Some investors are dialing up their bets on large European telecommunications companies, but shares struggle to recover previous highs amid a challenging near-term industry outlook due to muted top-line growth, stiff competition and heavy investments, analysts say.
The sector is in the middle of a costly transition to upgrade its infrastructure to 5G technology and to replace copper with more modern fiber-optic cables that transmit data faster. This, together with a combination of challenges that include weak revenue trends due to competition and high debts as a result of past mergers and acquisitions, have weighed on European telecom stocks.
Among Europe’s five largest telecom operators by market capitalization, only Deutsche Telekom’s shares trade clearly above their prepandemic level. The company’s T-Mobile US subsidiary makes it the only European telecom company with exposure to the U.S., which together with China are the global economic growth engines, Deutsche Bank analyst Robert Grindle said.
“They have done very well having enjoyed a better environment for telcos in the U.S. than in Europe. The U.S. economy has been stronger than in Europe and in that market there are fewer players and T-Mobile US has gained share,” Grindle said.
Meanwhile, shares in Telefonica, Orange and Vodafone haven’t returned to levels before the pandemic. While Swisscom’s stock exceeded prepandemic levels in 2022 and earlier this year thanks to investors’ perception of the company as a relative safe haven, a recent pullback due to competition fears in its home market left it trading roughly where it was in February 2020.
At 1006 GMT, the pan-European Stoxx Europe 600 Telecommunications sector index is up 5.5% year to date, but lags behind the 6.6% gain by the broader Stoxx Europe 600 index.
“I think the reason why investors aren’t interested is because they don’t believe the industry has pricing power, and it’s regulated whenever it’s successful,” Citi analyst Georgios Ierodiaconou said.
Over the course of the year, analysts have cut their earnings expectations for the industry. Earnings per share for the Stoxx Europe 600 Telecommunications index are now expected to fall 4.3% in 2023, according to consensus estimates compiled by FactSet. At the beginning of the year, analysts were projecting EPS growth of 3.8% for the index, according to the data.
In order to convince the public market, the industry’s revenue trends need to improve, and consolidation could help them achieve top-line growth, Berenberg analyst Usman Ghazi said. The other factor that could potentially motivate investors would be a shift in the antitrust European regulation, which seems unlikely for now, he said.
Meanwhile, the companies’ sluggish stock performances makes them vulnerable to external approaches, analysts say.
“In the absence of [telecom company] share prices going up and becoming more expensive, we will likely see more private equity, infrastructure funds and sovereign wealth from within and outside of the European Union investing in the sector,” Deutsche Bank’s Grindle said. Gulf investors with cash in hand who seek to earn long-term returns are showing interest, he added.
Among those were Saudi Telecom Co., which took a 9.9% stake in Spain’s Telefonica recently, and Emirates Telecommunications Group—known as E&—, which became the largest shareholder in the U.K.’s Vodafone Group.
But there is sensitivity among European governments on ownership of telecom companies from other jurisdictions, Grindle said. Spain’s acting Prime Minister Pedro Sanchez said at an event last week that the government is closely analyzing STC’s involvement in Telefonica.
Besides buying stakes in listed companies, STC could target telecom assets that become available from time to time, Citi’s Ierodiaconou said. “Six months ago, this was not on the table, but now things are changing.”
While the public market finds it difficult to value European telecom companies, there are reasons to be upbeat on the long-term prospects for the industry despite current challenges, Grindle said.
Though the industry’s investment in fiber networks squeezes cash flow and dividends in the short term, it also creates assets that will last for many years, he said.
Write to Andrea Figueras at andrea.figueras@wsj.com and to Adria Calatayud at adria.calatayud@dowjones.com
