Deutsche Telekom dividend faces squeeze to fund investment

Thu Nov 29, 2012 9:45am EST

* Analysts expect 2013 dividend cut of 18.6 pct - StarMine

* Deutsche Telekom has not much leverage headroom - Fitch

* Heavy investments needed in networks

By Harro Ten Wolde and Peter Maushagen

FRANKFURT, Nov 29 (Reuters) - After keeping up its dividend when all around it were cutting theirs, Deutsche Telekom is expected to join the throng of European telcos diverting cash from shareholder payouts to capital investment.

Deutsche Telekom, which will speak to investors at a two-day capital market event next week, has, with Britain's Vodafone , avoided such cuts so far, thanks to cost control and a relatively robust home market.

Not so Telefonica, hit by a 17.8 percent fall in nine-month Spanish mobile revenues, or the Netherlands' KPN , Telekom Austria, and France Telecom .

But as cable operators in Germany chip away at its share of the broadband market with faster, cheaper offerings, it will need to spend big just to stand still.

"If Deutsche Telekom cuts the dividend to invest in the future of the company, I think many investors will be able to live with it," said an investor who declined to be named.

High dividends have long been the selling point of telecoms shares, but many carry high debt loads from previous investments and are burdened with dwindling returns from legacy fixed-line operations and stagnant voice revenues, which has put dividends under pressure.

Unlike many of its European peers, Deutsche Telekom is at least not facing an urgent need to cut debt.

Next week Chief Executive Rene Obermann and Financial Chief Tim Hoettges will outline their strategy for the coming years.

In recent weeks, they have been flagging a need for additional network investment, which will inevitably compete with dividends for the company's free cashflow.

For the years 2010-2012 Deutsche Telekom kept its promise to pay an annual dividend of at least 0.70 euros ($0.90) per share.

But from 2013, analysts on average expect a payment of 0.57 euros per share, a 18.6 percent cut from this year, according to StarMine, which gives more weight to analysts with a better track record of accuracy.

In the past month, 11 out of 30 analysts have lowered their dividend estimates for next year by an average of 16.4 percent.

"A level of between 0.50 and 0.60 would make sense," the investor said. "We are talking about a difference of 300 million euros in free cash flow," he said.

NOT MUCH HEADROOM

The company is aiming to keep its net debt to adjusted operating profit (EBITDA) ratio or leverage ratio below 2.5. It stood at 2.1 at the end of the third quarter.

The credit rating agencies, which use slightly different metrics, believe it can maintain that level. Just.

"Based on our calculations, there is not much headroom for Deutsche Telekom to increase its leverage," said Nikolai Lukashevich, an analyst at Fitch CreditRatings.

"Keeping dividend at the current level and keeping leverage on track may be challenging for them," he said, adding the former German telecoms monopoly would continue to see declines in European and German business due to the weak economy and stiff competition.

The Bonn-based company will have to invest an annual 1 billion euros in the next five years to get its broadband network up to speed with cable providers such as Liberty Global and Kabel Deutschland, analysts estimate.

And that's only the start of it. In the next 20-25 years as much as 80 billion euros is needed to roll out a glass fibre network in Germany, investment that will need to be shared among the local telecoms operators.

In the meantime Deutsche Telekom wants to optimise its copper network via a process called vectoring, or VDSL2.

This cheaper alternative will enable them to offer Internet speeds of up to 100 megabits per second, up from current levels of 16 Mbit/s.

Cable companies at the moment offer 50 Mbit/s Internet for the same price or less as Deutsche Telekom's current speeds, and can already supply up to 150 Mbit/s.

"We strongly believe that VDSL and fibre investments in Germany will weigh heavily on Deutsche Telekom going forward," said Erling Thune, a fund manager at Norwegian fund DNB Asset Management, who holds Deutsche Telekom shares in his portfolio, though he rates them "underweight".

"We think Deutsche Telekom may face difficulties long term if they do not invest," he said, adding that it was difficult to comment on an acceptable dividend level.

Deutsche Telekom shares have been doing better than the sector in 2012, down 5 percent, while the sector has lost around 10 percent, and still trades at a 12-month forward dividend yield of 7 percent.

KPN shares trade at 3.4 percent and Telefonica at 5.2 percent.

France Telecom trades at a 10.2 percent yield, but that partly reflects a drop of more than a third in its share price so far this year.

For now investors are looking for clarity, even if just for 2013, rather than Deutsche Telekom's regular three-year dividend policy.

"We would rather have a clear dividend statement than have the debate on whether to cut it heat up every time a quarter disappoints," the German shareholder said.

"We have told Deutsche Telekom that we would be okay with it, even if they were to give only an outlook for 2013."