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Credit Crisis, Part 8: Show Us Your Labs

This is the latest in our acclaimed series of articles on the global financial crisis and its impact on the Telecoms-Media-Tech sector. With estimates of losses in the value of financial assets in 2008 now at $50 trillion (c.70% of global GDP), and financial stress and unemployment rising, our previous interpretations of the prospects for telcos in the financial crisis seem open to challenge as being overly optimistic.

However, there is little evidence from company results of an impending crisis in demand for telco services, at least for now. Accordingly, telecom sector relative performance continues to be strong, particularly during the worst of the market downdraft. However, investors appear to be increasingly selective in defining what differentiates one telco from the next. Our attendance at a recent telco innovation conference leaves us convinced that there is a story waiting to be told around research and innovation - if the pieces can be properly aligned.

Our analyst writes this while enduring the pain of a swollen jaw, traumatized earlier as it fell, in shock, to hit the desk from which he types. All this pain could have been avoided had he only not looked at the offending headline on my Bloomberg screen - that a new study by the Asian Development Bank estimates total losses in the value of financial assets worldwide during 2008 at $50 trillion. It’s noteworthy that the “trillion” value has historically been so seldom-used (outside astronomy) that there isn’t really a familiar,user-friendly abbreviation; but it’s still early days, as any Zimbabwean will tell you.

The ADB reckons that the portion of the $50 trillion in losses attributable to developing Asia, at $9.6 trillion, is greater than the entire region’s GDP in 2008. We in the developed world may take small comfort in our relatively more robust economic and political institutions - the $50 trillion global figure works out at 70% of the estimated purchasing power parity (PPP) adjusted GDP figure for the entire world according to the 2008 CIA World Factbook, $71 trillion.

We wrote recently elsewhere that, apart from the appalling implications for individuals in the current crisis, there is an aspect of this which is perversely exhilarating, as arguably all of (or the vast majority of) humanity collectively faces a common challenge. Not that humanity will collectively see it that way - our analyst would expect quite the opposite in practice, with nationalism and protectionism as sadly natural safety blankets to turn to in times of crisis. Nevertheless, if the ADB study’s numbers are anywhere near correct, then our assumption has been broadly vindicated: the majority of the planet’s working men, women, and (sadly) children slaved away during 2008, only to see the fruits of 8.5 months of their labor obliterated by the implosion of global asset values. The lucky ones may continue, while many now face unemployment and uncertainty.

Clearly it is no secret that conditions have grown breathtakingly worse since our relatively more upbeat assessment of what was once called the credit crunch, some six months ago. As one might expect in a period of such intense anxiety, anecdotal evidence of belt-tightening is easy to find.

Yet, when asked in a more structured framework, it appears that two-thirds of telco customers would look to cut-back on, rather than cut, services. We thus repeat our Telco 2.0 mantra that the telco should sell itself through the downturn on the basis of good value for money, access to critical information, and affordable entertainment - it looks like most of your customers have reached the same conclusion.

The market also seems to have solidified its view, for now at least, of telecom as a relatively defensive sector. In our re-worked ranked returns chart for the benchmark STOXX 600 index industry groups, we present a ranking by one month performance to 9th March (in red) with year-to-date performance included for reference (in blue). It’s important to note that the one month decline to 9th March in the benchmark is 20.8%, and the year-to-date decline is 20.4%. As we have previously expected, telecom is indeed performing better during periods of market stress (we think -21% qualifies) than during more benign periods (in this case telecom ranks eighth through the up/down volatility period, and third during the falling-off-a-cliff phase).

DJ STOXX 600 Rankings By Sector, 9 March 2009 vs YTD

The market may be putting its money where its mouth is, but do recent company results give us any tangible evidence of the resilience of these businesses during this crisis? Interestingly, given cable’s assumed position as a victim of consumer downsizing, we find encouraging signs in a couple of fourth quarter reports from European cable operators.

Virgin Media’s Q4 2008 results showed a somewhat surprising decline in overall churn, with the largest reduction coming in non-pay churn, a counterintuitive result in the current climate. Broadband net adds were relatively weak for the fourth quarter, but were respectably flat on Q3’s level, and digital TV net adds continued the progress of the previous three quarters. Explosive growth it ain’t, but neither are there any signs of a consumer crisis in evidence. Pan-European cable giant UPC’s Q4 results showed pretty much the same trend, with broadband growth somewhat anemic, though not desultory, especially when we consider that UPC’s footprint contains economic hotspots such as Ireland, Austria, Hungary, and Romania. Digital TV net additions were down on the punchier growth rates of the first three quarters, but at 59% YoY, hardly offered any cause for alarm.

Virgin Media estimated churn trends by category

Admittedly, these are but two isolated examples, and what we don’t know is how sustainable these trends will remain as unemployment rises, but for now, at least, it looks as if the consumer, even in some very stressed economies, is standing by telco/cable services for the very reasons we have proposed previously. While this is encouraging, life is obviously anything but straightforward for the telcos, with growing disparity between operators in market sensitivities to credit risk profiles. The chart below shows market consensus forecast net debt/EBITDA levels for 2009 (in the case of BT and Vodafone it is for the March 2010 financial year), along with their credit default swap spreads, both as at 9th March. Without going into the intricacies of credit default swaps, the main point is that, the higher the number on the chart, the greater the perceived risk of significant ratings downgrade or default.

While some of the numbers are easily explainable (Telenor, OTE, Telekom Austria and Vodafone’s CDS spreads reflect their emerging market exposure), while others are less so. In an ideal world, KPN would probably be perceived as roughly on a par with BT, except that KPN has a formidable recent reputation for financial conservatism, while BT has a significant pension liability which distorts the fundamentals of its business performance.

Source: m Capital, from Bloomberg data

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Comments

Is this a serious post? Have you actually compared capital writedowns to GDP? That is closer (in very vague terms) to comparing profits to revenue, and that is why you have ended up with ridiculous numbers like 70% and phrases like 'appalling'. What we are experiencing (at the macro level) is NOT appaling. Our long term real growth rate is 2.5-3%. That means we increase our wealth by around one-third each decade, but each decade or so we 'lose' around 18 months of that growth although we typically make it back again during the following decade (yes even after the Great Depression). Inconvenient, but not appalling. Consumers on some level seem to understand this and that is why the telco downturn muted.
p.s. the churn reduction is simply explained: people are moving home less.

Gary,

I sense we're going to have to agree to disagree on this one and meet up in five years to compare notes.

GDP growth over the past decade has been led by Western consumers, primarily Americans. Their enthusiasm was rooted in an unrealistically optimistic reading of future earnings and employment prospects, underpinned (or not, in this case) by distorted or fictitious asset values. Thus I feel it's entirely appropriate to show the scale of financial asset losses in relation to GDP.

On top of the extreme stress on the consumer (http://www.equifax.co.uk/About-us/Press_releases/2008/31PERCENT_COULD_ONLY_SURVIVE.html), we also have multiple banking, currency, and fiscal crises happening simultaneously, including the possibility of a number of sovereign defaults in heretofore "credit-worthy" countries.

Investors and traders I speak to in the financial markets, many of whom have survived the notable crises of the last three decades, all agree that we are entering into a period unprecedented in living memory - which is certainly how it feels to me.

My late grandparents, who were lucky enough to emerge from the Great Depression relatively unscathed, never described the period as "inconvenient." By the late '30s the stimulative effects of the New Deal were fading, and if not for a "convenient" war which claimed tens of millions of lives, who knows how long organic means would have taken to engineer a recovery?

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