European telecom companies poised for growth amid deregulation

The outlook is brightening for European telecommunications companies, says Andrew Lee, head of the Technology, Media, and Telecom Group in Goldman Sachs Research. That’s in large part because the prospects for greater pricing power and industry consolidation have improved as regulators focus more on Europe’s competitiveness.

This is bullish news for an industry characterized by slow or no growth for years. Since this improving outlook is not yet fully reflected in consensus forecasts or investor expectations, Lee says these developments may well serve as a catalyst for higher stock prices.

We spoke with Lee after Goldman Sachs’ European Communacopia Conference, where executives discussed the outlook for telecom growth into 2025 and the recent report on EU competitiveness by Mario Draghi, former head of the European Central Bank.

What were you hearing from telecom executives during the European Communacopia conference?

We’ve seen an acceleration in growth and an improvement in returns in the European telecom sector, driven in our view by deregulation of digital infrastructure. But investors don’t believe the acceleration is sustainable. So if we look at consensus models, they show a deterioration of growth into 2025, and share prices reflect that.

What we learned from the CEOs and CFOs of some of the most important European telecom companies who spoke is that the acceleration — the higher rate of growth they’ve been delivering — is sustainable into 2025. This is because they have seen increasing pricing power in fiber broadband, thanks to deregulation. Also, they’re better able to deliver to their potential in some of the more concentrated mobile markets in Europe.

What kind of growth numbers are we talking about?

We’re seeing 2-3% top-line growth across the most attractive companies, and 4-5% or more growth in EBITDA (earnings before interest, taxes, depreciation, and amortization), which translates to double-digit free cash flow growth. That is more growth than we’ve seen from the sector for most of the past 10 years — or pretty much in my whole career, which is 19 years.

Why has this sector’s growth been low in the past? 

The low-growth reputation is well-earned! And there’s one reason only: European telecoms have been very heavily regulated. This has been on both the fixed broadband side — the connectivity you have in your home — and on the mobile side of things — your phone. There has been heavy regulation purely to keep consumer prices down.

What that has meant is direct price regulation in fixed broadband and market concentration regulation in mobile, keeping mobile phone services as a four-player commoditized space. Those two elements have basically meant zero growth, and they have driven return on invested capital in European telecoms down from double digits 15 years ago to mid-single digits today. Returns are now below the cost of capital. It’s all been about regulation.

What has changed, and why we’re bullish on the sector, is deregulation. We’re definitively seeing that in fixed broadband. And there’s a chance we may see that in mobile market concentration as well.

Why do you think market concentration regulation might be changing?

There are local market regulators, and they’re the people who have deregulated fiber broadband. For mobile, what we need are governments and, more importantly, competition authorities to understand that they need to incentivize investment as well as keep consumer prices low.

A decade ago, when we were rolling out 4G, the competition authorities could have their cake and eat it. They were able to keep consumer prices low by keeping these four-player markets, but they were still getting investment into the network because returns at that point were still above the cost of capital. Today, because returns are below the cost of capital in European mobile, operators are not investing in new networks. So the 5G rollout in Europe is lagging the 5G rollout in the US and Asia. And that is a problem.

Is this why Mario Draghi, former head of the European Central Bank, kept coming up at the conference?

Yes. Draghi was commissioned by the EU to write a report on how to improve European competitiveness. And that was the report he put out recently. What he highlighted is that we need to allow market concentration to incentivize investment to support European growth. He has laid out European mobile services as one of the areas where they can do that.

The question then is whether this will actually change anything. I think the fact that he’s been commissioned by the EU to write this is important. And it comes at the same time as the head of the EU competition authority has changed.

What did speakers at the Communacopia conference say about this?

What we heard from all our company operators is that they think things have definitively changed. They see the Draghi report as a clear sign of an understanding that we need to change the direction of European regulation to support investment.

With the change of the competition commissioner as well, we think there’s a high likelihood that we will see attempts at consolidation to test this apparent new regulatory stance in the coming months and years. Markets where we might see that include Italy, the Nordic countries, Sweden, and Denmark, and maybe even Germany.

How bullish is this for the stocks?

We’ve had a lot of positive data points on the scope for in-market consolidation. That is the thing that can change the dynamic of growth and returns for European mobile. While we don't know how this is going to play out, it’s as positive as it’s ever been. Investors are not paying for any of that improvement right now. So we think it offers upside.

 

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