* Press stories in recent weeks suggest that some European Telcos are reconsidering geographic expansion, after several years of portfolio rationalisation. DT is reported to have considered KPN and is due to take an equity stake in BT for its EE shares (rather than cash out). Orange is also assessing expansion options, e.g. in Belgium and Romania, previously less important markets. This follows TDC last September entering the Norwegian cable market by buying Get. Telcos destroyed at least eu175bn in the 1999-2008 expansion cycle, on our analysis, due to a combination of a subsequent de-rating from the high multiples the sector was trading on at the time, the relatively small synergies achieved vs the size of the premium paid, and the subsequent decline in earnings of the asset acquired as the industry worsened and/or as the asset lost commercial momentum within a larger group. We consider whether this risk of a potential pivot back to Telco expansionism is a big enough to alter our positive sector view.
* More recently, cable operators have outperformed from expanding geographically, gaining originally from underlying asset-inflation, and more lately from greater leverage, from tax considerations and from a more aggressive approach to managing costs. The environment for such Telco expansion has also improved to a degree. The risk of a sharp decline in the value of European assets acquired is smaller, given the improving sector (in
our view). However Telcos won't replicate these cable M&A conditions,running more conservative balance sheets and tax structures, and typically with more operational inertia. Telco cost structures are evolving, creating a
bit more synergy than before from cross-border combinations with 1) network functions becoming more centralised and software-driven, 2) with roaming becoming potentially a greater cost for operators due to price
regulation and 3) with bargaining scale in content potentially more important over time. However, these cost synergies are still likely to be small in relation to the take-over premium paid and tendency for Telcos to trade at a SOTP discount if they just accumulate rather than trade assets. Overall, we believe Telco footprint expansion still risks destroying value.
* We would be very surprised if Vodafone and Telefonica made such a move– they have made the biggest steps to rationalise and pursue in-market scale. This means that if DT or Orange expand, it is less likely to turn in to a
sector-wide trend. However, large footprint deals by any Telcos could still upset their own specific investment case. We expect this point will be considered by executives as they assess their M&A strategy. TDC's ~15%
share price decline on news of the acquisition of Get is a timely reminder.