Global Weekly Reviews

European tower stocks have undoubtedly been the global telecom companies to own this year with Cellnex up 70% YTD and Inwit up 58%. Asset scarcity, falling bond yields, increasing M&A optionality and favourable accounting changes have all helped. The trend is your friend isn’t it? The upwards momentum should continue? We are now only selectively convinced. This week we did a deep dive review on the European tower names (see HERE), and came away with the conclusion that there should still be more momentum in Inwit, but that Cellnex’s giddy rise is harder to justify. Other names like Vodafone or Orange also look like alternative ways to play this theme.

The tower model is a simple one. Rent space from landlord. Build tower. Get anchor tenant. Add incremental tenants at high margin. Increase contract value each year. Job done. An arbitrage on owning the infrastructure. While the tower model is indeed extremely attractive, there is a price for everything, even as bond yields fall, and there are arguably a few warning signs on the horizon, that we think aren’t necessarily being fully factored in, especially when a company such as Cellnex is trading on a multiple as high as 25x EBITDA.

Longer-term growth for the tower companies will be driven by tenancy growth, but MNOs are desperately keen to save money themselves and finally realising that tower location sites aren’t necessarily the differentiator they once were. Hence the existing MNOs are looking to consolidate their existing tenancy locations to save on ground rent and tenancy costs. Vodafone is leading the charge on this through pooling resources with Orange in Spain and Telecom Italia in Italy. For Cellnex, they stand to lose tenancies in both markets, and Wind’s tie-up with Fastweb curtails what could have been future demand in Italy. Although political pressure will still remain to build out in rural areas, we believe the MNOs are likely to use new spectrum bands above 3GHz and small cells as the most likely routes to increase capacity, rather than continued macro-site buildout.

Lower bond yields have arguably the biggest support for these stocks, but that isn’t a one-way bet in Europe as tower contracts are almost all linked to inflation which means that real growth for these companies is actually little changed.

The big unknown that could support the tower thesis is continued consolidation and newsflow around M&A as the European tower market remains very fragmented. So far, this has been seen as a sure-fire way for tower companies to create value, as TowerCos have been able to arbitrage rising multiples, but sellers are increasingly likely to demand a higher multiple, as we saw with Vodafone’s disposal at 24x EBITDA in Italy. Increasing scale in the tower market raises the spectre of potential future regulation, and the proposed Inwit-Vodafone transaction will be an interesting test case. This could well force the tower companies to open up to more third party tenancies as an extra source of growth, but it could also lead to greater regulatory intrusion if TowerCo gains too much scale. The EC to date has generally been supportive of network sharing, but the recent Czech ruling shows that it won’t tolerate practices that ultimately curtail consumer choice. Just offering space to independent third parties might not be enough in the longer-term. Just ask the electricity grids – monopolies of infrastructure can ultimately lead to RAB-based pricing.

Cellnex is likely to be the leading consolidator in Europe, and if we were investment bankers, we would be encouraging them to issue as much equity as possible at these elevated levels to build a warchest for future deals, especially as the market is willing to award them such a low cost of equity right now.

For Cellnex specifically, we also believe the stock has been supported by the move to IFRS16, as we address this in more detail in our recent note. It remains the only developed market tower company to report EBITDA excluding leases and we do not believe this optical shift, but with no change to underlying cashflow, has yet been fully understood in by the market. We find most people tell us they think Cellnex is trading closer to 18x EBITDA, rather than our calculation of 25x – a sizeable difference. Inwit though which includes leases in guidance EBITDA looks more appealing to us at 20x EBITDA with higher tenancy growth. More details on our Inwit thesis are HERE.

Looking across the rest of the Europe, we believe Vodafone could also offer an attractive way to play the tower theme (see HERE for more details on this idea), and of the other MNOs in Europe with tower value still to be unlocked, Orange might well be the other way to play this (see HERE). Orange is still resolutely committed to its view that its tower assets are strategic, but that is what Vodafone was saying a year ago….The tower business model still has some way to play out, but with increasing valuation disparities now emerging, we believe Vodafone or Orange or Inwit represent better ways to play this as an investor rather than through Cellnex which has been the star name to date.

It’s been a busy few weeks in the European telecoms sector and we wanted to draw together all our recent materials in a single blog to make sure you have a chance to catch up on all our latest views.

Momentum reversing: We’re not quite through with European telecoms results season, but could we finally be at the much awaited turning point for the sector? After a dismal start to the year (in part reversing the Q4 18 outperformance), the sector has started to fare better and over the last three months, the telecoms sector performance has been the 5^th best performing sector out of 19 European sectors. If broader market worries persist, then we believe the sector’s defensive characteristics should prevail further.

Set-up still attractive: We continue to believe the sector looks attractive, and that the operational/ regulatory risk profile is now far lower than at any time in the past 10 years, especially as investors hunt for yield in a low interest rate environment. Even if we haven’t yet reached the nirvana of earnings upgrades, a 5.5% and 8.2% dividend/ EFCF yield respectively for the sector; infrastructure funds awash with cash, and companies taking active steps to try to unlock this value, still means the combination looks very appealing.

Vodafone remains one of our top picks and is the company where we have seen the biggest recent share price move, and we remain positive on the name having increased our target from 185p to 195p following their encouraging outlook for the rest of the year; news of their plans to monetise their tower assets and the Inwit deal, where they are selling at 24x EBITDA. After a 15 month wait, we have also seen them successfully close the German cable deal which we see at up to 20% EFCF/ share accretive.

The piece on the German deal closing is HERE, and we have written on tower monetisation upside HERE, and the upside generated by the Inwit deal HERE. (O2D also made positive comments on German pricing, which is also supportive given Vodafone’s increasing reliance on growth in Germany at a group level – see HERE).

Upside from towers elsewhere – maybe Orange: The share price bounce in Vodafone following the news about tower monetisation, raised the question of which other companies could do the same, and we feel Orange stands to benefit most out of the other large caps. More details on that and the potential impact on all other stocks HERE.

Whilst we are on the topic of unlocking value from infrastructure, it might be instructive to look at BT that way. The shares remain in regulatory purgatory, but with the shares depressed at 185p/ share, the market is now valuing the unregulated activities at only 5x P/E. It might take at least a year for a final resolution to be resolved on FTTP, but for those investors with that timeframe, this looks like a very attractive entry point as we believe a deal can ultimately be reached which will be in the interest of the UK and BT shareholders. See HERE for our detailed workings on this – and our past piece HERE on more details about how the economics of an FTTP migration might work.

Meanwhile, the outlook in France looks like it is improving. Altice’s results were stronger than expected and leverage acts as a major tailwind for the stock with improving sentiment. More details of that HERE, and this should have positive implications for the underlying story at Iliad – see HERE for more details. We continue to publish our regular monthly tariff trackers – see HERE for fixed, and HERE for mobile – and these indicate to us that the pricing environment in France remains rational which should be a further support for both names in H2.

In the Benelux region, trends look reasonably benign. Decent earnings prints from Proximus – HERE – and KPN – HERE – help to give a more supportive message for the sector as a whole.

Looking ahead, of the large caps, we still have DT to report on Thursday, but TMUS M&A activity still remains the main driver and we think that the decision on the dividend will be delayed until after the TMUS-S court hearing – see HERE for our analysis on this. The trial itself is something on which Blair has written extensively: HERE). Arguably though the bigger news on Thursday could relate to Liberty Global and whether they finally answer the 15-month question of what they will do with the $10bn excess capital following the Unity disposal. We are gunning for a $3-5bn buyback combined with more investment in Lightning, but let’s hope they don’t disappoint with something unexpectedly left-field….see HERE for our assessment of the options.

For most analysts, a sum-of-the-parts valuation can be something to drive you crazy. The spreadsheet tells you the value is there, but the Bloomberg screen tells you it is not. Waiting for sum-of-the-parts discounts to close can sometimes be like watching paint dry, and then blink and you miss it.

Past investors in Vodafone will remember what seemed like an endless discount to the sum-of-the-parts persisting before the sale of Verizon Wireless. Then all of a sudden, not only did the discount close, the stock moved to a premium as talk of an AT&T takeover emerged. Similar stocks today like Softbank and Naspers also look attractive on this basis today – and hopefully at some points those discounts to net asset value will close.

Today though, we re-examine whether a perceived discount in Vodafone sum-of-the-parts might be on the cusp of closing again, as operational trends improve and Vodafone has announced more active steps to unlock “hidden” value in its tower assets. On Friday we published a detailed review on their proposed intentions (HERE), and the announcements saw Vodafone’s share price rally 11% in the day. Almost unheard of in the European telecoms sector.

We had been cautious on the Vodafone share price since the Verizon Wireless disposal, as Vodafone was exposed to pan-European sector deflationary trends and we never could make the valuation look compelling. However at the turn of the year, we upgraded Vodafone and the European telecoms sector to overweight (see HERE). We thought inflecting revenue trends combined with an attractive double-digit EFCF yield was compelling. With the benefit of hindsight we were a few months early, but Vodafone has finally delivered inflecting service revenue trends and set out an optimistic tone for the next few quarters. We think Vodafone should be able to take service revenue growth back to over 1% growth by year-end, and the last time Vodafone was doing this, the shares were nearer 190p – 30% higher than the current price. The new consolidation of Unity will also help to further support organic growth rates.

However, the rocket fuel that might help to bring in new investors, is Vodafone’s clearer intention to monetise their tower portfolio more aggressively through a partial IPO at the very least, which marks a noticeable shift in strategy. As global interest rates have declined since the beginning of the year, the wall of money looking for yield assets has pushed up the value of infrastructure assets significantly – and Vodafone is now looking to cash in. When Cellnex is up 65% YTD, but Vodafone is down 4% YTD, who can blame them, otherwise activist investors might start to make themselves more vocal.

But Vodafone is being smarter than just selling to cash in on the multiple. They are also looking to unlock operational synergies from 5G RAN sharing first before handing over the value to a third party. This has clearly been borne out by the terms of the merger of their tower asset in Italy into Inwit. Their patience and the creation of operational synergies is allowing them to cash out the asset at 24x EV/ EBITDA, more than 2 ½ times higher than the equity value when TI cashed out back at the IPO in 2015. We think this transaction alone has created 4% value accretion for Vodafone, and they should be able to more than match that in Germany if they can deliver a tower sharing deal with either DT or Telefonica Deutschland. We don’t yet include the potential upside from this in our valuation.

The new management team isn’t yet celebrating its first birthday, but they are already trying to reinvigorate the equity story, which can be tough to do when your industry is still struggling to deliver sustainable revenue growth. While towers are clearly top of the agenda right now, this isn’t the end of the road for unlocking value. Vodafone would like to unlock the value in its Indian tower stake (albeit this might end up being used to fund ongoing losses at Vodafone Idea – see HERE for more details), but more value transparency might come over time from its EM assets – either a Vodacom spin-out or even a spin-out of the entire set of EM assets.

Sum-of-the-parts discounts tend not to just close of their own accord. Management, which is incentivised to get the stock price moving, often needs to take action – and this is what we are now clearly seeing. A very welcome step in the right direction.