Hit By Domestic Competition, Deutsche Telekom Posts Drop in End-2006 Net Profit; Plans International Expansion

Europe's largest carrier by sales posted a 43% year-on-year (y/y) fall in net profit last year to 3.165 billion euro, from 5.589 billion euro in 2005. Its core operating profit, as measured by earnings before interest, tax, depreciation and amortisation (EBITDA), adjusted for special items, fell 6.2% y/y to 19.4 billion euro, in line with company forecasts. The group revenue amounted to 61.3 billion euro, with a 5% y/y drop in domestic sales to 32.5 billion euro and a 13.6% y/y increase in international sales. In the fourth quarter alone, the telco posted an unexpected net loss of 898 million euro, against a net profit of 991 million euro a year earlier, due to the flight of fixed-line customers to rivals and costs related to job cuts. Fourth-quarter sales increased by 2.4% y/y to 15.9 billion euro, from 15.5 billion euro a year earlier, while fourth-quarter EBITDA fell by 12.5% y/y to 4.548 billion euro. In late January, Deutsche Telekom issued its second profit warning in six months, cutting its operating profit outlook for 2007, due to strong competition in its domestic market and increased capital expenditure plans on sales and marketing (see Germany: 29 January 2007: Deutsche Telekom Issues Profit Warning on Fierce Competition and Weak Dollar).  

The telco lost 2.3 million fixed-line customers in Germany last year to low-cost rivals, which dented its growth prospects and eroded its market share. In addition, growth prospects have been inhibited by high personnel. Deutsche Telekom's new strategy, developed by its new CEO, René Obermann, will focus on the international expansion of its wireless business. The company intends to use the proceeds from the planned sale of non-core assets on new acquisitions and expansion, especially in Central and Eastern Europe. Obermann, who replaced his predecessor, Kai-Uwe Ricke, in November last year, faces a challenge to boost growth as the company has been hit with fierce competition on its home market. The new CEO is also implementing efficiency measures in an effort to trim costs, which is expected to save 2 billion euro this year and between 4.2-4.7 billion euro by 2010. The measures will include job cuts and transferring at least 45,000 personnel into a newly created service unit, T-Service, which would see employees work 40-40.5 hours per week, compared to the current 34.5-hour working week. The initial plans for the T-Service division were initiated by Obermann's predecessor. Deutsche Telekom is also planning to cut 32,000 jobs by the end of next year. Obermann is expected to provide further details of the restructuring plan at a news conference tomorrow. The controversial restructuring plan has already been approved by the supervisory board, despite the opposition to the planned extended working hours and lower hourly rate from the Verdi labour union, whose members also hold seats on Deutsche Telekom's supervisory board (see Germany: 26 February 2007: Deutsche Telekom Supervisory Board to Vote on New CEO's Restructuring Plans).

Outlook and Implications

Domestic Landscape: Deutsche Telekom is facing a decline in profits as its fixed-line customers fled to more competitive offers from rivals, including Vodafone's fixed-line unit, Arcor, Telecom Italia's German division, Hansenet, and low-cost rivals, such as Mobilcom and United Internet. The company registered 38.96 million fixed-line and internet customers at end-2006, down by 5.4% year-on-year (y/y), compared to 41.2 million at end-2005. The number of broadband customers reached 11.72 million at end-2006, up 37% y/y, while the number of narrowband customers was down by 5.5% to 38.96 million. The telco expects that, thanks to extra investments, it will capitalise on the demand for broadband services, which will drive future growth in Germany. Deutsche Telekom hopes that its triple-play services, including its IP TV offering, branded T-Home, will drive growth in the future and stop the customer exodus at its German business. The company is targeting a more-than 40% rise in new customers this year in its domestic market. It also aims for 1.5 million new customers to its IP TV service by 2010.

Asset Sales and Acquisitions: Deutsche Telekom is planning to dispose of its internet businesses in Spain and France, as well as its real estate assets and its mobile towers in the United States and Germany. The company will also review for disposal minor media and broadcast assets at Deutsche Telekom's business division T-Systems. The German telco is likely to look at synergies in other high-growth European markets, where it is already present. Last month's speculations indicated that Deutsche Telekom is potentially interested in taking over C&W's business in the United Kingdom and is also eyeing Tiscali UK. The acquisition of C&W would give Deutsche Telekom—which currently only operates its mobile business, T-Mobile, in the United Kingdom—access to the country's second-largest wholesale broadband network, behind BT. It would give the telco an immediate entry into the highly profitable broadband market with its own unbundled local loop (ULL) network, in direct competition with incumbent operator BT. Tiscali, on the other hand, could give the telco a head-start in the United Kingdom's competitive residential broadband market. Tiscali, which has also been recently courted by BT, has around 1.5 million subscribers, or about 10% of the United Kingdom's internet market. In addition, Tiscali UK is well positioned for the IP TV market entry after it acquired the niche video-on-demand and IP TV provider, HomeChoice, in August 2006 for £100 million, which gave HomeChoice an 11.5% stake in Tiscali UK. By mid-2006, HomeChoice achieved only 45,000 customers in London and Stevenage, despite more than £100 million-worth of investment since 2003. The Italian group has now rebranded HomeChoice as Tiscali TV and is planning to launch the IP TV service commercially in March 2007 (see United Kingdom: 9 February 2007: Virgin Media's Launch Invigorates U.K. Broadband Market, United Kingdom: 7 February 2007: Tiscali UK to Launch IP TV in March and United Kingdom: 14 August 2006: Tiscali Dials into Triple-Play with US$189 mil. Swoop for HomeChoice).