Telekom is making an expensive bet on the future

Düsseldorf Even the first figures for the past fiscal year got Deutsche Telekom executives in a party mood. With around 81 billion euros, the group posted record sales in 2019. The outgoing boss of the US subsidiary, John Legere, sang: “What a Wonderful World.”

Corporate boss Timotheus Höttges can also present strong figures at the end of last year. Not only in terms of sales, but also in terms of profit, Deutsche Telekom has increased significantly. Consolidated net income rose by 79 percent to 3.9 billion euros.

When announcing the numbers, Höttges did not skimp on superlatives. He rated the past year as the best in the company’s history. “This is a historic day for Deutsche Telekom,” said the CEO.

Deutsche Telekom is doing well. She wants to have this strength confirmed at the virtual general meeting on June 19. CEO Höttges also plans to present another strategy for the important US market. But with all the jubilation, the Telekom top needs an answer to the central weak points: These include the rising debt level and the difficult integration in the USA.

Nothing is as important to Telekom as the future of its US business. After two years of sometimes difficult negotiations, the team around CEO Höttges and board member Thorsten Langheim succeeded in finalizing the merger with US rival Sprint. The merger was completed on April 1 and is therefore not yet on the balance sheet for the past financial year.

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The figures for 2019 already make it clear how important the USA is for Deutsche Telekom. Sales there rose by almost eleven percent to around 40 billion euros, and the adjusted operating result around ten percent to eleven billion euros. Telekom already generates more than half of its sales in North America.

In the home market of Germany, business is developing solidly. Although sales rose only moderately by less than one percent, the German subsidiary was able to improve its adjusted operating result by 2.4 percent to 8.7 billion euros. The European national companies also reported stronger figures to the group.

The conversion work at the major customer subsidiary T-Systems continues. The company shows an increase in adjusted operating earnings of 17 percent. But at 519 million euros, the profit is at a low level. Sales fell slightly by 1.9 percent to 6.8 billion euros. At least T-Systems managed to achieve an 8.2 percent increase in incoming orders, which points to better business in the future.

Central control variable improved

The return on capital employed (ROCE) as a central control parameter is particularly important for Telekom. It shows how efficiently the group manages the capital employed. This key figure is based on the operating profit after taxes (EBIT less tax expenses). This value is to be divided by the balance sheet total (minus non-interest-bearing liabilities and liquid funds).

The goal of the Telekom management is that the return on investment is above the cost of capital. Telekom shows the value for ROCE, but not that of its own cost of capital. The Handelsblatt used the “weighted average cost of capital” (WACC for short), which the financial services provider Bloomberg calculated. While the costs exceeded the return last year, Telekom was able to improve in the 2019 financial year. With a ROCE of 5.1, the return on capital exceeded the cost of capital this time.

CEO Höttges has also used the good figures to make important investments in the future. Without spending on mobile radio frequencies, Telekom spent 13.1 billion euros last year – for example for modernizing its networks. That is a record.

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At the auction of mobile radio frequencies in Germany in June, Telekom offered around 2.2 billion euros. But unlike previous auctions, the company is allowed to extend its payment to the federal government over around a decade. The financial burden is spread over a long period of time.

Despite the good numbers and long-term investments, CEO Höttges has to explain to shareholders how he intends to solve some problems. Due to the outbreak of the corona pandemic, the annual general meeting will take place virtually for the first time and three months later than originally planned.

When Telekom announced last November that it would cut its dividend, there were protests from shareholders. For years they had been used to the fact that the payout per share climbed further every year. Instead of 70 cents in the previous year, Höttges only announced 60 cents for the 2019 financial year.

After a number of companies cut or even canceled their dividends at short notice due to the corona pandemic, Telekom is doing relatively well. Because it should stay with the proposal. If the shareholders agree on Friday, the group will distribute 2.8 billion euros this year.

Debts rise to a record high

However, the payment contributes to the fact that the debt level for Telekom continues to rise. Net financial liabilities rose year-on-year by 37.2 percent to 76 billion euros. The increase also includes a special effect due to the new accounting standard IFRS 16, through which leasing obligations amounting to 15.6 billion euros flow into the balance of debt.

Telekom shows a value for its relative indebtedness. In doing so, it relates the net financial liabilities to the adjusted operating result. At 2.65, the value has never been as bad as in 2019, but it is still within the self-imposed corridor. From this it can be calculated that the Telekom would need 2.65 years to pay back its debts if the earnings situation remained the same.

Another unsolved problem for Höttges is integration in the USA. With the takeover of rival Sprint, the number of wireless service providers has been reduced from four to three. The Telekom subsidiary T-Mobile US can challenge the industry leaders AT&T and Verizon directly. At the same time, CFO Christian Illek admitted when presenting the quarterly figures that not all data on the economic situation of the Sprint company to be integrated was available in advance. “We won’t find out which bodies Sprint had in the basement for the next few months,” said an insider.

Telekom is assuming integration costs of $ 15 billion. After deducting all costs, however, the group expects synergies of 43 billion US dollars. It’s the job of T-Mobile US’s new boss, Mike Sievert, to lift them up.

In Germany, the group has so far got through the outbreak of the corona pandemic largely smoothly. “Telekom is something like the horse that pulls the plow through the field,” said Höttges recently in an interview with the Handelsblatt.

Difficulties in the US

In the USA, however, the situation is uncertain. An integration of two companies in times of a global pandemic with temporary contact restrictions is a particular challenge. At the same time, T-Mobile has challenged the competition in the USA with competitive prices. Some of the offers from the Telekom subsidiary are aimed at customers who do not have a high monthly income.

More than 40 million people in the United States had registered as unemployed since the pandemic broke out. Mobile phone companies were asked not to cancel connections for customers who could no longer pay their bills. CFO Illek admitted that it was not yet foreseeable how much the group could be affected by payment defaults in the long term.

With the takeover of Sprint, Telekom in the USA not only sustained better opportunities, but also incurred new debts. At least the capital market seems to have confidence in the group that it will master the integration well.

A few days after the acquisition, a $ 19 billion bond was issued. “We didn’t need the bridge financing negotiated long beforehand for security,” said Höttges. The CEO has everything in his hand to lead Telekom to a new level – if he succeeds in integrating it in the USA.

More: Every fifth German wants to change the mobile phone contract.

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