Telecommunications network operators: 2Q20 market review, MTN Consulting
The global telecom market saw YoY declines in both revenue and capex in 2Q20, for the second consecutive quarter. Lower revenues from roaming, advertising, and equipment sales contributed to a 5.4% YoY reduction, bringing overall market revenue to $427B in 2Q20. Exchange rate volatility also contributed to the decline. The pressure was felt more for telcos with exposure to Brazil, Argentina, Mexico and Chile. Revenue in USD fell on average by 28% YoY in 2Q20 for these LATAM markets.
Telco capex also mirrored the declining revenue trend, as it slid 6.2% YoY and touched $65.5B in 2Q20. Annualized capital intensity remained at 16.0%, the same level as 4Q19 and 1Q20; no 5G spending splurge is in sight. Barriers to capex spending include macroeconomic strain, a need to conserve cash, Chinese vendor risk, and uncertainties around how telcos will monetize 5G. Telcos also held back on discretionary spending due to future enterprise spend worries. Looking ahead, TNOs are likely to revisit their capex budgets and slash spending on 5G.
Key findings from our review of the data in 2Q20 include:
1) Revenues: Global telecom revenues in 2Q20 were $427B, down 5.4% from 2Q19. There are multiple reasons for this decline: decrease in handset sales due to closure of retail stores and supply chain disruptions and decline in roaming revenues arising from global travel restrictions. Mobile handset production also has been under pressure from the supply side, due to shortage in components and stalling of related supply chains caused by labor shortages and logistic disruptions. On a regional basis, the YoY revenues in 2Q20 fell across all the four regions, most notably in Americas (8%), followed by Europe (5%), MEA (4%) and Asia (2%). Though operators worldwide have tried to balance the impact from reduced prepaid and roaming revenues with uptake of higher fixed internet services and post-paid usage, the top-line growth continued to fall steeply due to the overall decline in economic activity.
2) Capex: Overall capex declined by 6.2% YoY to $65.5 billion in 2Q20. The industry’s annualized capex to revenue ratio was 16% in 2Q20, compared to 16.5% a year ago, as telcos prioritized their investment on maintenance and capacity upgrades rather than network coverage expansion projects. Telcos, especially in Europe, witnessed reduced capex spending as a precautionary measure to conserve cash for future spectrum auctions. By contrast, Chinese telcos are racing ahead with investments in network buildouts. The combined capex of the big three telcos in China reached $24B in 1H20, up 15% YoY. China’s preparation for 5G is well underway: the country began 2020 with ~130K 5G base stations, added 280K in 1H20, and aims to reach 600K 5G enabled base stations by end of 2020. China’s progress in 5G deployment is due to a government push, and has benefited key local vendor Huawei. That has come as a relief to Huawei given the spread of bans on its participation in 5G networks in a number of European and Asian markets.
3) Employees: Telcos employed 5.1M people in 2Q20, down 2% YoY. Global telco headcount has been relatively stable for several years, due in part to growth in Asia, but the 2020 recession could change this. In India, government-owned telecom players BSNL and MTNL slashed their headcount by 54K in 2Q20 compared to a year ago. In the US, the combined headcount of AT&T and Verizon declined by over 4% YoY in 2Q20. M&A deals also often result in workforce redundancies as there is a natural overlap of job roles, for example, T-Mobile’s integration with Sprint will also result in headcount reduction. The pandemic situation has put customer service jobs at risk as telcos are investing in chatbots and other AI enabled voice-based systems to cut costs. On the retail front, layoffs are on this rise with consumers opting for online purchases.
4) Revenue & labor costs per employee: On a revenue per employee (RPE) basis, the telco sector has been stagnant since 2011: the annualized figure was $363K that year, and the average figure for the last four quarters was $347K. By contrast, annualized RPE in the webscale sector exceeded $526K in 2Q20. Telco labor costs per employee, on an annualized basis, increased from $55.8K in 2Q19 to $56.1K in 2Q20.
5) M&A: The M&A climate continues to remain strong for the sector in 2020. Many telcos see their core markets declining and are buying their way into other markets while also streamlining their asset base. Noteworthy deals in 2Q20 include the merger of the UK-based Virgin Media (subsidiary of Liberty Global) with O2 (owned by Telefonica), and the merger of T-Mobile and Sprint. Some telcos are also investing in companies with significant software capabilities. Verizon’s acquisition of BlueJeans, a B2B video conferencing company, is one such example. Amidst consolidation, there are also some examples of small or new telcos emerging to impact broader markets, including Rakuten in Japan, Dish Network in the US, and Dito Telecommunity in the Philippines.
6) Profitability: Operating margins have been stable for the last 11 quarters, averaging around 13.6%, on an annualized basis. Single quarter operating margins, on an annualized basis, increased in 2Q20, to 14.1% from 13.6% in 2Q19. The rise in margins is due to a fall in opex (excl D&A) which declined by 6.8% in 2Q20 versus 2Q19. The decline in opex (excl D&A) was due to store closures and reduced spending on selling and marketing activities. EBITDA margins have been on the rise as well, with the growth recently stemming from weak capex results (which tends to reduce D&A expenses).
European telcos save cash for spectrum auctions, and sell tower assets to meet rising network costs
Operators with a presence in France, Austria and Spain saw a major YoY decline in their capex spending and capital intensity in 1H20, as they are saving cash for the upcoming spectrum auctions. French telecom regulator Arcep postponed the sale of spectrum in the 3.4 GHz to 3.8 GHz bands from April 2020 to September 2020, while Spain and Austria are yet to select dates for their auctions. Auctions for 5G spectrum in Germany and Italy raised over $7.4B each, so these are significant costs to manage. Telcos’ plan to invest in spectrum auctions in the near term is one factor behind why their current capex spending is low.
Faced with high debt, European telcos are also spinning off their tower assets to investors or independent tower companies. In 2Q20 alone, the region witnessed four major deals: Telecom Italia and Vodafone’s sale of their 9% combined stake in tower company INWIT; Telefonica sold its German tower assets to its subsidiary Telxius; Phoenix Tower purchased wireless tower assets from Irish telco eir; and Spanish telco NOS sold tower assets to Spanish tower company Cellnex. Such asset divestments are now a common phenomenon and can work well for both the parties, the independent tower companies and telcos. The telcos raise capital through asset sales and the tower specialist gets a long-term customer. Going forward, the region is likely to see more such M&A activity in this space as telcos weigh the value of their tower assets with the rising costs to build 5G networks.
Telcos are embracing OpenRAN technology to cut network costs
Operators worldwide are looking beyond their existing vendor gear manufacturers and embracing Open Radio Access Networks (OpenRAN) technology. In typical RAN deployments, proprietary protocols are commonplace, and the hardware and software are purchased from a single vendor, who then maintains and upgrades the systems leaving telcos with limited flexibility and options. OpenRAN disaggregates the RAN at both the hardware and software levels providing telcos more flexibility to build the RAN from multiple vendors.
Additionally, the uncertainty surrounding Huawei and the heavy costs involved in replacing it with other vendors is pushing telcos to consider OpenRAN. For instance, according to a German media outlet Handelsblatt, a ban on Huawei in Germany would cost Deutsche Telekom (DT) almost $3.5B over a five-year period as it would mean replacing antennas and other components that DT purchased from Huawei with another vendor’s equipment. The ban could also reduce supplier competition, leaving the market with just two key vendors – Ericsson and Nokia. Telcos are therefore looking to partner with software vendors like Altiostar, Mavenir and Parallel Wireless. Moreover, government support for this technology is an added advantage. For instance, the Trump administration has set aside OpenRAN funding of $1B to support these software vendors.
However, commercial deployments and managing the networks using OpenRAN will not be easy and certainly not cheap. Despite claims by Japanese operator Rakuten that OpenRAN can help telcos reduce overall capex and opex by 40% and 30%, this might not be true – or might at least be very specific to Rakuten’s network situation. Telcos will need to conduct multi-vendor interoperability tests of the infrastructure products before going live – and this would involve significant costs. The testing process is even more crucial where the RAN components – such as the central unit, distributed unit and radio unit – are sourced from multiple vendors. Traditionally, having a single vendor made it easy for telcos to resolve network performance issues. However, with OpenRAN, the telco must depend on system integrators and suppliers of different network components, making it difficult for the operator to identify the source of network performance issues.
Telcos are relying on dynamic spectrum sharing (DSS) for faster 5G rollouts
Telcos are slowly leaning on DSS technology – a process of using existing spectrum to deploy 4G and 5G services – as a short-term measure to meet rising network traffic demands. This is especially useful when 5G spectrum is inadequate, often the case in markets where auctions have been delayed or priced unreasonably. For instance, in the Netherlands, VodafoneZiggo has been providing 5G service with the help of its DSS supplier Ericsson –possibly because of scarce availability of mid-band spectrum (much of which is used by the country’s defense satellite system).
Telcos’ stance on DSS appears varied, though, and mostly driven by their spectrum holdings. In the US, for instance, T-Mobile seems less enthusiastic about using DSS. The reason is straightforward – the telco has accumulated large amounts of low and mid band spectrum post-Sprint acquisition which allows them to depend less on DSS. This contrasts with AT&T and Verizon who have been vocal about their plans of deploying DSS. In June 2020, AT&T rolled out 5G services in 28 additional markets using DSS while Verizon is working closely with Ericsson and Nokia and completed trials of DSS technology using low-band spectrum.
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