Once upon a time the sky was the limit to telecoms expansion. Industry IROs talk about how their message has now changed to one of cash conservation and survival
At the beginning of the 1990s most telecoms companies were boring old utilities - dependable, dividend-paying income stocks. But in the acquisitive flurry that followed, telcos began touting themselves as growth stocks - and investors were quick to take up the rallying cry.
By the turn of the millennium telcos were the superstars of the capital markets. Their share prices were heading seemingly for the sky, while their IROs were among the profession's highest paid. Larger telcos were gobbling up smaller ones, using their sky-high stock to pay the inflated prices expected. They were able to raise debt at will, and not a week went by without another high-profile issuance. Even in mid-2001, when telecoms companies had already taken a heavy hit, and only eight months before its own demise into Chapter 11, WorldCom managed to sell $11.8 bn worth of investment grade bonds to the market.
But why did the telcos risk such huge amounts of debt to finance network build-out, acquisitions or forays into mobile telephony? Roy Marsden, a fund manager at JO Hambro Capital Management, points to a shift in focus: 'Like investors in other utilities in the early 1990s, telecoms investors expected good cash flow, decent dividends and high credit ratings. But this changed when the stampede for mobile telephony and 3G started in earnest.'
Third generation telephony, and in particular the high prices paid for licenses like universal mobile telecommunications system (UMTS) licenses, are responsible for much of the debt load now weighing on incumbents such as Deutsche Telekom and France Telecom. With hindsight, analysts say telecoms companies overpaid for these licenses. At the time, however, investors looked askance at those who could, but would not, get involved in the 3G free-for-all.
'Virtually all the major companies in this industry were obliged by their investors to develop a position in what was perceived as the high-growth area of UMTS,' comments Ezequiel Nieto, investor relations manager at Telefónica.
'Three years ago investors were looking for growth through expansion into the areas of data, internet and mobile telephony. They were penalizing the companies that weren't getting involved,' adds Jason Hollands, deputy managing director at the UK broker Bestinvest. 'At the time of the great 3G race, the major telcos were in a very difficult position. Their investors expected them to get involved in UMTS auctions, and would have been most irate if they hadn't.'
Catrien Van Buttingha, senior IR officer at Dutch incumbent KPN, believes in the opportunities for mobile data. 'But the way some auction processes were structured caused enormous damage to the sector.'
'It was like game theory,' admits Damian O'Reilly, investor relations manager at BT. 'The large incumbents couldn't afford not to play, because shareholders would have lynched them. With hindsight it would have been a wise decision not to play, and a very brave one.'
However not all companies lost their heads during the excesses of UMTS auctions. Bart Morselt, director of investor relations at Swisscom, explains how the Swiss telco 'pulled out when the bidding went beyond internally-established limits. Our investors and the press were horrified, and accused us of missing an opportunity and lacking imagination.'
Cable & Wireless had already made its lack of interest in the mobile space abundantly clear, again much to the annoyance of some shareholders. 'When we explained our strategy, investors were enthusiastic about our intention to focus on the fixed-line internet and data markets,' says Chris Tyler, ex-director of IR and now CFO of Cable & Wireless, West Indies. 'Yet they frowned upon the company's stated goal of withdrawing from the mobile telephony and cable markets, both perceived as high-growth areas. When we sold our half-share in [mobile operator] One2One, there was a muted response, even though the timing was very good and we made a £3.5 bn profit on the disposal.'
There followed much investor grumbling over C&W's cash pile, which reached over £7 bn at one stage. The company ultimately proved right not to swap cash for expansion at the high end of the market cycle, and last year returned a total of £1.5 bn to shareholders in the form of a 15 percent share buyback and an extraordinary dividend. It also made some very canny acquisitions, including much of bankrupt Exodus Communications' network and the Japanese offices of the now defunct PSINet.
Companies with spare cash were under strong pressure to make acquisitions. Infonet Services Corp raised $1 bn when, near the peak of telecoms valuations, it floated around 14 percent of its shares outstanding in late 1999. Morgan Molthrop, vice president of IR, explains the prevalent attitude then: 'When we went public, we were under immense pressure from investment bankers and sell-side analysts to accelerate our growth through acquisition. But this would only have been a short-term measure to keep shareholders happy, and in retrospect it would have ruined our balance sheet, and perhaps our business, too.'
The devil-may-care attitude to raising and spending capital only really began to change with a number of high profile bankruptcies. First were the competitive local exchange carriers (CLecs) such as Teligent which in their prime had raised huge amounts of cash to take on the big boys. ISPs like PSINet and web hosting companies such as Exodus Communications soon followed. In 2002 the giants began to fall too. WorldCom swiftly followed Global Crossing down the tubes (or should that be 'fat pipes'?). Nor were the survivors immune to heavy stock market declines. Today, the shares of even the most established telcos are now trading at a fraction of their 2000 highs.
Imagine the life of telecoms IROs now that their companies have gone from darlings to dogs. 'The cash crunch and the slow rate of roll-out for 3G have forced those telcos that can to demonstrate to investors their cost-consciousness and their ability to conserve cash,' says Marsden of JO Hambro.
When Telefónica pulled the plug on some of its loss-making activities in July, the cost of ditching its 3G operations in non-Spanish speaking Europe was an estimated $5 bn. 'There are too many doubts hanging over UMTS for us to continue investing in non-core markets,' said a spokesman at the time. Adds IRO Nieto, 'Now our investors are really focused on cash flow generation. They are increasingly looking for a transparent, simple and comprehensible balance sheet.'
In August KPN made a whopping $9 bn write-down of its foreign mobile assets, and effectively put its 15 percent stake in Hutchison 3G up for sale. The KPN and Telefónica write-downs would have shocked investors just a year before. Now, according to both Nieto and Van Buttingha, these radical steps were seen as the dawn of a 'new realism' in the industry.
In November 2001 BT had taken an even more radical step, spinning off its mobile arm (renamed mmO2) altogether. 'Investors were very apprehensive about our demerger from mmO2, accusing us of giving away our growth opportunity,' recounts BT's O'Reilly. He believes BT's share price is being depressed even now because the company has no wholly-owned mobile business, although it is now providing mobile services.
Given the changing environment in which telecoms companies are now working, how are IROs supposed to get their message across to investors? According to Roy Marsden of JO Hambro, 'There are a lot of opportunities, but at the moment companies have to convince investors of their cost-consciousness; everything else takes second place.' He adds an ominous warning: 'If we do see the much feared double-dip recession, some of the highly geared companies will be in trouble.' Bestinvest's Hollands concludes: 'It will take a while for over-capacity to work its way through the industry. Telecoms companies are wide open to economic downturn, and at current multiples some of them still don't look very cheap.'
Chris Tyler, CFO, Cable & Wireless, West Indies
We set strategy at the beginning of 1999 and spent the first twelve months explaining it to people. Now people understand it, and so we are telling them about our performance. At the height of the bull market I had, in particular, more growth investors from the US coming to see me. That has gradually diminished until now, when value investors have started arriving.
It has been an extremely interesting period to go through, although the priorities of the job are the same as they ever were - trying to inform the market where the company is going. That is true whether investors put a premium or a discount on the shares.
Damian O'Reilly, IR manager, BT
We took the necessary restructuring steps before the market was ready to recognize what we were doing. In April 2002, we communicated to our shareholders that we are now focusing on free cash flow and on earnings per share growth.
We need to convince investors that it will take time for new revenue streams such as BT Broadband to work through. To get our message across, we need constant dialogue with our shareholders, which is why our management is spending a great deal of time on the road in the UK and Europe.
John Diercksen, senior VP of IR, Verizon
Investor perceptions have certainly changed over the years. However, the Verizon IR role has remained sharply focused.
Verizon is a company with an executable business plan, strong cash flows and access to capital. Investor issues and concerns may change over time, and as such, our messages and emphasis points address the current issues on their minds. Our messages have not changed significantly - our strategies for growth, business plan execution and focus on shareholder value creation are still pretty much the same. The mix of investors is essentially the same, too, although we may have more value investors than three years ago.
Bart Morselt, director of IR, Swisscom
Many telecoms companies that spent wildly in recent years are now having terrible problems with their debt structure. We have the reverse problem: we need to find intelligent ways of spending our cash. Last year, Swisscom returned some of its cash pile to shareholders, buying back around 10 percent of its stock. The company is considering further buybacks or acquisitions aimed at improving the capital structure.
In late 1999 we didn't have the same growth story as other more aggressive telecoms companies, and we were underperforming the sector. But since 2000 we have outperformed vastly. We have been relatively conservative, and are seen as a safe haven. Investors have never really seen us as a growth stock.
Our message hasn't changed over the past years. Two years ago some investors thought that we were lacking in imagination. Now investors appreciate our conservative message. But market opinion is swinging all the time.
Catrien Van Buttingha, Senior IR officer, KPN
Last year was terrible; people thought we were going bankrupt. There were rumors of rights issues and mergers almost every day, and most of them had some basis of truth. But later, we were one of the first companies with a heavy debt burden to adopt a new realism and redimension our operations, scaling them down drastically. The measures ensured that company debt escaped junk status and the company itself moved on to financial and operational recovery.
Our job of explaining the numbers to people has not changed, but the environment has. Investors and analysts are much more cautious than before. Now that we are seen as a value company, the proportion of value investors has increased.
Last year we would be getting calls all day, and had no time for anything. Now we do have time so do some background research, reading reports on our peers and so on.
Ezequiel Nieto, IR manager, Telefónica
We have managed to maintain a constant investment grade debt rating over the past six years thanks to our financial discipline. We stopped our cash dividend in 1998 but have given shareholders seven bonus issues since then. We will submit the reintroduction of the cash dividend at the next AGM.
Investor expectations have changed with the big correction, which has accelerated over the last year. We are still talking to the same people, but investors have changed their focus. They are now paying more attention to the strong cash flow that the company generates. Telecoms companies themselves are now focusing more on capital controls and the tight allocation of capital expenditure.
With regards to the job itself nothing has changed. In IR we still need a deep knowledge of the market and strong communication skills to get our message across to our investors. But nowadays it is the investors themselves who are more analytical.