German Mobile - Discount segment competition intensifying. Assessing the contagion risk
Both DT and Vodafone began 2016 on a constructive note, unveiling ARPU
accretive "more for more" tariff changes. Disappointingly, this has since been
overshadowed by a domino effect of price cuts with operators reacting to
Drillisch’s aggressive June promotions. While network operators have
sensibly channeled their response through sub-brands, limiting the spillover
into the mass market, this has stretched the price gap between these segments
to >40%. With Drillisch and United Internet locked in a strategic stand-off,
and all operators needing to compensate for mounting regulatory headwinds,
we worry promotions may persist. To minimize the contagion risk, we believe
operators should move to further enhance the value proposition of their
premium brands by selectively raising mid-tier data allowances and
stimulating greater bundle adoption. For DT and Vodafone, German mobile
risks look manageable (10% revenue exposure). While pure-play O2D is very
exposed (JPMe 3% below 2017E consensus EBITDA), we remain Neutral
noting an up to 10% EBITDA benefit if United Internet acquires Drillisch.
* Aggressive promotions: In June, Drillisch (an MVNO with 3m subs)
revamped its offers. This comprised a material increase in data allowances
and an extension in promotional discount durations from 12 to 24 months.
Its core offer includes unlimited voice and 2GB for €7.99/month vs. €15-20
previously. With United Internet (3.8m subs) responding with even greater
cuts, it has prompted a reaction across all Germany discount brands.
* The contagion has been limited for now: All three network operators own
sub-brands. Channeling their competitive response through this medium has
helped avoid mass market price contagion. While there are significant
structural differences between the premium and sub brands (the latter lack
4G, offer limited customer service and do not include free EU roaming) the
resulting >40% price gap between these segments looks somewhat stretched.
* What should companies do? While Drillisch and United’s mainstream
2GB plans are being promoted at an aggressive €7-9/month, their higher
tiered packages are actually much dearer (4GB €17-20 and 5GB €22-25). As
such, by raising premium brand data allowances by 1-2GB operators should
be able to shift the focus of comparison away from the most attractive price
points. We also see merit to increasing the perceived value of premium
brands through other initiatives, such as stimulating greater bundle adoption.
* The silver-lining: Structural concerns around MVNO economics lead us to
believe United Internet will (eventually) fully acquire Drillisch (the latter
has a fixed-cost “MBA-MVNO” on the O2D network). Migrating United's
subs, from Vodafone onto O2D, would offer up to a 10% EBITDA uplift.
* Stock views: For DT and Vodafone, German mobile risks look manageable
(10% revenue exposure). Pure-play O2D is more exposed with our 2017E
EBITDA 3% below consensus and valuation (5.7x 2018E EV/EBITDA)
offering little room to maneuver should competitive pressures persist.