January 28, 2013, 4:27 p.m. ET
Investors Hang Up on Europe's Telecom Stocks
By ARCHIBALD PREUSCHAT
Investors used to rely on Europe's telecommunications operators for their high dividend yields, but now such payouts are seen as a sign that cuts may be on the way.
Companies across the sector have recently slashed dividends. Some investors are fleeing the sector, and those that have already done so say that despite historically low valuations, it is too early to reinvest.
The dividend cuts have come amid a worsening economic environment in Europe and changing consumer behavior. Users of mobile devices are streaming more content, and shipping more data for storage in the cloud. The shift requires the companies to invest large sums of money to upgrade their infrastructure. Regulatory measures are also weighing on profits in the sector, including cuts in roaming charges and mobile termination fees, which national operators charge one another to use their networks.
"Telecom shares used to be, but are no longer, quality high yield, but this applies to the sector in Europe only; telecom shares in the Americas and Asia perform much better," says Thomas Schüssler, the global fund manager for value equity at DWS Investments, which is owed by Deutsche Bank AG DBK.XE -0.22% and has €280 billion ($377 billion) of assets under management. "A high payout in the European telecom sector is nowadays more a danger signal that the dividend yield is not sustainable," he adds.
Among those that have already cut payouts to shareholders are Germany's Deutsche Telekom AG, DTE.XE +1.05% which is reducing its dividend to help fund a €30 billion three-year investment in its network; Spain's Telefonica SA, TEF.MC +0.23% to cope with a recession in its home market; and the Netherlands' Royal KPN NV, KPN.AE +1.64% which spent three times more than expected in a domestic auction of wireless spectrum late last year.
France Télécom SA FTE.FR +1.13% and Telekom Austria AG TKA.VI 0.00% have also lowered their dividends as both providers face fierce competition.
"We have reduced our exposure to the telecom sector in anticipation of upcoming dividend cuts. We think it's too early in most cases to hope for a stabilization or a reintroduction of dividends," said Heinrich Ey, a telecoms analyst at Allianz Global Investors, which has €300 billion under management. "There are certainly stocks which could look interesting on a longer-term view, but we want to see more clarification on the regulatory side in terms of investments in fixed broadband," he added. Mr. Ey declined to say which stocks he favors over the longer term.
Given the tough operating climate and reductions in dividends, the Stoxx Europe 600 Telecommunications index, made up of 20 fixed-line and mobile telecom companies from across Europe, has fallen 4.1% over the past year. The broader Stoxx Europe 600 index has gained 13.3%.
Share prices in the telecom sector have recovered slightly from heavy losses in 2012, as speculation over takeovers in the industry mounts. Still, analysts don't anticipate the sector's fortunes improving a great deal this year.
"We expect 2013 to be another tough year for the EMEA telecommunications industry as revenues are likely to decline in Europe by up to 2% next year, due to continuing macroeconomic weakness, aggressive price cuts and tough regulation," Moody's Investors Service said in a recent report.
To be sure, given the raft of cuts to dividends, some industry watchers, such as Bernstein analyst Robin Bienenstock, think more reductions are unlikely. Most companies that need to cut their dividends have already done so, she argues.
Analysts have welcomed some of the dividend reductions. Late last year, Deutsche Telekom announced it would pay a yearly dividend of €0.50 per share for 2013 and 2014, representing a yield of about 6%, down from €0.70, or a yield of about 8%,for 2012. The cut is to fund investment in the U.S. and Germany.
"Deutsche Telekom is doing the right thing operationally and their turnaround efforts in the U.S., where the iPhone deal with Apple will boost [revenue] and accelerated investment in fiber networks in its German home market will pay off," Ms. Bienenstock says. She acknowledged, though, that it will likely take time for the results to appear, so investors may "take a while to warm up to the story with its now lower dividends."
There is also the chance that with valuations low, some companies may attract takeover interest. The Wall Street Journal recently reported that U.S. telecommunications giant AT&T T +1.84% is considering buying a counterpart in Europe to diversify its business.
Such speculation has helped boost share prices in the sector so far this year, although many industry watchers remain cautious.
"We believe Q4 results could further challenge 2013 expectations, as mobile service revenues and other trends further deteriorate, and we believe is far too soon to see tangible reward for fiber investments," analysts at J.P. Morgan Chase JPM +0.44% & Co. wrote this month. "Spectrum risk remains," the analysts said, referring to the danger that companies will pay more than expected for spectrum. "And some markets are even seeing increased competition or market entries."
"A constructive view of the sector would position 2013 as another difficult year," they added. Share prices already reflect some negative factors, and many companies have already cut their dividends, but "there remains scope for disappointment."