THE WALL STREET JOURNAL
Date: 19.02.2007 Media Type: business magazine Distribution: USA
European Markets Outlook: Small, nimble telecom firms shape up as favorites for '07 --Profits, takeover talk drive analysts' picks; risk in behemoths? European telecommunications stocks should favor smaller companies over the behemoths, analysts and fund managers say. Shares of large and small operators alike sizzled last quarter, aided by strong earnings and low valuations. This year, takeover speculation and earnings expectations should drive small operators -- though not to gains as sparkling as those of last quarter -- while former national monopolies suffer from thinning profit margins. "There's just so much money out there in private equity. Now they're looking at much bigger deals and these midsize European telecoms have come on their radar screens," said Philippe de Weck, a fund manager at Pictet & Cie. in Geneva. Private-equity firm Blackstone Group, for one, said in November said it was looking at a stake in Telecom Italia SpA. Other possible targets in the sector include national incumbents whose governments are expected to sell shares this year. Lessening government involvement could make it easier to turn them into efficient private enterprises. Among analysts' picks: Greece's Hellenic Telecommunications Organization SA, or OTE, and Sw eden's TeliaSonera AB. Shares of TeliaSonera have climbed 6.2% so far this year, while OTE has eased 2%. By comparison, the telecoms portion of the pan-European Dow Jones Stoxx 600 index has risen 4.6%, slightly more than the overall market. Emerging-market operations are also attractive prey, with Western European firms keen to tap into rapid growth elsewhere to offset stagnant demand at home. Vodafone Group PLC, which earlier this month said it agreed to buy 67% of Indian cellphone operator Hutchison Essar Ltd., has said it is hoping to buy still more this year. Tel ekom Austria AG, Norway's Telenor ASA and France Telecom SA are also shopping, accor ding to Citigroup analysts, who say that operations in Vietnam and Serbia are attracting the European hunters. Telenor last year took over one of Serbia's two mobile-phone networks, the formerly stateowned Mobi 63. (Telekom Srbija is the other.) Telenor also has a "representation office" in Vietnam to explore the market, a company spokesman says. A France Telecom spokesman declined to comment on the speculation, while no Telekom Austria spokesperson was immediately available for comment. Investors likely will reward companies that buy their way into genuine growth markets, rather than the ones simply looking to grab any available market share. "The market seems to be rewarding high-growth companies tapped into emerging markets," said James Enck, a European telecom analyst with Daiwa Securities SMBC Europe Ltd.
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The sector's losers are likely to be bulky national incumbents, most of which are expected to remain high on analysts' sell lists this year. These companies face increasing competition and are the target of stringent European Commission antitrust regulations that are expected to slash profit margins. "The category with a lot of risk are the really big guys," warned Bruno Lippens, a fund manager at Robeco. "I see more opportunities in niche players with a strong focus in one particular market." Mr. Lippens said his favorite buys include Germany's Mobilcom AG, which sells contracts for Germany's four mobile networks, and France's Bouygues SA, which operates one of France's mobile networks in addition to a number of nontelecom businesses. Both are expected to keep cutting away at the margins of national champions Deutsche Telekom AG and France Telecom. Mobilcom shares have risen 6.3% this year, while Bouygues has surged more than 11%. Deutsche Telekom is in the midst of a 3 billion euros ($3.9 billion) upgrade of its broadband network in 50 German cities that will combine high-definition television, telephone and Internet service. But European regulators have ordered it to share this upgraded network with competitors, making potential returns less inviting. The company in January issued its second profit warning in six months, blaming fierce competition in the German market and the weak dollar. Deutsche Telekom's T-Mobile USA is the fourth-largest mobile-phone operator in the U.S. by subscribers. The stock has slipped 1.2% so far this year. The new EU competition rules that force dominant market players to share their networks with competitors is one reason smaller companies are expected to do well; they also are seen as better positioned to cut costs and offer growing revenues. Analysts and fund managers say their favorites in this category are Italian broadband company Fastweb SpA, French multiservice provider Iliad SA and Greek telecom and Internet operator Forthnet SA. These players in particular, and their peers in general, are giving entrenched incumbents serious competition with flexible structures that allow for fast cost-cutting and smart marketing that is winning over subscribers. For the year, Fastweb's shares are down 0.1% and Forthnet's are down 1.3%, while Iliad's have jumped 24%. One old monopolist that may also do well is KPN NV. Its expansion into the German cellphone market, investments in two small Internet-access companies and new technologies are expected to increase market share and boost earnings. The Dutch company's stock is up 7.5% this year. But here, too, takeover speculation plays a role. Credit Suisse rates KPN "outperform," and adds the company is also "a potential bid target."
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