He arrived not a moment too soon. When Ad Scheepbouwer agreed to take over from Paul Smits as Royal KPN's chief executive last September, the Dutch telecommunications operator , with E22.3 billion ($20.4 billion) in loans and annual revenues of only E12.36 billion in 2001 , was on the brink of missing an interest payment. Scheepbouwer, the no-nonsense former boss of TPG, the Netherlands' privatized postal operator, immediately arranged a E2.5 billion credit line for KPN and announced a massive cost-cutting campaign. He laid off 5,200 people , 13 percent of the workforce , slashed manager salaries by 10 percent and promised to reduce annual capital expenditure by one third, to E2 billion.
Last December, riding a wave of investor enthusiasm, the former bookkeeper cut the company's debt by E5 billion, via a massive secondary offering that nearly doubled the number of KPN shares. Remarkably, the move didn't even dent KPN's share price; investors were relieved that the company was no longer in danger of bankruptcy. In the first quarter of 2002, KPN had earnings before interest, taxes, depreciation and ammortization of E1.1 billion on revenue of E3.3 billion. KPN, which fell to E2 per share in August after peaking at E70 in March 2000, has been the best-performing telecom stock in Europe over the past ten months, more than doubling to a recent price of E4.80.
Yet KPN, which is only Europe's sixth-largest telecom in terms of revenue, still has E15.4 billion in debt, or 4.3 times its 2001 ebitda. To bring debt down to E14.5 billion by the end of the year, the company has put operations in five European countries on the block. But it has refused to consider selling its German mobile phone subsidiary, E-Plus. KPN purchased E-Plus in 1999 for E9.2 billion. In 2000 it tried to strengthen its position by buying a German universal mobile telecommunications system, or third generation, license for a further E8.4 billion. Recognizing the plunging values of mobile phone operators, however, KPN has written down E12.4 billion of its investment in E-Plus. Scheepbouwer is hoping that the March introduction of I-mode, an advanced mobile Internet technology licensed from KPN's minority shareholder, Japanese wireless leader NTT DoCoMo (see story, page 49), will help E-Plus increase its stagnant 13 percent market share. Nonetheless, building a third-generation network in Germany will cost several billion euros, and E-Plus will face five other operators in what is likely to be a brutally competitive market. Scheepbouwer recently discussed his company's outlook with Institutional Investor Staff Writer David Lanchner.
Institutional Investor: The strategic goal of KPN until recently was to be the third-largest mobile operator in Europe. Is that still your goal today?
Scheepbouwer: Our aim is to have a significant position in the mobile markets where we are already present. That is the Benelux states and Germany, which represent about one third of Europe's wireless customers. Even though we are now focusing on a region rather than on all of Europe, we still expect to stay close to our former goal of being the third-largest mobile operator in Europe. The only competitors clearly bigger than us are Vodafone and Orange. In the years ahead we expect to stay neck and neck with Deutsche Telekom, vying for third or fourth place on a pan-European basis.
Your debt-to-equity ratio remains one of the highest in Europe. Would you consider another rights issue?
The world can change fast, but we are not planning any rights issues. We expect to have proceeds from further asset sales, and we will be cash flow positive in operations this year and next year. We will look at refinancing our debt at some point, probably lengthening the maturities of our current loans, but that will, if anything, decrease any potential pressure to seek further shareholder funds. What is very clear is that we must continue to drive the debt down, because E14.5 billion is still too high for the long-term health of this company.
How will you get there?
Already we've reduced our annual costs significantly through all the layoffs we've implemented. We want to further bring costs down without harming productivity by reducing our ratio of capital expenditure to revenue. That should be fairly easy, because we've invested nearly E3 billion more than the average European telecom operator over the past three years. We are also being a lot more careful with the miscellaneous costs that people incur. Today we are approving at board level every temporary or permanent employee we hire.
How about margins?
We still only have operating margins of 35 percent, but we are trying to move in the next few years to something more than 40 percent, in line with our historic figures. Our margins fell from 42 percent to 35 percent in the past two years. That had to do largely with a falloff in productivity, because employees had all sorts of worries tied to whether the company would remain solvent or not and did not look after their daily operations. But now our focus is back on the business.
Analysts estimate that you've targeted a further E2 billion worth of asset sales for this year. Is that true?
We have completed E2.1 billion worth of asset sales since I've been here. We have further assets we want to sell, but we have not announced a specific amount we expect to raise. What I can tell you is we want to sell our directory services business and our 27 percent stake in Cesky Telecom, but only if we get high prices. We have an asset list, and we will sell from that if and when we get the right price.
Why is E-Plus considered a core asset, given the likelihood of cutthroat competition in Germany?
First of all, there is going to be consolidation in Germany. Second, we are the third-biggest player there behind Deutsche Telekom and Orange, and in a country of 80 million people, I think there is room for three players. So we think we have a potentially highly profitable asset in the biggest market in Europe. Moreover, now that we've introduced I-mode, we think we can enhance the value of E-Plus. We think that the three UMTS license holders that are smaller than us will have to consolidate to be profitable, but not us.
Would you consider merging with or buying any of those competitors?
No, because we wouldn't be able to justify the price of acquiring another UMTS license. Everybody has just paid E8.4 billion for a license. So if we tried to consolidate by buying out or merging with a competitor, we would be obliged to just write off that cost.
How should the problem of overpriced UMTS licenses and an overcrowded market be resolved?
I think it would help greatly if companies merged with conditions that allowed them to give back one license to the government in exchange for their original investment. We proposed this. Whether or not our proposal is accepted, it is clear that something has to give in Germany.
If the competitive landscape does not change in Germany, will you be able to make a decent return on the E8.4 billion you spent on E-Plus's license?
We could make a decent return if the models on which we based our bidding prove valid. The problem is the perception in the world since we acquired the licenses has changed. Initially, the markets were happy with how much we paid. Now the view is that the value of these licenses is zero, given the number of competitors in Germany and the projected customer base for third-generation mobile networks. Yet there are still no real criteria on which to base the value of UMTS licenses.
By how much will the March introduction of I-mode increase your revenues?
We don't have a specific target, but we expect its impact will be significant. The degree to which I-mode appeals to the consumer will give us an idea of what we can look forward to with UMTS. The essential services are not that different.
Would KPN ever merge with a larger incumbent?
Everything is possible, but so far there is no broad evidence that it is really profitable to put fixed network operators together. Overall, we think our future as an independent operator is bright.
