The lumbering giants of Europe's telecom sector aren't getting much love these days.
Stocks like Deutsche Telekom (NYSE:DT), BTGroup (NYSE:BT), RoyalKPN (NYSE:KPN), Telefonica (NYSE:TEF), and Telecom Italia (NYSE:TI) all seem to sport pretty high dividend yields as investors shy away from the debt-heavy balance sheets, large entrenched workforces, and the perception that more nimble operators in mobile phones and Internet services will eat away at their franchises.
In the case of Deutsche Telekom, investors seem both irked at the company's lower guidance for 2006 EBITDA (earnings before interest, taxes, depreciation, and amortization) and plans to accelerate spending in an attempt to grow both the broadband business and the base of customers subscribing to multiple services. Are they overreacting?
Third-quarter results looked all right. Revenue was up about 5%, EBITDA up about 4%, and free cash flow up about 6%. The company had almost 43% more broadband lines in service and more than 10% growth in mobile subscribers. The U.S. mobile business, T-Mobile, also did well for itself -- increasing subscribers by more than 24% and revenue by more than 26%.
The issue for investors here is pretty straightforward: Can Deutsche Telekom continue to grow sufficiently to support a healthy dividend? I don't think anybody really has illusions of DT being a growth story. But I do believe that investors would like to see a lean, liquid operator with the ability to produce the cash flow to keep hiking the dividend.
To their credit, the people in management are saying the right things. They're targeting a pretty aggressive workforce reduction, likely to be achieved mostly through voluntary retirement plans. And they're willing to spend to make the broadband and mobile businesses more appealing. That said, investors weren't too keen to hear that 2006 EBITDA would be below analyst projections, even though the forecast for 2007 was stronger.
It seems to this Fool that most of the bad news and worries are baked into the stock. People have been concerned about infrastructure spending, liquidity, cash flow, and competition for as long as I've followed the stock. With little in the way of expectation, maybe the bar has been lowered enough that DT has more potential to surprise than disappoint.
For more telco Takes, see:
Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
