The boring and risky business of yield farming among European telecom operators

You start with a company that builds a box. Ignore what it’s doing, or pretend it’s doing literally nothing. It’s just a box. You can take a dollar, you can put it in the box and you take it out of the box. The total amount in the box is approximately €22 billion and will bring in €2.5 billion, a return of 11 percent! That’s very good! By the way, the box is called Vodafone.

OK – it’s a joking comparison. What is worth noting, however, is that the dividends currently being promised by European telecoms are as good, if not better, than those available from those magic crypto boxes around 2022. See:

EU Telecoms: Dividend Yield for FY23E (%) © Barclays

Will telco yield farming prove safer or more sustainable than the crypto guy? History says no, mostly for worldly reasons. Once sector divi yields hit 7 percent, this is usually just a signal of management disapproval, not hidden value:

© Barclays

Part of the problem is that telcos, as quasi-utilities, are defensive only by association. Telecom companies face inflation and interest costs while operating primarily in regulated markets that lack both pricing power and cost flexibility. Revenue is volatile while expenses are recurring, so high returns have almost always proved illusory.

Telecom Italia, BT, Telefónica and KPN have all brought their payouts to zero over the past decade, with Deutsche Telekom, Proximus, Orange and Telia all falling sharply. Only Norway’s Telenor has had a clean dividend maintenance record since GFC, and its current yield of ~10 percent suggests little confidence in maintaining the winning streak.

But is it different this time? Barclays says maybe. A note this week from analyst Maurice Patrick and his team argued that as long as one-off costs are truly one-offs, most European telecoms should be able to weather a recession without hurting cash returns.

© Barclays

The sector’s overall debt remains high — €280 billion in 2022 versus €185 billion in 2012, for a net debt-to-ebitda ratio of 2.7 — but funding costs are in what has been a quiet year for spectrum auctions should be manageable. Here’s Barclays’ Free Cash Flow Risk Calculator:

© Barclays

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There are many moving parts involved. Take Vodafone, which lowered its free cash flow forecast in November and parted ways with CEO Nick Read in December. Even after the partial sale of the Vantage Towers business, Vodafone’s leverage is uncomfortably high. Just because the new management could keep its dividend doesn’t mean it should.

Vodafone’s FCF target of €5.1bn for 2023 excludes restructuring and spectrum, which averages €1.5bn per year and varies widely at currency translation costs for operations in countries such as Turkey and South Africa can. Investment in the 5G network has been scaled back but the German quad-play sales pitch remains unproven and a lack of football rights in southern Europe could be a growing disadvantage. In short, it’s tight, which will be a reason not to buy for many:

© Barclays

Still, telco bosses usually need an excuse to push themselves past tough times: a price war, a new entrant, a network upgrade, a transformative acquisition, a pandemic, etc. The lack of any of these things will be a problem for Vodafone, according to Barclays, as well as for Telefónica, Orange, Telia and BT:

“We see both adequate FCF coverage and manageable leverage and no obvious investment alternatives to generate higher returns that would justify a cut. Therefore, we doubt that many telecom companies will adjust their dividends anytime soon.”

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