Impact of financial crisis on the Communications & Media sector

Communications, media and entertainment

How will the financial crisis and recession impact the Communications and Media sector in Europe?

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1980 1985 1990 1995 2000 2005 2010

Recessionary periods (indicative as periods differ by country)

Telecommunications revenues expressed in 1990 real terms

Figure 1: Impact of recessions on European telecommunications services revenues (1980-2007)

Barring the self-induced dot.com crash of 2000-1, European telecommunications has

been quite resilient during past recessions (Figure 1), less so media and entertainment

where revenues have dropped by 5-15% on each occasion. However, the financial

crisis and its rapid contamination of the globalised economy make this recession very

different from anything we have ever experienced before. The communications, media

and entertainment (CME) sector will be impacted but each segment and market will fare

differently – who will be the winners and losers?

More to the point, what does this mean for you? Even if you feel comfortable

about your own company’s situation, have you thought about your main customers,

suppliers and competitors – how is your market changing? Are there new opportunities

or threats? Have you evaluated the main economic scenarios and developed action

plans accordingly?

For further insight into the crisis and how to respond, see Mark Thomas’s

handbook “Surviving and thriving in the economic crisis” available from

www.paconsulting.com

Who will be the winners and losers?Pressure on short-term liquidity has been the most immediate impact of the financial crisis

in most industries. Companies that have relied on debt have suddenly found that it is no

longer straightforward or cheap to raise or roll over; having said that, the CME sector is

generally looked on favourably by banks due to its high levels of free cash flow. In fact

numerous companies in the sector have been able to raise debt funding in recent months

but going forwards some will find it much harder than others. Such generalisations tend to

be misleading, so in the following sections we have taken a closer look at the three main

CME segments: operators, content aggregators and suppliers.

Source: ITU, World Bank and PA Consulting Group

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Winners Potential winners

Casualties Targets

Figure �: Analysis of publicly-quoted European operators

Operators – most had finished clearing up from the millennium debacleBefore the financial crisis hit, most network operators had managed to clean up their

balance sheets following the dot.com crash, consolidation frenzy and 3G licence fee

bubble that coincided with the start of the millennium. A number of companies had even

gone so far as starting/restarting dividend payments (eg, Vodafone, FT, DT), commencing

share buy-backs (eg, FT, BT, Telefónica) and restarting their acquisition machines (eg,

Vodafone, FT, Telenor) – particularly with an eye to high-growth emerging markets.

There are still a number of operators that hadn’t finished the job for a variety of reasons.

Typically these are the ones in the bottom right quadrant of Figure 2 that are trying hard

to improve their liquidity position through major cost reduction programmes, dividend

cuts/suspensions and asset sales.

Theoretically some of these companies are takeover targets but competitors will probably

be more interested in acquiring specific assets or churning customers – taking advantage

of them while they are weak. Acquisitions are more likely to involve unquoted alternative

fixed network operators (‘altnets’) or fourth/fifth mobile operators with cash-strapped

shareholders who are unable to hold out until valuations begin to recover.

‘Operators’ includes fixed, mobile and cable network operators. ‘Content

aggregators’ includes internet service providers (ISPs), television broadcasters,

radio broadcasters and print (newspapers and magazines). ‘Suppliers’ includes

network equipment vendors, passive infrastructure providers, handset suppliers,

IT vendors, system integrators (SIs), etc.

Figure �The horizontal axis assesses the level of over/undervaluation by the market using a simplified (and intentionally conservative) form of discounted cash flow which assumes that long-run return on equity (ROE) will be close to the average ROE over the last three years and long-run growth will be around 3% per annum. On this axis, more than one represents an undervalued company, less than one is overvalued.

On the vertical axis we have assessed liquidity, determined by the weighted average of a number of factors: primarily interest cover, dividend cover and the ratio of debt to equity. On this axis, a company below one is likely to have substantial difficulties in covering its debt payments and therefore refinancing its operations.

The circle size represents annual revenue.

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Early liberalisation such as UK duopolies

First GSMnetwork live

First 3Gnetwork live

EUliberalisation

Consumers

Enterprises

Banks

Operators Content aggregators

Suppliers

Slower handset replacement

Deferred CapEx Increased outsourcing

Reduced expenditure

Deferred CapEx

Reduced lending Higher borrowing costs


Reduced advertising

Reduced expenditure for premium content

Figure �: Timeline showing recessions and major telecommunications developments

Figure 4: Impact on operators of the crisis and recession

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Figure 5: Analysis of publicly-quoted European content aggregators

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How will the recession affect operators? In the recessions of the 1980’s and 1990’s,

operators fared reasonably well but cast your mind back to those days and the industry

landscape was very different (see Figure 3). It was dominated by fixed voice incumbents;

some countries were still liberalising their telecommunications markets; and, mobile

operators were still the new kids on the block. Will it be different this time? Figure 4

summarises our view of the main impacts on operators.

As of today most pundits believe that the main impact of consumers tightening their

belts will be delayed mobile handset replacements – tough for the handset suppliers

but beneficial for operators that subsidise handsets. That is, unless someone starts

a price war to win over the more price-sensitive customers.

The enterprise market will be affected by companies trying to reduce costs or going

out of business. This might be offset somewhat by greater expenditure on productivity-

improving services and solutions.

Be careful about your forecasts for new services or any growth in existing services.

Consumers and enterprises alike are unlikely to spend more on communications in the

current environment unless they can see a clear business case with low up-front costs.

A longer-term issue that shouldn’t be forgotten will be the need for some governments

to raise additional funding to pay for the bailouts and economic stimulus packages.

Any increases in personal or corporate taxation will affect consumers and enterprises,

which in turn will impact operators – as we show in Figure 4. Of more concern is any

form of sector-specific taxation such as that contained in the 2010 US Budget plan,

“A New Era of Responsibility”, which proposes a tenfold increase in spectrum fees

over the next few years. Might this happen in your market?

Content aggregators – suffering from advertising cutbacksThis segment didn’t get into such a mess at the start of the millennium as the operators

and so in most cases companies are less leveraged – except for those who have a

(newspaper/magazine) print background or have expanded into telecommunications.

A number of European network operators (such as Deutsche Telekom, France

Telecom, Telefónica, and Vodafone) grew over the last 20 years through international

expansion. Although their domestic markets may have matured, they are continuing

to grow through their exposure to emerging markets. The same has not been true

of the content aggregator segment except for a few rare cases such as Vivendi

and RTL. Most are heavily reliant on their domestic markets and consequently

very exposed to their vagaries.

Advertising is the critical revenue stream in this segment. In recessions advertising

expenditure typically shrinks by 5-15% – even though industry bodies argue that the

most successful companies behave to the contrary.

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Consumers

Enterprises

Banks


Suppliers



Reduced expenditure

Deferred CapEx




Reduced advertising

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TargetsCasualties

Consumers

Enterprises

Banks


Suppliers



Reduced expenditure

Deferred CapEx




Reduced advertising

Figure 6: Impact on content aggregators of the crisis and recession

Figure 7: Analysis of publicly-quoted global suppliers

Figure 8: impact on suppliers of the crisis and recession

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The recession is therefore more significant for this segment than the financial crisis.

In previous recessions print has always lost market share to television and radio.

Since the dot.com crash, the Internet’s market share has grown rapidly and we expect

that this will continue through this recession, albeit at a slower pace, at the expense of

all other media. The winners in this segment will be the companies that have strongly

embraced or grown up with the Internet. The losers will be any print-based companies

that failed to see the trend, for some of whom it could be the end of the road.

Equipment and service suppliers – a mixed pictureThere are many European-based suppliers but the segment is best viewed from a

global level and by its sub-segments: network equipment vendors, handset suppliers,

IT vendors, system integrators (SIs), etc. A few key players, such as Samsung, NSN

and Huawei are missing from the chart because they are divisions of larger groups

or are not publicly quoted. Despite this it is clear from our analysis that the network

equipment vendors and handset suppliers are in for a stormy ride whereas the SIs

are in better shape.

Having been hit hard by the dot.com crash, European and North American network

equipment vendors have been under huge pressure during the last decade from China.

Massive overcapacity has been addressed initially by major cutbacks and then through

consolidation, such as Alcatel-Lucent and NSN. Many of these companies are still

bleeding cash and so the recession will necessitate further cutbacks, mergers

and possibly bankruptcies.

Unfortunately the financial crisis and recession, combined with low cost competition

from Asia, are a ‘perfect storm’ for equipment vendors (see Figure 8). Not only is their

indebtedness a problem but most of their operator and enterprise customers are looking

to defer capital expenditure to improve their own liquidity. For example, will mobile

operators try to sweat their 2G and 3G investments through upgrades rather than

investing in 4G as the vendors hope?

However, as the English proverb goes, “every cloud has a silver lining”, and for the

network equipment vendors the maturing European telecommunications markets is

increasing demand for network outsourcing to reduce operators’ operating costs.

Some mobile handset suppliers are hoping that smartphone take-up will compensate

for slowing sales of other handset models but the deeper and longer the recession the

less likely that consumers will be willing to spend on handset replacements – regardless

of the new applications and services they might offer.

Because system integrators (SIs) typically work across many industries they were

less exposed to the dot.com crash although they did suffer somewhat from a post-Y2K

hangover. Most are not hardware manufacturers and have built substantial outsourcing

businesses which provide recurring revenues. The financial crisis will have a low impact

on most SIs because their liquidity is generally better than the network equipment

vendors’. However the recession is likely to reduce operators’ and content aggregators’

expenditure on applications development as it capitalised. Much more importantly for

SIs will be their exposure to industries harder hit by the crisis and recession, such as

financial services, retail and manufacturing.

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Base case

Lost Decade 2

Great Depression 2

GDP

2008 2009 2010 2011

What does this mean for you?Even dropping down from the global to a regional level is still a generalisation from your

perspective. What you are most interested in is your own market, which in most cases

tends to be a specific country. You need to develop your (short- and long-term) action

plans based on what you think might happen to the overall economy and its impact on

the key players in your market.

What might happen in the economy?Examples of three scenarios (see Figure 9) that you might evaluate:

A normal recovery starting in late 2009 or early 2010

Major depression where the economy gets much worse – as bad as or worse than

the Great Depression of the 1930s

Very slow recovery similar to Japan’s ‘Lost Decade’ of the 1990s.

‘Base Case’: most companies are already taking appropriate actions assuming a base

case where the economy starts to recover later in 2009 or early 2010. Cost reduction

is important (particularly need for working capital) but it is also important to ensure the

business will be competitive when the recovery begins. The company needs to be agile

and well positioned in the marketplace so that it is able to take advantage of market

opportunities as fast as, or faster than, potentially weakened competitors. Targeted

investments should also be considered seriously where management believes the

earliest and strongest growth opportunities will occur in the recovery.

‘Great Depression �’: operators and content providers must understand what such a

bleak scenario means for their business. In the CME sector it will mean low (and falling)

revenue per customer, few opportunities for up-selling new services, and demand

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Figure 9: Scenario examples

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for services that reduce ongoing costs for both consumers and enterprises. Because

inflation will be negative, there will be a tendency to wait before spending money and

this will encourage operators to put minimum upfront costs onto a contract or focus much

harder on pre-pay (or pay as you go) models so that customers can manage costs more

actively. In the most extreme cases, operators may have to change their operations

dramatically (in some cases perhaps withdrawing all subscription services) so that they

can operate a much more simplified business model to enable them to make profits

in such difficult times. Such models have been used by operators in many developing

and emerging economies, particularly in Africa and India, and operators in developed

economies may need to learn from them

Ultimately this type of scenario may unleash a ‘mega-consolidation’ where only one or

two converged infrastructure-based operators are able to operate profitably in a country,

testing the judgement of regulators, competition authorities and governments.

Needless to say the outlook for infrastructure and service providers will be extremely

difficult – downsizing and consolidation will become the order of the day. Any introduction

of new technology such as LTE will be suspended for as long as the depression lasts.

With the fall-off in capital investment, services such as outsourcing will become critical to

the survival of many suppliers.

‘Lost Decade �’: rather than negative growth, operators and content providers will need

to prepare for stagnation. To address this, similar measures can be taken as for a major

depression scenario (see Great Depression 2) but in less extreme ways. Cost savings

for consumers and enterprises will still dominate but subscription-based services will be

more attractive. Competition will be harsh and building a sustainable cycle of continuing

enhancements to service packages for the same cost will be critical to retain customers

and generate strong margins.

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Market Actions

Scenarios You Customers Suppliers Competitors Short termMedium to long term

Normal recovery

Great Depression 2

Lost Decade 2?

Equipment suppliers will struggle but the introduction of new technology will still be

possible yet delayed, just as 3G was successfully introduced in Japan during its Lost

Decade. Outsourcing will grow steadily as operators work hard to find all possible cost

savings. Some supplier consolidation will occur albeit not at the same pace as in the

major depression scenario.

How will your market change?Undoubtedly the key players in your market have already been impacted by the financial

crisis and the recession. It is dangerous to assume that the status quo will remain

unchanged even in your base case scenario. Take a fresh look at your main customers,

suppliers and competitors using the analysis set out in the first section of this document

for each of the scenarios that you have identified – see Figure 10.

Major customers: are any of them in the Casualties or Targets quadrants? What would

be the impact on your business of them being acquired or going bankrupt? How much

do they currently owe and are their payments taking longer? Should you be proactive

and enter into discussion with their senior managers to find out more details and perhaps

offer help in some way (not necessarily financial)?

Critical suppliers: are any of them in the Casualties or Targets quadrants? What would

be the impact on your business of them being acquired or going bankrupt? Do you have

alternative suppliers to whom you could switch? As with some of your customers, should

you be proactive and enter into discussion with their senior managers?

Figure 10: Analyse your market for each scenario

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Market Actions

Scenarios You Customers Suppliers Competitors Short termMedium to long term

Normal recovery In progress

Great Depression 2 Contingency

Lost Decade 2 Contingency

Vulnerable competitors: what would be the impact on your business of them being

acquired or going bankrupt? Assuming that you are in better shape, do they have assets

that you might be interested in acquiring? How else might you take advantage of their

current weakness – what might you do to attract their customers or better employees to

you? Could the market situation attract new competitors?

Government: when looking at the medium to long term outcomes for your market, don’t

forget to consider the effect of the financial crisis on the government. As highlighted

in the earlier section on operators, there may be taxation and licence fee implications

resulting from the government’s actions to address the crisis.

What should you do?By now your executive management team should already have a good understanding

of your liquidity position and taken the necessary actions with shareholders and banks

regarding maturing short-term debt, interest payments and dividends.

Have you done everything regarding revenue assurance, capital expenditure deferment

and operating cost reduction? Our experience is that these tend to be approached

from an accounting or process perspective with limited understanding of the underlying

technology or appreciation of the customer impact. There may be quite a bit more that

you can do without damaging the customer experience or your brand.

Do you have short-term contingency plans in place for the other scenarios,

particularly with respect to events concerning other market players (customers,

suppliers and competitors)? See Figure 11.

Figure 11: Develop action plans and contingency plans

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Having readjusted your short-term plans, you can start to look further forward.

Some of the questions that you need to address include:

How should you adjust your business mix in the short and medium term to

focus on economic profit and build on your competitive strengths?

How can you improve performance in the medium term? Large cost reduction

programmes, for example, network outsourcing or sharing, are complex and

many companies fail to realise fully the anticipated benefits on time.

What might your market look like in 5-10 years? How can you take advantage

of the current environment to emerge from the recession in a stronger position?

We believe it is possible to arrive at a strategy not just for surviving but thriving

in the current crisis. It involves evaluating the main scenarios for your key markets

and realistically appraising your position in the context of changes in your competitors,

customers and suppliers. These scenarios should look at the dynamics of the industry,

as some of the outcomes may not always be intuitive. From this assessment you will

then be able to build short-, medium- and long-term action plans that take account of

the many uncertainties that abound.

Further reading from PA:

“Surviving and thriving in the economic crisis”

“Taking control of tomorrow – evolving a future strategy for organisations

in the CME landscape of 2015”

“Delivering network outsourcing success”

“Network sharing – is your marriage made in heaven?”

To access these documents please visit www.paconsulting.com/cme.

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Impact of financial crisis on the Communications & Media sector