Global Insight Perspective | |
Significance | Europe's largest telecoms group, Deutsche Telekom, has cut its profit and revenue outlook for this year due to strong competition in its domestic market and weakening of the dollar against the euro, which has an impact on its revenue from its U.S. mobile operations. |
Implications | The highly competitive environment in Germany hit Deutsche Telekom's end-2006 results, prompting the telco to restructure its domestic business. However, the recovery will not be quick. |
Outlook | The downwards revision will increase the management's flexibility with regard to its new strategy in efforts to halt customer losses and improve its operational performance. The expected pressure on the group's margins reflects the need for more investment to boost its broadband and mobile businesses in 2007 in the face of tough competition. |
The German fixed-line incumbent, Deutsche Telekom, has reduced its forecast for adjusted core operating profit, or EBITDA (earnings before interest, tax, depreciation and amortisation) by 1.2 billion euro (US$1.6 billion) to 19.0 billion euro, compared with an earlier estimate of between 19.7-20.2 billion euro. Slower growth at its fixed-line business in Germany will also result in lower sales than previously expected. The group's free cashflow is now estimated at approximately the same level as in 2006, or some 5.5 billion euro, excluding some US$4.2 billion it paid for extra spectrum in the United States.
The move to cut its targets a month into 2007 is a sensible move by the group's new chief executive officer (CEO), René Obermann; raising expectations would simply have postponed the need for delicate explanations later in the year. It is Deutsche Telekom's second profit warning in the last six months, and the previous one, which was issued at the end of August last year, resulted in a top management reshuffle (see World: 13 November 2006: Deutsche Telekom CEO Resigns Under Shareholder Pressure, World: 10 August 2006: Deutsche Telekom Lifts Q2 Revenue by 2.6% Y/Y, Helped by International Operations and World: 9 November 2006: Deutsche Telekom Posts 20.4% Y/Y Fall in Q3 Net Profit on Customer Exodus).The company also reduced its 2006 revenue estimate, which indicates that the company missed its last year's targets. The group's sales are expected to come in at 61.3 billion euro in 2006, against its earlier guidance of between 61.5-62.1 billion euro, as the number of customers who fled to rivals nearly doubled in the last year. Deutsche Telekom will release its full-year financial results for 2006 on 1 March.
Outlook and Implications
Competition Intensifies: Deutsche Telekom expects sales growth to slow further this year, as its German fixed-line business struggles against fierce competition. Deutsche Telekom lost 0.5 million fixed-line subscribers for a fourth consecutive quarter, bringing the total number of customers who fled to competitors during 2006 to 2.3 million. 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. Its rivals, Vodafone's fixed-line unit, Arcor, Telecom Italia's German division, Hansenet, and low-cost rivals, such as Mobilcom and United Internet, have stepped up discounting of voice telephony pricing and now also resell DSL services as heavily discounted broadband packages. Deutsche Telekom expects to increase its spending on developing new products and services, as well as on marketing efforts to retain its customer base, which will also affect its EBITDA margin. The telco expects that, thanks to extra investments, it will capitalise on the demand for broadband services. It also forecasts 800 million euro less than previously expected in EBITDA at its domestic fixed-line and broadband division, T-Com. In addition, the dollar's 10% decline against the euro last year automatically reduced revenue at T-Mobile USA, Deutsche Telekom's fastest-growing unit. T-Mobile International registered 8.6 million new customers last year, bringing its total subscriber base in Europe and the United States to 106.4 million, indicating a growth rate of 8.8%. The exchange-rate fluctuations are estimated to cost the mobile division 200 million euro in pre-tax profit. Its mobile division, T-Mobile International, will also be hit by a cut in mobile termination fees in Germany. The cut in termination fees that the cellco charges other operators to connect to its network will reduce T-Mobile Germany's profit by an estimated 200 million euro, compared with previous forecasts.
Operational Restructuring: When René Obermann, the former head of Deutsche Telekom's mobile division, replaced Kai-Uwe Ricke, who stepped down as the group's CEO last November due to the company's poor performance under his reign, he cautioned not to expect a quick recovery in the face of intense competition (see Germany: 8 December 2006: New Deutsche Telekom CEO Does Not See Quick Recovery in Customer Losses, World: 6 December 2006: Deutsche Telekom Reshuffles Top Management and World: 13 November 2006: Deutsche Telekom Appoints Obermann as New CEO). This was already a signal to investors not to raise their hopes too high as the German incumbent is unlikely to stem customer losses in the short term, reflecting the fact that turning around the group's domestic operations in Germany, where Deutsche Telekom has lost ground to major competitors, would be the biggest challenge for the new CEO. Under Obermann's customer-oriented strategy, the company is planning to step up its investments in 2007 on a number of marketing initiatives in an attempt to recover its German business and position it for growth in the long term. The company announced last week its new organisational structure at its domestic business in efforts to deal more effectively with competitive pressures in Germany. The move reflects an integrated market approach for its T-Com, T-Mobile Deutschland and T-Punkt units, while its internet unit, T-Online, becomes the group's centre for product development headed by Christopher Schlaeffer, formerly the group's Chief Strategy Officer (see Germany 24 January 2007: Deutsche Telekom Reorganises Consumer Unit in Germany and Germany: 8 January 2007: Deutsche Telekom Reiterates Plans to Focus on Costs and Price Cuts). The company is planning to revitalise its distribution network in Germany, as it opens an additional 200 T-Punkt retail outlets, in efforts to boost its broadband market share and maintain its leading position in the mobile sector. 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. In an attempt to increase the scale of its IP TV services, Deutsche Telekom earlier this month dropped its controversial plans for its hefty 3-billion-euro VDSL roll-out in Germany, instead opting for more cost-effective ADSL2+ technology. The VDSL network linked only 10 major cities in 2006 at the cost of 500 million euro, but the planned roll-out to a further 40 cities in 2007 was postponed. The tactics will enable the telco to expand the reach of its advanced IP-based services significantly and speed the take-up of IP TV services among its DSL customers (see Germany: 15 January 2007: Deutsche Telekom Changes Its VDSL Roll-Out Strategy). However, the demand for T-Home is expected to develop slower than expected in the short term. T-Home registered 25,000 customers since its launch in October last year, which rendered its investment in VDSL unprofitable (see Germany: 12 January 2007: Deutsche Telekom Registers 25,000 IP TV Customers).