and reported to be looking at accelerating its mobile strategy by purchasing either EE (owned jointly by Orange and T-Mobile) or O2 (owned by Telefonica) in the UK. Vodafone will need to respond to such a development and is reported to be assessing a bid for Liberty Global. Hutchison Whampoa, owner of mobile provider Three, is also reported to be considering its options. Sky and TalkTalk are talked about as possible targets in the UK.

The list of recent deals is long. O2 and KPN’s E-Plus merged in Germany. Vodafone purchased Ono in Spain and Kabel Deutschland in Germany with its Verizon booty. Liberty Global recently completed its acquisition of Ziggo in the Netherlands. Altice, owner of cable operator Numericable, bought SFR in France and, in Portugal, it’s just announced a deal for the Portuguese assets of Portugal Telecom from Brazil’s Oi. Hutchison Whampoa bought Orange in Austria and O2 in Ireland. France’s Orange is buying Jazztel in Spain.

The attraction of combining mobile traffic with fixed assets is highlighted by the growth in data traffic over connected devices like smart-phones as an exhibit from the Ericsson Mobility report below shows.

click to enlargeGlobal mobile data traffic 2010 to Q3 2014

A recent article from the FT speculated on other combinations in the European telecom sector. France’s Iliad, who made an audacious yet unsuccessful bid for T-Mobile in the US, may have another crack at Bouygues Telecom (maybe with SFR-Numericable taking some assets). In Italy, Hutchison Whampoa, owner of 3 Italia, may have a go at the debt heavy Wind, although the part ownership by the Russian Vimplecom may be an issue.

I haven’t taken an active (or economic) interest in the sector in Europe since Virgin Media came out of Chapter 11 and was subsequently bought out by Liberty Global a few years later. Although I have looked at Liberty Global a few times since, I couldn’t get over the valuation at the time or the massive goodwill/intangible items from its acquisitive history (currently over 40% of total assets). Liberty’s debt load of over 4.5 times EBITDA is scary but not overtly so given its strong cash-flow. At a current enterprise value (EV) to EBITDA multiple of 9.5, a merger with Vodafone would not be cheap (which currently trades around a 7.6 EV/EBITDA multiple with a lower net debt to EBITDA ratio of less than 2.5). A Vodafone/Liberty merger would be a fascinating test for European regulators as such a match-up would have been unthinkable just a few quarters ago.

The only European telecom firm that I have kept up with is the disappointing COLT (who I posted on here and here). COLT may get caught up in the merger frenzy as a target. I suspect majority owner Fidelity is looking to exit whilst maximising its value (or minimising its loss is more accurate in this case). COLT recently bought the Japanese operator KVH (who also had Fidelity as an owner). I updated my projections, as below, but given that COLT will likely spend most of its cash pile on the KVH acquisition and integration, the medium term operational outlook for COLT looks uninspiring. COLT does have a €150 million debt facility which is more than enough to get it to free cash-flow (I estimate that will not be until 2017 with KVH integration costs), unless of course it goes shopping!

click to enlargeCOLT Telecom Revenue & EBITDA Margin 2006 to 2016 incl forecast

So overall, the European sector is getting really interesting and, although I can’t see any obvious way to play it that excites me, it will be fascinating to watch from the side-lines.

Pricing Pressures & Risk Profiles

There have been some interesting developments in the insurance market this week. Today, it was announced that Richard Brindle would retire from Lancashire at the end of the month. The news is not altogether unexpected as Brindle was never a CEO with his ego caught up in the business. His take it or leave it approach to underwriting and disciplined capital management are engrained in Lancashire’s DNA and given the less important role of personalities in the market today, I don’t see the sell-off of 5% today as justified. LRE is now back at Q3 2011 levels and is 25% off its peak approximately a year ago. As per a previous post, the smaller players in the specialty business face considerable challenges in this market although LRE should be better placed than most. A recent report from Willis on the energy market illustrates how over-capacity is spreading across specialist lines. Some graphs from the report are reproduced below.

click to enlargeEnergy Insurance Market Willis 2013 Review

One market character who hasn’t previously had an ego check issue is John Charman and this week he revealed a hostile take-over of Aspen at a 116% of book value by his new firm Endurance Specialty. The bid was quickly rejected by Aspen with some disparaging comments about Endurance and Charman. Aspen’s management undoubtedly does not relish the prospect of having Charman as a boss. Consolidation is needed amongst the tier 2 (mainly Bermudian) players to counter over-capacity and compete in a market that is clustering around tier 1 global full service players. Although each of the tier 2 players has a different focus, there is considerable overlap in business lines like reinsurance so M&A will not be a case of one and one equalling two. To be fair to Charman the price looks reasonable at a 15% premium to Aspen’s high, particularly given the current market. It will be fascinating to see if any other bidders emerge.

After going ex-dividend, Swiss Re also took a dive of 9% this week and it too is at levels last seen a year ago. The dive was unusually deep due to the CHF7 dividend (CHF3.85 regular and CHF4.15 special). Swiss Re’s increasingly shareholder friendly policy makes it potentially attractive at its current 112% of book value. It is however not immune from the current market pricing pressures.

After doing some work recently on the impact of reducing premium rates, I built a very simple model of a portfolio of 10,000 homogeneous risks with a loss probability of 1%. Assuming perfect burning cost rating (i.e. base rate set at actual portfolio mean), the model varied the risk margin charged. I ran the portfolio through 10,000 simulations to get the resulting distributions. As the graph below shows, a decreasing risk margin not only shifts the distribution but also changes the shape of the distribution.

click to enlargeRisk Premium Reductions & Insurance Portfolio Risk Profile

This illustrates that as premium rates decline the volatility of the portfolio also increases as there is less of a buffer to counter variability. In essence, as the market continues to soften, even with no change in loss profile, the overall portfolio risk increases. And that is why I remain cautious on buying back into the sector even with the reduced valuations of firms like Lancashire and Swiss Re.