Turning around the funding oiltanker

Wouter Moerel, director of The Carlyle Group, the world's largest private equity company that which focuses mainly on early-stage venture capital buy-outs, emphasises that his company is involved in more than just the opportunistic acquisition of undervalued businesses. "Increasingly we're into corporate equity finance," he declared.

In a presentation at the FT Conference he described the key themes in the telecoms sector, from his point of view:

• overcapacity in many sub-sectors — with space for only two or three competitors in any one market;
• past lack of focus on return on capital, which was in over-supply; and
• the difficulty for an alternative carrier to beat an incumbent.

Carriers had rushed to be the first to market with new services, but the financing was unsustainable, especially after the cost of regulatory licence fees for wireless. "While broadband has now taken off, pay TV is in crisis."

Telecom revenues per bit fell 19% in 1998 and 23% in 2000 and are forecast to fall 27% in 2002 and 28% in 2004 so, if operating expenditure per bit isn't reduced accordingly, the results could be "nasty", says Moerel. "I wouldn't rule out further collapses."

However, for alternative operators there is still tremendous opportunity in the local loop, but unbundling is "not happening significantly". Incumbents still control most access to the last mile.

So, while investment is mostly via private equity in the USA, Europe is "light years behind". Whereas Ireland's Eircom is the "most intriguing example of where private equity has taken a leadership role", this is "impossible" with Deutsche Telekom and France Telecom. "There are few players likely to be left in the EU," he concludes. Nevertheless, Carlyle has been working with corporate partners (such as NTL) on corporate finance solutions.

Aidan Fisher, VP-senior analyst for Moody's Investors Service Ltd, concurs that incumbents will retain a leading market position, since they still have a 70% share of traffic. Total European telecom capital expenditure will fall from EUR69bn in 2001 (23% of revenue) to EUR61bn in 2002 (18%), before rising slightly to EUR64bn in 2003 (18%) and EUR63bn in 2004 (16%). In particular, Deutsche Telekom's CapEx has fallen from EUR23bn in 2000 to EUR11bn in 2001 and will be just EUR8bn in 2002.

But, while some companies are reducing CapEx below 16% of revenue, Fisher reckons it should maybe be lower still, perhaps 10–12%. Operators don't need to spend much more on fixed line, while maintenance spending is less, he says.

However, a change in the industry is that most incumbents now have different management teams with "defensive capabilities", with an emphasis on generating cash-flow despite declining revenue streams (especially in fixed-line) via cost reduction. External funding will be lower over the next three years. For the next 12 months companies will focus on cutting costs and reducing debt, Fisher says. Some incumbents might continue to make small acquisitions to complete their footprints. There will be some mergers among the smaller incumbents, while further consolidation or restructuring is expected among new-comers. However, no significant mergers are foreseen among the large incumbent operators. In the meantime, before restructured competitors emerge, there is a "competitive window".

In Europe the banks have been supportive. KPN had a EUR2.25bn bank facility before its EUR5bn equity issue, Sonera had a EUR1.33bn bank facility before its EUR1bn equity issue, while Deutsche Telekom successfully launched EUR5bn of new bonds despite WorldCom's collapse. Liquidity should be less of an issue in 2003 than in previous years: telecoms debt has fallen from its peak of EUR270bn in 2001.

However, Moody's still factors implicit government support into its ratings: the level of government ownership is 34.7% for KPN, 52.8% for Sonera, and 55.5% for France Telecom. While government support has been a saviour for European incumbents as others have fallen by the wayside, the level of government ownership is generally decreasing. So, a more open funding model may be needed in future.