In her State of the European Union speech last fall, Commission President Ursula von der Leyen proclaimed the 2020s the “Digital Decade”. According to von der Leyen, it is unacceptable that, in Europe, 40 percent of people living in rural areas still do not have access to fast broadband. Shortly after the Commission announced seven flagship programs, including the swift build-out of fast broadband networks – especially fiber and 5G – in the EU. Now the Commission presented the Digital Compass outlining targets for Europe’s digital transformation by 2030. One key point: all European households should have gigabit connectivity by 2030 and all populated areas should be supplied with 5G.
But: the road to get there is rocky. Because the investment gap is large. The Commission puts it at 65 billion euros a year for networks and other digital infrastructure.
And Europe's telecommunications industry, which is supposed to build modern and fast networks, is ailing. Actually, 2020 should have been a golden year for the industry. Millions of people had to work from home in Corona times and were more dependent than ever on broadband and mobile networks to do their jobs and entertain themselves. Demand for the industry's most important product – connectivity – was at an all-time high.
However, the reality is different. In the past year, listed European telecommunications companies lost 15 percent of their value on average. This continued a downward trend that began in 2015, when investors became increasingly skeptical of the European telecommunications environment. In September 2020, Orange and Telefónica lost their places on Euro Stoxx 50, the leading index for Eurozone stocks, due to their losses in value. This is a notable example of the decline of the European telecommunications industry. Deutsche Telekom benefits from its commitment in the U.S. and was able to achieve value growth in 2020.
Caught in a vicious circle
The European telecommunications industry is stuck in a vicious circle of declining revenues, low returns, below-average market valuation, and high debt. Data traffic is increasing by around 30 percent a year – volume increases that barely any other industry can boast. At the same time, revenues of the European telecommunications industry have been falling year on year since 2015, and margins are also declining. From an investor perspective, this is mainly because the European telecommunications industry is more heavily regulated than almost any other sector, with no end in sight. The current regulatory mindset is still very much focused on price pressure and thus, colloquially speaking, continues to take money for investments out of the market. For example, with the EU Commission imposing EU-wide requirements for the calculation of the weighted average cost of capital (WACC), return on capital is artificially brought down to new lows. Or through a renewed lowering of wholesale roaming fees that mobile network operators can bill each other, which has just been proposed. All of this without need, without market failure and without consumers benefiting from it in any way. Instead, this type of compulsive price regulation is affecting the investment climate in Europe, which is already ailing due to the Corona crisis.
At the same time, European antitrust authorities have prevented consolidation in the past and, as a result, have also prevented the chance of leveraging economies of scale which would enable cost reductions.
Declining revenues and margins inevitably lead to a low return on capital, which for European telecommunications companies is on average eight percentage points lower than return on capital for U.S. telcos – a huge difference. Return on capital plays a major role in capital-intensive sectors such as the telecommunications industry: on average, European telcos invest a remarkable 18 percent of their revenue, over 50 percent of their EBITDA margin. This is significantly more than companies in other industries, but also more than the counterparts in the U.S. However, as revenues and the EBITDA margin in Europe are on a comparatively low level, the investment levels – when considered in absolute terms – are too low. This is illustrated by the comparison of per capita network investments: in 2019, these were 214 euros in the U.S. and only 95 euros in Europe.
However, investors are – understandably so – concerned that the return on capital of many European telcos is barely enough to cover the cost of capital. This means it is no easy task for the companies to convince investors of the sense of investing billions in modern 5G or fiber-optic networks.
Many European telcos also suffer from a high debt burden – frequently the result of high investments in new networks or expensive acquisitions in the past. High levels of debt coupled with declining or, at best, stagnating revenues mean that rating agencies and analysts are keeping a close eye on debt levels and pushing for debt reduction. This restricts entrepreneurial room for maneuver: budget discipline takes precedence over investments in new products, services, or networks.
The result: sluggish network build-out in Europe
Five years ago, Europe wanted to play a leading role in the build-out of 5G. Today, however, it appears that Europe’s 5G build-out compared to the U.S. or leading Asian countries is as sluggish as its 4G build-out was at the time. This year, the leading 5G countries – U.S., China, Japan, South Korea – will transmit up to 22 percent of mobile communications traffic via 5G, compared with just 4 percent in the European Union. The industry association GSMA forecasts that Europe will still lag far behind the leading 5G nations in 2024. Here, too, Deutsche Telekom is an exception, with almost 80 per cent 5G coverage in Germany already and similar figures in Austria and the Netherlands.
And it’s not only network build-out that’s the problem: the European investment bank recently found that the entire 5G ecosystem in Europe has fallen behind. In the U.S., many start-ups and technology companies are now developing innovative software and hardware around 5G and Open RAN. Open RAN – mobile base stations without highly-developed proprietary chips and specially created software from equipment suppliers – is considered the technology of choice for future mobile communications networks.
There is a need to catch up not only in mobile communications, but also in fixed networks. In large parts of Europe, two Herculean tasks need to be tackled: firstly, FTTH build-out and, secondly, provision of fast internet to rural areas. The build-out will require billions of euros of investment, which will have to be shouldered primarily by private companies. However, the burden is unevenly distributed.
Internet companies benefiting from the crisis
Demand for online services has exploded in the crisis. The major internet companies have benefited with record profits and huge rises in share prices. Today, Apple alone is worth five times more than all the European telecommunications companies. Newcomer Zoom, which hardly anyone knew about before the crisis, is now worth more than Vodafone, Orange and Telefónica combined.
But the Internet companies contribute nothing to the build-out, stability and security of the networks on which they operate their flourishing businesses. Ten digital companies account for 80 percent of Internet traffic on our infrastructure – and the trend is rising. It would only be fair if billions from the Valley could also be used for fiber optics in Europe.
Conclusion
The build-out of digital infrastructure is a key focus of the Commission's new digital plans. If the Commission wants to achieve the goal of putting Europe in a leading position by 2030, Europe's digital vicious circle of declining revenues and margins, value erosion and low investment must be broken. This means better framework conditions for digital investments in Europe, antitrust law that allows for size and cooperation, and fair participation of Internet companies in network build-out. Europe's telecommunications industry must regain the confidence of investors – a crucial prerequisite for more investment in fast networks.
