Tuesday, April 16, 2019 12:24 PM / Fitch Ratings
5G investments will persist in global telecom over the intermediate term, even though revenue may materialize gradually, according to Fitch Ratings. We anticipate 5G spending will continue even in a downturn due to fairly resilient top lines and the flexibility to reduce operating costs, or even dividends before capex, if necessary. This should not have negative credit implications due to substantial cash flow and balanced capital allocation for most issuers.
Wireless investment, particularly related to the densification of the network, continues to be an area of emphasis for telecom companies due to the strong demand for 4G LTE capacity for rapidly growing data services and to position networks for 5G's arrival. 5G is a strategic priority for the sector due to the internet of things growth and the highly competitive and evolving competitor landscape.
Upgrades to networks are required to support increased speed and connectivity, and to maintain and grow market share. The proposed T-Mobile (BB+[EXP]/Stable)/Sprint (B+/Rating Watch Positive) merger could further accelerate 5G spending in the US, given the combined entity would have a greater ability to invest. We view the odds of regulatory approval as greater than 50%, although the probability will depend on the regulatory lens used to analyze the transaction. For instance, whether the FCC considers factors such as the need to have three 5G networks in the US, increased rural coverage, or the potential for fixed wireless competition versus cable could skew the odds.
Capex intensity for Verizon (A-/Stable) and AT&T (A-/Stable), which have been investing in fiber, spectrum and cell sites for several years, will remain around the recent average at about 13% through 2020. These companies are leveraging existing 4G networks to efficiently facilitate the nationwide rollout of 5G with modest additional software and hardware upgrades. Post-dividend FCF for Verizon and AT&T is expected to remain significant, despite 5G spending, ranging from about $9 billion to $10 billion in 2019 and 2020 for both companies. This will allow deleveraging to continue.
Verizon is the first carrier to launch 5G Ultra-Wideband mobile service in the US. The roll-out began in Chicago, IL and Minneapolis, MN last week and the company intends to expand the service to more than 30 US cities in 2019. Verizon rolled out commercial 5G residential broadband services in a handful of US markets in late 2018.
In Europe, network-sharing joint ventures (JV) may help manage 5G investments and improve competitive capability. Vodafone (BBB+/Stable) and Telefonica (BBB/Stable) plan to extend their network-sharing JV to 5G in the UK. Vodafone also announced a similar arrangement in Italy with Telecom Italia earlier this year in part to enable faster deployment of 5G over a wider geographic area at a lower cost. Nonetheless, 5G auctions, network rollouts and contractual commitments will keep capex high and subdue FCF. Capex for incumbent operators typically accounts for a sizable 15%-20% of revenue, excluding spectrum costs.
Deutsche Telekom (BBB+/Stable) should generate moderately positive FCF over the near term and Telefonica should sustain positive FCF generation of around EUR2.0 billion-EUR2.5 billion over the next three years. Conversely, we project Vodafone's post-dividend FCF will be negative. Financial flexibility in a downturn might depend more on dividend policy, as European telecoms demonstrated a willingness to reduce dividends in times of crisis. Reducing capex is less likely because as technology evolves investments are needed to maintain competitiveness.
We anticipate the path for 5G adoption will be more evolutionary than revolutionary. Network deployment must be completed and customers will need to assess the added benefit and cost of next generation technology. Fitch Solutions estimates in a special report 5G - First An Evolution, Then a Revolution dated April 9, 2019 that there will be more than 4 billion 5G subscriptions globally by 2028, representing around 45% of the global total.