Mark Habib, Director of Corporate Ratings at Standard & Poor’s, discusses European regulation, M&A and strategy The deal to merge the Danish operations of Telenor and TeliaSonera is off after disagreements with Brussels. What impact will this have on other ongoing deals?

Mark Habib: It’s too early to tell. Though the transaction termination in Denmark sends a signal that recent critical statements from DG Comp regarding consolidation are not mere lip service, we take Commissioner Vestager’s subsequent comments that each decision will be made on a case-by-case basis at face value.

While the Danish transaction is the first mobile-mobile merger the new Commission has considered, it would have resulted in a virtual duopoly for the Danish market with market concentration of about 85 percent and a weak position for the new number three operator, making effective remedies more challenging.

We don’t view the proposed transactions facing the Commission in the UK and Italy as yielding the same level of market concentration as they both involve the number four player.

DG Comp’s next decisions will be more revealing in terms of how they are calibrating their view of appropriate competition.

Recently, S&P warned European telcos not to jeopardise emerging revenue growth by offering shareholders excessive returns. What impact could such returns have?

A rush to commit to shareholder returns, particularly if not linked to free operating cash flows, could lead to a re-run of debt financing which can weaken leverage ratios and raise the same financial policy concerns we had in the early 2010s when companies were slow to adjust their shareholder returns downward in line with their tougher operating environment and lower cash generation.

To be clear, we believe improving revenue trends combined with stable margins and capex intensity moderating beyond next year will give telco managers the flexibility to revisit shareholder returns.

Our note of caution is related to how aggressive any increases may be.

There is still a way to go before the sector returns to growth in Europe.

The trends are positive and we see pockets of positive growth, but we still expect an overall year-on-year decline in top-line revenue for the sector in 2015.

Do telcos need to increase their prices for mobile and fixed services?

Not necessarily, if we think in terms of prices per unit (of consumption).

We believe growth can come from further penetration in bundling and upselling in terms of speeds or, for mobile in particular, data buckets.

Growth can also come from a reduction in the promotions that lower the effective rate while leaving headline rates the same.

But of course, each market has its own dynamics. For example, prices will likely need to rise in the UK to recover some of the increased costs of sports content.

The risk we see is if competition leads telcos to keep providing more services for the same or even less.

We think this risk is more likely in certain markets where, after years of declining prices as a result of intense competition, price increases could be hard to achieve (eg, France or Denmark).

Free has recently announced that they will increase their 4G data bucket in France to 50GB from 20GB per month for the same €20 price.

Vodafone has also announced incremental data increases in Holland for similar costs, or in some cases less.

While good for the consumer, we believe such offers may threaten returns on the considerable investment in spectrum and infrastructure needed to deliver these services.

You have forecast that capex at European telcos is set to decline from this year. Could this lead to the region falling behind the rest of the world again?

We think so. The lag in 4G coverage compared to the US has narrowed significantly from about 60 percent to about 20 percent in the last three years, and has remained steady for high-speed fixed networks at about 20 percent.

Continued investment is required to close this gap further, especially when it comes to reach the last 10-20 percent of the population which reside in lower density, more expensive to cover rural areas.

That said, there are significant national variations with Portugal, Germany, Switzerland and Finland above 90 percent LTE coverage, while France, Italy and Spain were below the European average at year-end 2014; likewise for high-speed broadband where Holland and Belgium are near full coverage, mainly due to high cable penetration.

Cross-region and cross-country comparisons are inherently difficult since it is not only the absolute amount of spending that matters, but also the cost of deployment, which varies greatly as a function of population density, national rules for infrastructure roll-out, etc.

That said, a key factor in our view is how quickly and how sharply revenues rebound.

With steady top-line growth forecast in the US, the absolute amount of capex spending is actually set to rise, which means the infrastructure gap could in fact widen rather than decline if European investment stalls.

What is your view on the Commission’s net neutrality stance?

We view this as modestly positive, but not material in the short term.

Fundamentally, the Commission’s stance is more accommodating than the US FCC’s, because it theoretically allows network operators the ability to strike interconnect agreements with content providers, and monetise more of the distribution services being provided to bandwidth-intensive users like Netflix, Google, Facebook, etc.

But in practice we are not convinced that this ability will translate into significant additional revenue.

Since operators are not allowed to selectively degrade performance levels, it’s not clear how much leverage they can wield in negotiations.

We also think local implementation of the Commission’s net neutrality rules and telco competition are likely to prevent any significant capture of rents.

In the long term, telcos may benefit if they can offer enhanced services on upgraded networks, for example to a mission critical, high bandwidth future service like self-driving transportation.


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