Number crunchers turn positive on telecoms

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Deutsche Telekom's slow progress in selling assets has worried the ratings agencies

Should credit investors be starting to look favourably at European telecom bonds despite the volatility of the market?
Immediate indications suggest not. There are still credit concerns about France Telecom's contingent liabilities and at Deutsche Telekom deleveraging is making slow progress. Vodafone faces questions about whether goodwill from acquisitions is overstated on its balance sheet.
Technical factors are also worrying investors. The frantic hedging efforts of bank lenders committing themselves to France Telecom's e15 billion ($13 billion) syndicated refinancing facility last month blew out the company's spreads in the credit default swap market, spooking bondholders.
Some analysts take all this on board but are fundamentally optimistic. "It's a really frenzied environment at the moment", says Satyajit Chatterjee, a TMT fixed income credit research analyst at HSBC. "Credit default swaps have driven spreads wider as a result of negative news flow from France Telecom, Deutsche Telekom and ratings downgrades from telco equipment suppliers Alcatel and Ericsson." But he concludes: "We're positive on the sector as a whole for its defensive qualities".

Rick Deutsch, head of Europe, Japan, Asia/Pacific investment grade research at BNP Paribas, takes a similar view. Speaking at the Euromoney bond investors congress in London last month, he said that he expected the market to rally early in the summer once the major credit concerns surrounding heavyweights France Telecom and Deutsche Telekom had been played out. He also cited the greatly reduced level of new issuance expected this year as a potential support for bond prices. According to bankers, European telecom operators are expected to issue bonds worth between e25 billion and e30 billion this year compared with e80 billion in 2001.
The telecom sector's fundamentals show signs of dividing the players into two distinct groups. Vodafone, BT, and Telefónica have made substantial moves to bring down their debt. Add to these KPN, the recovered fallen angel. Any investor unlucky enough to buy its bonds late last July would have lost more than 20% of his money in about six weeks. Buying in early October would have meant a 24% gain in under two months. Once the company replaced its CEO, began considering assets disposals and completed is rights issue, its bonds recovered very quickly.
France Telecom and Deutsche Telekom, however, still await the resolution of some key credit defining issues. Management disagreements and accusations traded between France Telecom and MobilCom, its German partner, have added to worries that the French operator could be forced to consolidate MobilCom and its more than e6 billion of net debt (see page 49).
Opinions are divided over Deutsche Telekom. Joeren van den Broek, head of investment-grade strategy at ING in Amsterdam, argues that the German operator's bonds show more value than others such as BT and France Telecom. He also argues that the company has substantial scope to reduce its debt through the sale of cable assets and the flotation of wireless subsidiary T-Mobile, expected to raise about e10 billion. Van den Broek also expressed faith in the company's strategy. "Deutsche Telekom's strategy has historically been very strong, compared with say France Telecom or KPN. They are very committed to their debt reduction target." HSBC's Chatterjee is less optimistic. "Both the sale of its cable assets and the IPO of T-Mobile have a high execution risk. Chris O'Hare, a telecoms analyst at Investec Asset Management, agrees. "Deutsche have a slim chance of selling their cable network to Liberty Media, and the IPO of T-Mobile may have to be delayed for as long as a year. There is also the possibility of a ratings downgrade".
These fears were recently confirmed. First, Ron Sommer, Deutsche Telekom's chief executive, announced on February 22 that the IPO of T-Mobile could be delayed until 2003 because of the volatile state of the equity markets. Then on February 26 the German Cartel Office formally rejected the sale of its cable assets to Liberty Media. Although other parties such as Compere Associates, Klesch&Co and Callahan Associates International LLC, have expressed an interest in the cable division analysts doubt whether they would be willing to match Liberty's offer. Also, both Moody's and S&P have announced that they are reviewing the company's ratings for a possible downgrade. A one-notch downgrade could add as much as an additional e100 million in interest payments.
O'Hare also cites the problems surrounding UK company Energis and its failure to secure support for its $1 billion bid to buy a Belgian cable network as a worrying indication that banks might be increasingly cautious in lending to some telecom firms. "We are cautiously optimistic about the telecom bond market, but think we have to wait and see a bit longer," he says.
There is greater consensus on the outlook for Dutch carrier KPN. Its asset disposals have helped to bring down it debt to Ebidta ratio to more manageable levels and the management's commitment to turning its free cashflow positive in 2002 is now seen as credible.
While management's ability to deliver on its promises still remains to be seen, the consensus seems to be that the bonds, if not a bargain, are a safe investment once more.

Abigail Hofman:

No. 6: If you don’t give it to me you’ll only lend it to someone else and look where that got us

Number crunchers turn positive on telecoms

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