Opinion: KPN’s Perfect Storm

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By Herman Wagter

The early morning fog over Heathrow on February 19th reminded a lot of people going to the FttHEu2013 conference of the fact that in real life many risks have asymmetric outcomes: the “risk” that your plane arrives a bit early is inconsequential. The probability that a delay can grow to many hours or even “indefinite” is small but the outcome can cascade into a “perfect storm”. As many livid participants stuck in airports could confirm.

Diffraction Analysis published a report entitled “Timing the Infrastructure Investment in Next-Generation Access Networks” in 2011. The report analyzes the (asymmetrical) risks of various strategies for incumbents to upgrade their copper plant to Fttx. Any upgrade takes a lot of time, easily a decade, if only because of financial constraints. What happens if the world – and especially the market – changes in the meantime? The analysis shows that there is a serious risk of a runaway negative spiral. If an incumbent holds back, tests the water with some FttC and FttH, slowly ramps up the rollout by cherry-picking locations, there is a “stuck in the middle” phase during which the company is quite vulnerable. If the flows from the old cash cows (usually DSL, voice and text) drop, if DSL comes under attack as outdated/not good enough and customers have alternatives, there are insufficient resources to quickly ramp up the investments in FttH. Ratios of debt to EBITDA suddenly look awful, topline and bottom-line go south.

A variant of this scenario is what KPN, the Dutch incumbent, is currently experiencing. KPN recently surprised the financial markets by announcing a proposed claim-emission of Euro 4 billion, at a market capitalization of around 4.6 billion (dropped from more than 11 billion (!) a year ago). KPN had earned a reputation of being efficient and tightly run financially, lavishing shareholders with high dividends. In the last decade over 17 billion Euros of cash have been dispensed to shareholders, according to the financial press. FttC was introduced early (but never gained much traction against cable) and the FttH joint venture Reggefiber is seen as a smart example of how to upgrade efficiently. So what went wrong?

First of all the cable companies (Ziggo, UPC and others) have improved their products and service levels over time,  and started to blow DSL out of the water, taking the lucrative legacy fixed voice income away in the process.

Additionally, it took KPN a couple of years to go through the learning curve of how to define a competitive fiber offering with a state of the art TV package, which is the traditional strength of cable. Challenges included defining and marketing equivalent service offerings over a dual but unequal “fiber” architectures (FTTC and FttH), and at the same trying preventing cannibalization of much higher priced business connections over fiber. Sorting that out in practice delayed the emergence of compelling FttH offers. Marketing the services only in selected geographies is a new trick for an organization used to market nationwide. Delivering the service in volume was the last hurdle they had to face. To be fair, any incumbent will have to go through that learning curve, even if none of them seem to anticipate it. It’s made all that much harder when the cable hounds are barking at your heels.

KPN's FTTx is competitive now, as the recent cable operator subscriber numbers show. The side-effect of the fierce FttH vs. DOCSIS cable competition is however that DSL is becoming obsolete real fast, faster than KPN can upgrade it to fiber.

Additionally, revenues from mobile cash cows have peaked and are now in decline. The smartphone revolution created a massive shift to data instead of “ticks”, and an increased demand for large investments in mobile networks (with little associated revenue growth). KPN had no option but to offer whatever was required to get a slice of LTE spectrum in the Netherlands, in an auction designed to help new entrants into the market and therefore biased against incumbents. A staggering 3.8 billion euro was the total tally from auction (compared to 2.7 billion in 2000, which was considered insanely high at the time), of which KPN and Vodafone each have to pay 1.3 billion.

KPN’s borrowing capacity maxed out in 2011, a year during which money was borrowed to keep up the dividend levels. With EBITDA levels dropping KPN now has no room to move.

A perfect storm.

In hindsight it would have been wise to dispense “only” 12 billion of cash to the shareholders over the last few years. Investing the rest early and aggressively in upgrading both the fixed and the wireless infrastructure instead of trying to raise the cash now that everything is working against them would have been a better solution.

Hopefully KPN will survive the conundrum and come out stronger. The fact that its largest shareholder America Movil decided to support the emission suggests they will. But KPN’s case should be seen as a warning sign for other European incumbents.


Herman Wagter is an Dutch entrepreneur and independant consultant in the telecoms industry. He is a Diffraction Analysis collaborator. He is one of the driving forces behind the development of the Amsterdam FttH project (Citynet). On his blog Dadamotive Wagter likes to muse on the differences between facts and spin in the telecom industry. He tweets under the handle @hermanwagter.

Photo Credits: Castle by hil vanderwaal (Creative Commons CC-BA)