France Telecom (Orange) held its annual investor day on May 31. At the event, CEO Stephane Richard highlighted the issues facing the company and sought to clarify Orange’s role in the industry, particularly in relation to its approach to over-the-top (OTT) players. Richard spoke of his positive discussions with Google CEO Eric Schmidt and promised to announce partnerships “soon”.
Defining Orange’s industry role
Richard began the day by highlighting the fact that without telecoms networks, online services would not exist. However, he also acknowledged that OTT players drive demand for the networks. While Richard’s statements are true, networks are simply the delivery mechanism for the content and services that are important to end users.
As well as setting the usual financial and operational targets, Conquests 2015 has focused on attempting to establish Orange’s role and identity within the telecoms industry. It appears that Orange has made some progress on this front, with its building of best-in-class networks an example of its future strategy. Orange sees the quality and coverage of its networks as a key differentiator for its customers and for content and service providers at a wholesale level and it is an area of competitive advantage that Orange plans to maintain across its entire footprint. However, at the end of the event there was still a lack of clarity over how Orange would deal with OTT players.
A recurring theme of the event was that Internet players should contribute towards content and service delivery costs. To this end, Richard reported on recent meetings with Google, Apple, and Facebook. While he was bullish that partnerships will be announced “soon”, no details were revealed as to the nature of the partnerships or whether Richard was able to negotiate the volume-based charging models touted previously. It seems unlikely that such models will be introduced as they could derail Internet player’s profitability targets and raise issues around net neutrality.
Like many in the industry, Orange has moved on from competing with OTT players to “co-opetition”. That is a good move as we believe telcos will struggle to compete head-on with the Internet behemoths. However, Orange’s boundaries between competition and cooperation were not entirely clear. On the one hand, presentations highlighted its open innovation model. For example, French music-streaming service “Deezer” was reported to have made strong progress. On the other hand, the fact that some web players have struggled to launch services such as Netflix outside of North America was highlighted as an opportunity for Orange rather than as a chance to partner.
As well as working with Internet players, Orange is being more pragmatic about data profitability - a welcome change from the company’s previous comments that bemoaned the fact that OTT players are getting a free ride. Richard indicated a desire to introduce more tiered pricing schemes, differentiated classes of service, and yield management-based data pricing for consumers. Orange also plans to offer services to OTT players that are designed to improve the distribution of content, in particular content delivery network (CDN) services. CDN provides telcos with an opportunity to make a difference, but it also highlights that the future is not black and white, with web players playing the role of customers, competitors, or partners to telcos.
Addressing investor’s concerns
Investors have voiced concerns over Orange’s ability to meet its targets in the face of increasing competitive pressure in France; continued global regulatory pressure; its ability to reduce costs; its ability to manage its broad portfolio; continued state involvement; and its ability to create value from mergers and acquisitions.
Deputy CEO and CFO Gervais Pellissier sought to address the concerns by splitting the 2015 timeframe and its targets in two, and rebranding the strategy “Adapt to Conquer”. The first three years (2010 to 2013) are the “adapt” stage, during which Orange will seek to stabilize its financials. Pellissier targeted a 0.6% compound annual growth rate in revenues during this stage, with Europe, Asia, the Middle East, and Africa set to offset declines in its France and Enterprise divisions. Pellissier anticipates that the challenging economic situation that Orange operates in will have improved by 2013. When combined with opex reductions (through a focus on driving increased operational efficiency), Pellissier claims the moves will allow the group to stabilize its EBITDA. Orange also intends to deliver the operating cash flow needed to fund investment and a stable dividend, which was confirmed for 2011 and 2012.
Orange’s anticipated capex during the “adapt” phase is set to peak at approximately 14% of sales in 2012 and average 13.4% over the next three years. The peak will occur during investment in network capacity and modernization, in particular the rollout of FTTH in France and LTE. Other major spending will be on IT and front-line customer service. Capex is forecast to fall back to 11% of sales during 2014 and 2015.
The firm has an aggressive timeline to meet its EBITDA margin targets, aiming to achieve 60% of its projected €2.5 billion cost savings (measured against its 2010 cost base) by 2013. Other incumbents, such as BT, have been able to cut costs at a faster rate than their revenue decline by significantly reducing headcount and renegotiating supplier contracts. That is followed by a rationalization of networks and IT systems, and a focus on reducing the cost of failure through a company-wide right-first-time program. All of these elements formed part of Orange’s presentation. If the anticipated benefits of the joint procurement agreement with Deutsche Telekom are added to these initiatives, there appears to be plenty of scope for cost reductions.
However, Richard was careful to avoid talk of headcount reductions, which was particularly prudent given Orange’s recent history. He preferred to focus on an organic reduction in headcount due to ageing staff. Orange saw its full-time equivalent (FTE) employee base fall by 2.7% in 2010, with most of the reduction occurring in France and Poland. By 2020, a further 30,000 staff in France are expected to have retired.
Orange’s investment in next-generation networks and its focus on driving efficiencies within its operations will directly impact its profit and loss and cash flow. However, uncertainties surrounding the degree of economic stabilization in Europe, the speed at which it will occur, and the true impact of increased competition in its domestic market all add to the risk that the company will struggle to meet its targets and thereby undermine investor confidence.