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Deutsche Telekom - Sprint merger boosts results

Nicholas Hyett, Equity Analyst | 26 February 2021 | A A A
Deutsche Telekom - Sprint merger boosts results

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Deutsche Telekom AG NPV

Sell: 18.82 | Buy: 18.82 | Change 0.02 (0.10%)
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Deutsche Telekom's full year net revenue rose 25.4% to €101.0bn mainly because of the Sprint acquisition in the US. Excluding the acquisition revenue grew 3.0%.

Adjusted cash profits (EBITDA AL) rose 41.6% to €35.0bn, again reflecting the impact of the acquisition. In organic terms cash profits rose 7.9%.

Management is proposing a full year dividend of €0.60 per share, in line with last year.

The shares were broadly flat in early trading.

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Our view

Despite being a German company, Deutsche Telekom (DTE) makes the bulk of its revenue and profits in the US through subsidiary T-Mobile. The merger with rival Sprint makes the US bigger still.

The deal has much to recommend it. While Sprint had been struggling, it owns a large chunk of valuable mid-band spectrum and DTE estimates that cost savings will outweigh integration costs after three years.

The combined group should have both the bandwidth and scale needed to take on Verizon and AT&T in the US 5G market but mergers always come with risks, especially one of this size. Either way any material benefits are unlikely to be realised before 2023, though management is enthusiastic about progress.

The tie up has led Standard & Poor's, a credit ratings agency, to downgrade the group from a "BBB+" rating to "BBB ". Integrating Sprint will be costly and complicated, and Standard & Poor's expects it'll reduce free cash flow in the near term - increasing the burden of the group's substantial debt pile.

It doesn't help that telecoms is a difficult industry to do well in.

Firstly, building and maintaining modern communications infrastructure, like towers, cables and data centres, costs a fortune. Add the ever increasing payments to governments for spectrum rights, and the capital requirements of the business become truly eye watering. In 2020 alone Deutsche Telekom spent €18.7bn in cash on investments and spectrum. Spectrum investment varies considerably year to year and are long term investments, so telcos typically report free cash flow excluding these payments. But they're a real cost, and investors should keep a close eye on them.

Secondly, the industry lacks pricing power. Telcos compete primarily on price, which leads to pretty feeble margins and meagre returns on the massive amounts of capital employed. This is why telcos are bundling broadband and mobile data with entertainment services and other perks, and in DTE's case Magenta TV is a big part of the offering. The idea is to offer something meaningfully different that justifies higher pricing. Unfortunately it's led to something akin to an arms race as each provider hunts for unique content to bolster its offer.

Debt has mounted as a result, especially since the merger, and efforts to keep it in hand recently led management to trim the dividend. The group intends to pay a minimum dividend of 60 eurocents per share until 2022, although nothing is guaranteed. We doubt investors will see much if any dividend growth until Sprint has been properly embedded, and that's conditional on the integration going smoothly.

In the medium term DTE's fortunes are largely dependent on the Sprint merger. We think the strategic rationale makes sense, but executing is another matter. If all goes well the combined group could be formidable and the dividend could rise in the medium term. If not the group may struggle beneath its capital requirements and debt load.

Deutsche Telekom key facts

  • Price/Earnings ratio: 13.2
  • 10 year average Price/Earnings ratio: 15.3
  • Prospective dividend yield (next 12 months): 4.1%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Full year results

US revenue increased 55.0% in dollar terms to €61.2bn, primarily reflecting the Sprint acquisition without which revenues would have risen 5.0%. This reflects growth in both Equipment and Service revenues, mainly due to the merger. Adjusted cash profits rose 92.8% in dollar terms to €21.0bn and cash capex increased 67.3% to €10.4bn.

In Germany revenue was up 0.2% to €23.8bn, reflecting growth in fixed line broadband which offset lower mobile revenues. Consumer revenue rose 1.0% and Business revenue fell 1.0%. Adjusted cash profits rose 1.6% to €9.2bn thanks to increased revenue and cost efficiency. Cash capex fell 5.5% to €4.2bn, mainly due to accounting changes for spectrum investment.

Europe generated €11.3bn in revenue, a decrease of 2.2%. When the sale of Telekom Albania and currency movements are excluded revenue was stable. Management described the fixed network business as "solid", but the mobile business struggled with lower roaming charges as a result of travel restrictions. Adjusted cash profits increased 2.1% to €3.9bn when Telekom Albania and currency are excluded, reflecting lower costs in personal, travel and marketing. Cash capex rose 22.0% to €2.2bn, largely due to increased spectrum costs, primarily in Greece and Hungary.

Systems Solutions generated adjusted cash profits of €235m, down 6.0% on last year. Cash profits from Group Development rose from €1.0bn to €1.1bn.

Net debt increased €44.2bn from the end of 2019 to €120.2bn, which is 2.8 times adjusted cash profits. This primarily reflects the debt acquired as part of the Sprint merger. Adjusted free cash flow fell €0.7bn to €6.3bn. Cash capital expenditure was €17.0bn before spectrum investment and €18.7bn including it.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.