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Deutsche Telekom - more progress in the US

George Salmon | 9 May 2019 | A A A
Deutsche Telekom - more progress in the US

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Another strong showing from the US business has helped Deutsche Telekom's first quarter underlying revenue rise 3.5% to EUR19.5bn. Underlying EBITDA rose 8.3%, or 3.9% at constant exchange rates, to EUR5.9bn. All operating segments delivered growth.

With the results broadly in line with expectations, the shares were little changed on the news

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Our view

Deutsche Telekom is one of Europe's biggest telcos, and management are intent on making it bigger still.

The group's US subsidiary is looking to acquire rival network Sprint in an all-share merger. Due to the heavyweight nature of the deal, the regulator has a close eye on it. Investors shouldn't count their chickens prior to its final decision, which is due later in the year. But there are several attractions to the tie-up.

Firstly, there's the benefit of scale. The combined US business would generate revenues of around $73bn and the group expects to derive close to $6bn in annual cost savings. That underpins DT's confidence that the merger would boost cash flow and profits 3 years after closing.

There are strategic reasons for merging too.

The US market has four big suppliers. AT&T, Verizon, Sprint and T-Mobile. T-Mobile had been last in the pecking order, but a disruptive, flexible pricing strategy helped it take significant market share. DT wants the management that oversaw that transformation to repeat the trick with the struggling Sprint business.

Spectrum licences should dovetail nicely too. Not all bandwidths are made equal, and T-Mobile doesn't have the mid-range frequencies it needs to support the roll-out of 5G nationwide. Sprint does.

We think this part of the deal is important to DT. While there are improvements in the US and signs the group' building a popular integrated TV, phone and broadband offer in Europe, the cost of acquiring mobile spectrum is a perennial problem.

Bandwidth is sold off via auction by governments, and these outlays, which topped EUR7bn in 2017, mean free cash flow hasn't always covered the dividend. The general trend has been for prices to increase year-on-year too.

Still, we think the balance sheet looks solid enough, with leverage reasonable when compared to both cash earnings and assets. That should support the 5.1% prospective dividend in the short-term. Longer-term, the group has adopted a policy of linking the payout with earnings.

We think market share gains offer the potential for profits to rise, but at what rate depends on the fate of the merger.

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First quarter trading details

The group had 179.1m mobile customers as at 31 March, up 9.2m from a year prior. The group also saw the number of broadband contracts rise 1.5m to 20.6m.

Growth in both areas was driven by continued progress in the US, which helped underlying divisional revenues rise 7% to EUR9.8bn. After excluding one-off costs including around the proposed Sprint deal amd favourable currency movements, adjusted EBITDA rose 6.2% to EUR2.7bn. Churn now stands at 0.88%, an improvement from 1.07% in Q1 last year.

In Germany, the number of customers signed up to the MagentaEINS fixed-network and mobile offering rose 17.1% to 4.4m. That more than offset the decline in wholesale and other customer numbers, as customers migrate to their own networks, helping revenue rise 0.6% to EUR5.4bn. EBITDA rose 2.4% to EUR2.1bn.

Elsewhere in Europe, the deactivation of 2.4m Austrian SIMs saw customer numbers fall 5.4% to 47.8m. Broadband and TV customer numbers were broadly stable. Underlying EBITDA rose 1.5% to EUR945m.

Underlying EBITDA in the Systems Solutions business, which provides IT services to large multinational corporations, rose 53.3% to EUR92m. That reflects growing cloud businesses and improved efficiency following a restructure of the core IT business.

Free cash flow rose from EUR1.3bn to EUR1.4bn, as the higher profitability was only partially offset by a 22.6% increase in the capital expenditure, to EUR3.8bn, including EUR145m on spectrum. Net debt increased from EUR55.4bn to EUR71.9bn, however once the impact of an accounting change that requires some leases to be reclassified as part of debt is excluded, the position increased by EUR850m.

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