Since Iliad’s mobile launch four years ago, French Telcos have shown little
pricing discipline, with a systematic prioritization of volumes over ARPU
protection. Mobile price points collapsed, broadband entered an interminable
promotional period, and fibre was given away with no premium. In this report,
we make the point that FTTH is likely to change the game dramatically. The
capex burden is too heavy for the industry, with or without consolidation;
pricing inflation is required to protect value. We are net buyers of French
Telcos with an Overweight rating on Num-SFR and Iliad while we are Neutral
on Orange and Bouygues. We see two main reasons to be positive: i) the
capex risk is flagged while the prospect of pricing restoration is not, and
ii) consolidation is a cheap option.
* FTTH capex is significant and will persist for many years. Our FTTH
capex model suggests that the fibre bill should top €17bn to cover very
dense and medium dense areas. Over the next 10 years, the industry is likely
to invest €1.5bn pa on average in FTTH, which should absorb 3-4% of the
industry annual revenues and c.15% of OpFCF.
* Pricing inflation is required. Altnets’ improved margins in FTTH are often
seen as a barrier to pricing inflation. This postulate overlooks the capex side
of the equation. Our bottom-up cash cost model suggests that altnets’
margins expand by 14-26ppt when they co-invest in fibre, but contract by
13ppt if they rent fibre access. However, normalized OpFCF margins are
improved only in very dense areas (18% of lines) AND only when operators
have enough scale. In the vast majority of cases, alternative operators’ cash
generation deteriorates in the fibre world. The ULL avoidance is not enough
to fund FTTH investments. Getting the pricing model right is paramount.
* The colossal FTTH bill increases the consolidation rationale but given
the history of the French M&A situation, it is hard to predict the outcome of
the ongoing discussions. That said, we believe Mr Bouygues is likely to
regard Orange as a more suitable buyer. A deal with the incumbent provides
an honorable exit for Bouygues on jobs protection, fixes the use of cash
issue and offers continued exposure to telecoms with an equity-based
transaction. We discuss in this report Orange’s crucial role as well as key
anti-trust considerations post the failed Danish transaction. Visibility on the
regulatory prospects is limited but securing approval is possible.
* Stock views and Dec-16 TPs: We are Overweight Num-SFR with a €50 TP
(39% upside potential), and Iliad with a €265 TP (19%), while we are
Neutral on Orange with a €18 TP (16%, rating reinstated, previously Not
Rated) and Neutral on Bouygues with a €36 TP (3% downside).