Moody’s TMT seminar, my notes.

Moody’s invited us to their TMT (Technology, Media, Telecoms) Ratings Risk seminar this week. The main focus of the talk was European Telecoms, takeaways:

Top line:

Top line is generally expected to be stable with moderate growth, poses challenges to distressed names such as Altice who may be partially reliant on strong earnings growth to meet refinancing deadlines.

• 12-18 month sector outlook stable
• Moderate revenue growth of 2.5% expected in 2024, driven by price increases & continued customer shift towards higher speed products
• Broadly speaking the uptake of 5G has been “not met with great enthusiasm” – effectively the use case isn’t clear any many consumers & businesses see only a small marginal benefit to greater speeds. As such the 2.5% number above is muted relative to what may have been expected when 5G investments were initially made.
• Moody’s caveat that in the long run emergent technologies (AI, augmented reality, autonomous vehicles) pose upside, but will require another wave of capex spend (investment in systems & upskilling labour). 

Capex:

Capex is to remain elevated, issuers who seek to defer capex run a very material risk of weakening their competitive position as churn rates in dated networks are higher. So there is a catch-22 for HY issuers – defer capex to improve leverage, or continue to invest & protect the multiples of your assets. This isn’t anything groundbreaking, but the point is that with rates where they are it’s become increasingly pertinent & the current environment heavily favours issuers with lower credit spreads. Also note: large variation in quality of networks across geographies, issuers in UK / Belgium more exposed to dated networks, France less so.

• Capex to remain elevated due to ongoing rollout of 5G & increasing penetration of Fiber to the home.
• Issuers with strained financial health will have to make a tradeoff between maintaining their capex and maintaining their competitive position (subject of course to the relative strength of their existing infrastructure).
• Reiterated that churn rates are generally higher for low speed / dated networks e.g. broadband via copper cables (I’m thinking of TalkTalk & challenges in turning around this biz).
• Some issuers may elect to defer capex given current high levels of debt funding, however Moodys don’t see much leeway given ongoing investment programmes in 5G & Fibre.
• Important trade off between moderating capex (to improve financial health) and maintaining competitive position. Further there is a large disparity between geographies, with regions such as France having relatively up to date networks (large scale Fiber rollout), while the UK & Belgium are particularly dated.

Capital structures:

High rates coupled with low earnings growth prospects pose a challenge to the typical pattern of encumbering assets with debt (as earnings growth < discount rate growth in a stag-flationary environment). Interesting comments on the increasing prevalence of asset light models where investments are carried out in off balance sheet SPVs or 50/50 consolidated via JVs creating great complexity & by extension financial risk.

• High interest rates pose a “global challenge” to the sector, with “much higher rates” posing headwinds to cash flows in 2024. Moody’s “expect” peak rates in 12/18 months, so issuers with debt maturity profiles concentrated around this period face tough refinancing hurdles.
• Shift towards “complex asset light financing structures” – JVs (50/50 consolidation) & off balance sheet financing (generally no consolidation) are becoming increasingly prevalent (i.e VMED/O2). Such structures allow for spreading the risk of capex funding & allows providers to leverage outside expertise to offer new services.
• However, increasing complexity is making credit risk more difficult to gauge, which is increasing financial risk within the sector. Further, the encumbrance of assets off balance sheet reduces financial flexibility for issuers in times of financial stress (unable to dispose).
• Moody’s don’t expect material deleveraging across the sector due to sustained high capex spending requirements for issuers to retain their competitive position. However, some European issuers will be reaching peak capex “soon” after which Moody’s see a clear path to deleveraging (absent any emergent technologies which will require large scale capital deployment).

Regulation & M&A: 

In the context of the previous three segments consolidation becomes key, over-levered issuers have been moving to sell assets, which appears natural in a “highly fragmented” market. Regulatory tolerance for consolidation could become critical for issuers attempting to dispose of assets at deleveraging multiples (buyers w/ greater synergies willing to pay more).

• Moody’s notes that the sector is highly fragmented, which is creating “excessive competitive pressure”, so there is a “clear rationalization” for consolidation.
• The idea of reducing national operators from an average of 4 to 3 has been gaining momentum, particularly in the UK, France & Italy.
• However, European regulators have been hostile to such mergers, the ongoing merger talks between Orange SA and Masmovil Ibercom SA in Spain are being keenly watched by Telecoms executives, and will act as a bellwether event for future tolerance of consolidation by regulators. (I would also comment that this is particularly relevant to the likes of Altice France, whose owner Patrick Drahi has stated that all of the group’s assets are up for sale. Drahi was reportedly approaching rival operators Bouygues & Free about a potential sale of Altice France’s SFR business).