KPN: looking back to the Eelco Blok era

The end of the current KPN executive board could be near, so let's take a moment to look back to the Eelco Blok era, that started April 6, 2011. Let's first focus on things that didn't go so well.

• Finance/corporate
• Profit warnings: at 11Q1, and 11Q4.
• Dividend reductions: at 12Q2, 12Q4 and 13Q1.
• Rights issue: at 12Q4.
• Failed sale plans: Base (2012) and E-Plus (2012).
• Failed acquisitions: Caiway (2012).
• Overpaying (that is, what the market perceives) for Dutch 4G licenses: Dec. 2012.
• Sale of E-Plus to Telefonica: no consent form major shareholder and silence on what the cash will be used for (having just raised EUR 4bn in a rights issue): at 13Q2.
• Replacing most executives, threatening continuity.
• Business/government relations
• Raid by cartel office: Dec. 2011.
• Increased oversight by regulator: Dec. 2011.
• Attempts to control OTT services, leading to Net Neutrality regulation.
• Hassle over large government contract, in the end losing it to Tele2: 2011-2013.
• Fine KPN Business over illegal discounts: Jan. 2013
• Business/strategy
• Ortel expands into Europe, then is sold.
• Handset lease model introduced (2012) and abolished (2013).

As a result of all this, the share price dropped and the interest of investors was aroused. In the end, America Movil stepped in and will most likely replace current management.

The roll-out of new networks was somewhat successful. The LTE network was largely constructed even before the auction ended, allowing KPN to launch services just six weeks later. Pricing however hasn't been convincing. The FTTH efforts were strengthened by expanding the Reggefiber stake, by acquiring Reggefiber and Reggeborgh units, and by signing Vodafone, Tele2 and CanalDigitaal as wholesale customers. Still, adding 400k HP per annum is just too slow (see next post). When it comes to WiFi, the deal with FON took a long time to materialise and be implemented.

How about the services? TV and triple play services haven't been convincing for a long time. On the OTT front, cooperation was limited to Spotify.

All in all, there hasn't been a clear focus or growth strategy. Management was surprised by changing market conditions on many occasions, leading to a long list of profit warnings and dividend reductions. KPN turned into a defensive player with a hybrid strategy on several fronts.

No need to be afraid of America Movil

America Movil's planned offer for KPN worries some people. There are probably two reasons for this:

• Security: the importance of vital national infrastructure. Roads, railroads, water, gas, even electricity: they remain in government hands, even if services companies have been sold.
• Financial: the risk of breaking up the company, load it with debt, sell-off subsidiaries, extract cash, etc. The TDC scenario looms, i.e. the risk of under-investment.

As to the first, infrastructure is abundantly present and most routes have probably long been duplicated by the likes of Eurofiber (now majority-controlled by Doughty Hanson), Tele2 (incl. Versatel, BBned), Relined (government), BT, Verizon, etc. KPN is still dominant in the access network (DSL, FTTH, FTTO), but not in backhaul and long haul or in connecting network nodes and data centers. Business customers in many cases require redundant connections, i.e. from different providers. Further, there is ample regulation in place that KPN has to adhere to.

There is probably a sentimental reason for being worried as well: after all, America Movil is led by the world's wealthiest man, who unashamedly collected his wealth in a poor country. You can read all about it in this chapter. But if you read carefully, you will learn that:

• Carlos Slim is crazy about money. It is not he who fails (!), it is the Mexican government, that granted Telmex a 6 year monopoly and has since been unable to regulate the market in a proper way. You can blame Slim, but he acts merely like the hacker (or a Nick Leeson) who is looking for weaknesses in the system. It is the country that fails, and if it weren't for Slim, somebody else would have taken advantage.
• The Slim empire and Mexico have an 'unhealthy symbiosis', the writers claim. A monopoly does lots of harm, especially in a poor country. It remains to be seen where Mexico would have been without this company gathering all this wealth around it.
• Slim is now a major philanthropist, but this is all dismissed as 'white-coating', for PR reasons. He is also accused of 'green-washing'. While donating to charity and investing in green technology, Slim supposedly maintains an empire of companies that violate everything charitable or green. However, this is only underpinned by his stakes in cigarette production and by "customers who complain about high consumer rates and unstable connections". This doesn't seem to be enough to completely dismiss his good intentions.

Judge for yourself, but it is Mexican politics that is failing (and hell, all of capitalism if you will). Carlos Slim doesn't appear to be any worse than other people having been able to collect filthy amounts of money.

As to the second reason for worry over America Movil's involvement with KPN, this seems unjustified. America Movil isn't private equity, but a telecoms company. KPN may be broken up, but that isn't necessarily a bad thing. Especially if fixed and mobile are allowed to compete on the Dutch market. And if the government finds a way to block the takeover, they could still break-up KPN along the passive/active line, and deny America Movil the right to acquire passive network elements in the Netherlands. There will be plenty of interest in owning passive components (NBN, CIF, IPO, ...).

What will America Movil do with KPN's Dutch fixed-line network?

What's next in the battle for KPN/E-Plus, now that America Movil stated that it plans to offer 2.40 EUR/share for the remaining 70.23% of KPN that it doesn't already own (aiming for an acceptance ratio of at least 50%).

First, let's establish that this is all about E-Plus:

• AMXL has an interest in mobile only, as it sees an opportunity in Europe with low 4G penetration.
• Base (Belgium) is too small and KPN Mobile NL is small as well and too much hooked up to the fixed-line network. Hence, it's all about E-Plus.

Next, let's establish that AMXL is not amused with KPN's action to sell E-Plus to Telefonica Germany:

• AMXL's interest in KPN only pertains to E-Plus (see above).
• KPN apparently sold E-Plus without the approval of the AMXL supervisory board members (2 out of 8). Note: AMXL spent billions buying its 30% stake and supported KPN´s rights issue.
• AMXL cancelled the shareholder agreement, paving the way for the intended offer for KPN.

What will happen to E-Plus? A merger with Telefonica Deutschland will unleash synergies valued at EUR 5.0-5.5bn by KPN and Telefonica.

• KPN may still succeed in selling the asset to Telefonica Deutschland, because of the timing of its EGM. AMXL may then withdraw its offer for KPN, but will still be stuck with its 30% KPN stake.
• AMXL may stop the sale of E-Plus to Telefonica Deutschland, either through its intended takeover of KPN or through the KPN EGM (note: AMXL may already be a KPN stock buyer and have its stake increased beyond 30%). The KPN management will likely be replaced. America Movil may hold on to the mobile activities and sell the Dutch fixed-line operation. Next, AMXL may try to buy Telefonica Deutschland.
• Telefonica may launch a higher offer for E-Plus, trying to get approval from America Movil. If it succeeds, America Movil is stuck with the Dutch/Belgian assets of KPN.
• A third party may launch a counter offer for E-Plus. Only Liberty Global seems to be a candidate, as it too will see synergy potential from a takeover. Liberty is expanding into mobile and has a country-by-country approach, ranging from a full MNO in Chile to a 'heavy' MVNO in Belgium (with 2100 spectrum) and other places, to a WiFi focus in the Netherlands (with 2600 spectrum).

What will happen to the Dutch fixed-line activities of KPN?

• If AMXL gets stuck with the Dutch and Belgian units of KPN only, it may try to sell its stake (either 30 or 100%) in due course.
• If AMXL ends up with all of KPN, it may sell the Dutch fixed-line activities. In theory, there are several candidates: the Dutch government (afraid this 'vital' asset to come under foreign ownership), CIF (the Communication Infrastructure Fund managed by Rabobank, whose ideal is to create a national venture controlling all passive network elements in the Netherlands), the public (in an IPO) or a competitor (Vodafone certainly is a candidate, especially now that it is buying Kabel Deutschland).

All in all, it seems likely that AMXL will end up controlling KPN, including E-Plus. The question then is: will it separate the mobile and the fixed-line activities in the Netherlands? And what will then happen to the latter?

What will be the consequences for KPN Fixed? This will obviously depend on who ends up owning it.

• If KPN's Fixed and Mobile activities in the Netherlands are kept together, not much may change.
• If Fixed and Mobile are separated and KPN Fixed is sold, there will be competition between KPN Fixed and KPN Mobile/AMXL, as KPN Fixed may embrace a mobile strategy of some kind.
• KPN Fixed may increase network investments, which will be bad news for Ziggo and UPC.

Finally and in summary, here are the wild cards:

• Liberty Global may make a counter offer for E-Plus.
• Vodafone may buy KPN Fixed NL.

Proof is finally in: FTTH beats cable networks

Never trust the FTTH or the cable lobby for predicting the future. But the recent numbers from Ziggo and UPC NL are starting to show that indeed cable infrastructure is NOT future-proof. There is a clear relation between the rise of FTTH (and even VDSL) and the deterioration of the cable market in the Netherlands.

The point is that the fiber lobby has been stating for years that cable networks have inferior infrastructure. However, one could never tell from looking at the numbers, but that is now changing.

Ziggo and UPC have entered a phase of negative revenue growth (UPC NL Q2: -2.0%), network penetration is dropping (UPC NL: now below 60%), loss of market share on the video market is accelerating, growth on the broadband/VoIP market is slowing and is only sustained by upselling 3P's to 1P and 2P subs.

At the same time, profitability is falling to a structurally lower level: Liberty Global: "... the Netherlands is experiencing significant competition from the incumbent telecommunications operator, who is overbuilding our network in the Netherlands using FTTH and advanced DSL technologies. As a result, the Netherlands is experiencing lower operating cash flow margins during 2013, as compared to 2012, and we believe the Netherlands will be challenged to maintain its current operating cash flow margin during the remainder of 2013 and future periods".

Entering the mobile market, not with a WiFi-based network (as Ziggo has been testing) but with a true MVNO, will boost revenue growth. But there is much less room to maneuver on the Dutch market, compared to Belgium where Telenet shows +12% revenue growth. And worst of all: margins of an MVNO are very small and will first be negative, further reducing profitability.

And it's not only opex that is rising, it is capex as well. At the end of 2009, capex/rev (-12 months) at UPC NL stood at 13.1%, it now stands at 19.2%.

Hence, a merger of Ziggo and UPC makes sense - for the short term. But it will be only a matter of time before Liberty Global decides to abandon the Dutch market. Two losers can't make a winner.