Edited by Raffaele Barberio
Energy, telecommunications, automotive and fintech: these are the four drivers that will shape the future of financial markets. Only those who can look to the future, ready for a paradigm shift and not conditioned by the past will have a chance to adapt to the new context of markets and technologies of the next decade. In Italy, the experience of Open Fiber is envied across the world for the value it has built for the country and for itself. 5G could be the right opportunity for a change of pace for the telcos. But they must commit to change their focus and their mindset looking at the markets in a new, bold way.
Our Monday interview with Francesco De Leo, Executive Chairman of Kauffman & Partners in Madrid. An appointment, now awaited by all professionals in the sector: but this time we intend to focus on Francesco De Leo’s speech at the Third International Conference “5G Italy and the Recovery Fund”, held in Rome on December (1-3). There were talks in other panels, as well, about the contamination and convergence between the telecommunications, energy and automotive industries. There is a growing feeling that only a fundamental change of unprecedented magnitude can trigger the rescue of incumbent telecom operators, while they are in a race against time to identify new business models to recover their path to growth.
The result was a very extensive interview that we decided to divide into several parts. Today we present the first one of them.
Key4Biz. We are heading towards the end of the year. What are the expectations gaining momentum across financial market for 2021?
Francesco De Leo. There is still a great deal of uncertainty: it is not clear what the evolution will be, in 2021. It is likely that we are facing a historical “bifurcation”: on the one hand, a third wave of COVID-19 could bring down the Eurozone, but at the same time, the acceleration of the digital transformation, now in front of everyone’s eyes, could be the “catalyst” of an unprecedented change of pace and unlocking of value. All in all, we expect the launch and quick ramp-up of new tech players, with deep pockets, capable to leverage technology to “blitzscale” across the globe.
Key4Biz. Which of these two scenarios do you consider the most plausible?
Francesco De Leo. History tells us that these two scenarios could coexist for some time, as it happened in all waves of transformation in the past. It will require an undiluted focus and sense of urgency from investors and analysts: they will have to be more selective in addressing the most critical “market rotation” in history, due to a massive value migration from mature sectors, to new asset classes.
Key4Biz. And which scenario would you personally lean towards?
Francesco De Leo. Our analyses show that we are facing the greatest value creation opportunity we have ever had in history over the last 150 years. At the end of 1800, beginning of 1900 there were 50 years in which three technological platforms shaped the evolution of the world as we know it today: (1) the internal combustion engine (2) electricity (3) the telephone, which set in motion the development of the financial system. Nowadays, as never before we are facing the rapid convergence between (1) energy, (2) telecommunications with their own catalyst (3) in the next-gen automotive industry, and the progressive (4) digitization of financial services (fintech), due to the spread of mobile telephony across the world.
Key4Biz. What is the difference with the past?
Francesco De Leo. It is the speed of propagation of technologies on a global scale and the possibility, for lead players, to trigger “blitzscaling”, growing global in 2 max 3 years: all of this did not happen in the past. But there is a second-order effect, perhaps even more significant than what happened between 1880 and 1929: the velocity of “hybridization”, the ability of each of these 4 platforms (energy, automotive, telco and fintech) to contaminate the others triggering subsequent, disruptive waves of innovation.
Key4Biz. Yet there is much concern on the part of large investors, due to geopolitical instability and market volatility. Are you really expecting that “everything will go well”, as it was said a bit abruptly, at the beginning of the pandemic?
Francesco De Leo. In a phase of rapid transformation, it makes little sense to look at the daily fluctuations of stock market prices or the results of next quarter. This pattern of analysis has led to a short-term focus, quarter after quarter: this mindset has not allowed us to grasp the transformations that are taking place today, leaving no room for recovery for those who are anchored to legacies, inherited from the past. What the 50 years before 1929 and the current phase have in common is the yield inversion: short-term rates are higher than medium/long-term rates. For some observers we are faced with the events that culminated in 1929, with the aggravating circumstance that the contagion mechanisms of financial markets are much quicker to pick up momentum, due to the growing interconnectedness of the global economy. Personally, I am of the opposite opinion: the reversal of rates is due to the observation that the players and the industries that will emerge in the coming years command a lower risk profile than the asset classes currently part of the main stock markets. The new players will replace the old ones, unable to adapt to the magnitude and speed of change: the “new normal” is likely to trigger an unprecedented “unlocking” of value for investors. But those who are left behind will just be fortunate if they will not be the victims of this inevitable Darwinian extinction.
Key4Biz. Thus, what do you expect?
Francesco De Leo. I am convinced that the energy world and the transformation of the automotive industry are the trigger of a deep, unprecedented change of the global economy. This paradigm shift is reflected by the reaction of financial markets: today Tesla is worth more than 500 billion dollars, and a few players in China, “borne electric”, will soon reach comparable levels of capitalization. Analysts and investors agree that one of the undisputed leaders of this transformation is ENEL, capable to double its market value in just 5 years. There are margins for it to continue to be a global player in terms of capitalization. If we analyze the initiatives underway, the geographic footprint, the level of innovation and the new businesses where ENEL has been able to assert its leadership over the last 3/4 years, there is room for further appreciation of the stock. With its presence in Spain (Endesa) and Latin America, ENEL is leader in 32 countries: it is likely that its value is still largely underestimated, at these levels. Looking ahead, it is set to exceed 100 billion euros in capitalization within 8-12 months: at this rate, it can double its market capitalization within the next three years, becoming part of that small corporate club with a market cap in excess of 150 billion euros. If this is the case, it will represent an impressive achievement on a global scale, a key-driver through which Italy can reach a position of technological leadership in the energy field. And I am confident that this will please everyone across the country: ENEL has been able to accept the challenge of an unprecedented paradigm shift and it won an important race to the top of its industry. In hindsight, it could not be taken for granted: its growth can make further progress, from now on.
Key4Biz. Agreed. But then, digging into more detail, what are the implications for the telecommunications sector?
Francesco De Leo. It is a great opportunity insofar as the European telcos, and more specifically the incumbents, will be able to offer a credible path to growth and answers to financial markets. They need to be able to get out of the debt spiral, more than 500 billion euros, with a rating close to junk bond level: they are dealing with a twenty-year period where the conditioning of debt pressures has deeply limited their ambitions in terms of innovation. Finding a reversal path is neither immediate nor simple: investors have been waiting for a long time, with growing expectations for a fundamental shift in strategies and management. The sector has already seen, from 2015 onwards, the emergence of new players, such as tower management companies, which with their undiluted focus and consistent execution have earned the favor of financial markets. To some extent, the de-verticalization process has already begun and it has accelerated further, because of the pandemic. Going back to the past, to the “good old days”, is out of time and out of question. The sooner the “new normal” is acknowledged, the better for all stakeholders involved. It cannot be just the workers paying the bill for the delays accumulated over the last 20 years.
Key4Biz. But confident you are that de-verticalization is the trend for the next future?
Francesco De Leo. It is not a future trend; it is already reality. Two cases above all: Cellnex and Open Fiber. They have 5 fundamental characteristics in common that are not found across incumbents, that seem to be strongly appreciated by investors:
(1) They are independent operators
(3) Not vertically integrated
(4) Without legacy inherited from the past and
(5) With room for rapid “blitzscaling”, on a global level.
I would add that the key value driver for both Cellnex and Open Fiber has been the choice of cutting-edge technological solutions, which have contributed to a significant reduction of their carbon footprint in network management. The focus on improving the energy efficiency of mobile and ultra-broadband networks is rewarded by investors. It is difficult and at this point quite unlikely for many of the incumbents to achieve comparable levels of excellence, given the heavy legacy costs of copper networks, and the limited room to improve their energy efficiency, and thus their carbon footprint.
Key4Biz. What are the opportunities for further growth for new infrastructure operators?
Francesco De Leo. Just on May 7, 2015, when Cellnex was originally listed on the Madrid Stock Exchange, it had the 7,737 towers under management across Italy, acquired a few months earlier from Wind, and approximately 6000 mobile towers in Spain, previously acquired by Telefonica, specifically across rural areas. Today, 5 years later, with the acquisition of Hutchison’s mobile phone towers for 10 billion euros, it manages a portfolio of 103,000 towers with a pan-European presence and undisputed leadership in indoor coverage (DAS, Distributed Antennas Systems): almost 10 times the towers under management at the time of its listing. This explains why the stock market value has risen from 3.2 billion euros since the launch of its IPO (Initial Public Offering) to 25 billion euros today. According to a research note of Goldman Sachs, the target market cap can get close to 40 billion euros. With the current growth rates, leadership in 5G networks, targeted at the automotive industry and autonomous driving, and the management’s commitment to sustainability, Cellnex is the undisputed European leader in a new asset class, with room for further growth, yet to be explored. And all this in less than 5 years.
Key4Biz. You also referred to Open Fiber as a player capable of following the path that led to Cellnex’ success in such a disruptive way. But towers are one thing, ultra-broadband networks another. What is your assessment?
Francesco De Leo. Open Fiber is a clear success in the evolution of telecommunications networks in Europe. In a country like Italy, just a few years ago ended up in a rearguard position in Europe in terms of broadband penetration, Open Fiber was able to set in motion the digitalization of the country with the most advanced technology available today (FTTH, Fiber To The Home): today there are 6.7 million housing units connected with fiber and there will be 10 million, soon. No operator in the world has been able to achieve these results in such a short time. It is true that there are complaints from many quarters about the delays in the execution of the rollout: but, in just 4 years, Open Fiber has established itself as the number one independent, neutral and not vertically integrated operator of fiber networks in Europe. It is likely to be worth 6/7 billion euros, according to a market consensus. But if we look at the projections, and considering the plan to replicate the Open Fiber model abroad (across many of the countries where ENEL is in a leading position) we can expect the doubling of the “potential” value from the current 6/7 billion euros to 14/15 billion, within the next 12-18 months. I would be a mistake to think that a potential upside will not be within reach as in the case of Cellnex, capable to multiply its capitalization by 8 times since its IPO.
Key4Biz. In recent weeks, critical voices have emerged against Open Fiber from several observers, including institutions part of the current government, as in the case of Infratel. In your opinion, what are the criteria that should be used to evaluate Open Fiber?
Francesco De Leo. Open Fiber is no different from Tesla, clearly not in terms of industry, but in terms of how it is playing a pivotal role into creating a new asset class. Just two years ago, many doubted Tesla’s capitalization. But today Tesla alone is worth about 500 billion euros, more than GM (General Motors) and Toyota, put together. The same criteria used to evaluate a traditional incumbent are of no use for Open Fiber: it is not correct from a methodological point of view, nor from the point of view of financial analysis. When we analyze Open Fiber, we are looking at a player that, like Tesla, has no legacy and operates with an open source model: it has nothing to do with vertically integrated incumbents, and does not have to deal with the legacy of a copper network, which sooner or later must be decommissioned. The share price of an incumbent reflects for 20% the future cash flow generation potential, and for 80% the current cash generation. In the case of Open Fiber exactly the opposite applies: the price is given for 20% by the current cash flow, and for 80% by the projection of future cash flows related its potential international expansion and the entry into new vertical markets, such as the next generation automotive industry. Investors appreciate the prospective value of Open Fiber, due to the “parenting advantage” of ENEL: it can grow more than proportionally, following ENEL’s leadership in its foray into new, high-growth target markets.
Key4Biz. All right, all this is plausible, and you make an ambitious assessment of Open Fiber. Who owns the merits and why can Open Fiber aspire to a value close to 14/15 billion euros?
Francesco De Leo. In part this is all due to the acceleration of convergence between energy and telecommunications. Few years ago, it could not be taken for granted and to some extent it was even difficult to predict. A key value-trigger is what we identify as “parenting advantage” (Goold and Campbell, 1987). We need to give credit to the top management of ENEL, which set in motion a game-changing transformation ahead of time, leapfrogging its competitors: it was not easy and only ex-post one recognizes its value. But this is exactly what the markets have appreciated: the uniqueness of the strategic vision that anticipates the times, the strict discipline in terms of execution and, no less important, the consistent performance from an operational point of view. When one looks at the incumbents telcos across Europe, one would say that there is a pervasive mediocrity: the strategies communicated to the analysts seem to be made with “cut and paste”. By and large, no distinctive elements emerge, as if the European incumbents were following the same playbook, perhaps because they generally hire the same consultants and investment bankers for advice. On average, the progressive decline towards widespread mediocrity in terms of analysis and strategies has not led to anything good, but to an all-out defense of the status-quo. Investors are tired of waiting for a signal of change and therefore they turn their favor elsewhere. They would be better off reading Rumelt’s “Good Strategy/Bad Strategy”: definitely worth some time for the upcoming Christmas holidays.
Key4Biz. It’s hard to believe that it’s just a matter of “bad strategy” and “poor execution”. One has the feeling that you have something in store that still you do not tell us…
Francesco De Leo. Well, as a matter of fact the structural problems lie elsewhere. There are 4 innovation platforms in which the European telco industry has accumulated a delay, that should be a reason of concern for all of us: (1) AI, Artificial Intelligence, (2) Blockchain, (3) Deep Learning and (4) Next-Gen Cloud.
If there is no evidence of timely initiatives in these 4 areas of innovation as the top priority, it is difficult for investors to be convinced that a real turnaround can be triggered. A striking example is the challenge of the next generation cloud: European telcos, or at least a few of them, have been chasing the search for an alliance with Google. It is not easy to find the reasons why, but it seemed more like a shortcut for an easy press announcement than a deliberate value creation strategy. The acceleration of electrification across the automotive industry and the evolution of IoT networks put energy companies in a lead position, more aligned with the future. The cloud is rapidly changing architecture and enabling technologies. Latency issues in autonomous driving are pushing intelligence to the periphery of networks, as in the case of edge computing. Following Google in a B2C, centralized approach is a mistake: the structure, architecture and topographic distribution of next-generation data centers goes in a completely different direction. All in all, it has confined the European telcos into a corner, relegating them to a position of structural and irreversible delay: it could be good for Google, but bad for the future of the telco industry in Europe.
Key4Biz. But are you definitely sure about this? Are you sure that the challenge is the relationship between the center and periphery of networks or, if you like, the evolution toward different network/cloud architecture?
Francesco De Leo. It is no coincidence that analysts and investors are more aligned with the leading players in the energy sector which, for history and skills nurtured over time, are able to offer more assurance in rolling out a granular structure of “light” data centers, both in metropolitan as well as across rural areas. It is a fact that energy distribution networks are more granular and widespread in terms of topography and “geographic reach” than telecommunication networks: the management of a group like ENEL has been better trained for generations to deal with these problems. It is quite anomalous, and in some ways surprising, that the boards of directors of the lead incumbents have not captured this “contradictio in terminis” and they have not triggered actions to address it: the future is not about centralized, vertically integrated networks, but it is moving toward edge computing and “light” data centers, located at the networks’ edge. If this infrastructural challenge is not addressed, the incumbents will not stand a chance to play a leadership role: a fundamental problem that must be addressed, promptly.
Key4Biz. So, what are the expectations? If you’ll allow me, I would like to go back to the starting question: what is in store for 2021?
Francesco De Leo. 5G can be the trigger that allows the lead incumbents in Europe to recapture a trajectory of growth. But it may be the last call for many of the them. Those who are left behind will not have much chance of staying in the race and, from a perspective of consolidation of the sector, they will quickly move on to a season of abrupt divestments (asset disposal), dictated more by the pressure of leverage than by a clear and robust industrial vision. The risk is that it will only serve to pay the end-of-year bonus to bankers and executives. In some ways, the markets got tired of waiting: the start of a cross-border consolidation process was expected from many sides: but it did not take place, because of partisan interests and pressures from individual national governments about the issue of governance. There is a risk that the European market will be crowded with divestments that will trigger an oversupply, leading to a downward valuation of the assets to be divested: at these prices and under these conditions it is now a “buyers’ market”. Challenging times for directors who will have clear responsibilities, subject to the judgment of time and financial markets. The only ones to benefit will be private equity funds, frustrating the best intentions of the EU and national governments to witness a real turning point, after years of frustration and unmet expectations. Without a change of pace, Europe cannot catch up with the emerging innovation wave, as it happened with the creation of GSM in a now too distant past. A Jurassic era seems to have passed: but at that time, at the top of the telcos there was a leadership of different quality, absolute excellences that were lost over the years.
Key4Biz. And so, in summary, what is your proposal?
Francesco De Leo. To revamp the sector as a whole, and to aim at 5G as an accelerator of the transformation process, there is only one way forward. And this path is to handle the cumulative debt of the telco industry the same way we managed the NPLs (non-performing loans) of the banking industry, with the support of the ECB and national governments. A partial sterilization of the telcos’ debt will unleash fresh resources to accelerate the rollout of 5G. As a matter of fact, the burden of debt has progressively instilled a stubbornly “risk averse” attitude on the part of management teams, just when pushing innovation is the most effective antidote to reduce the risk profile with which the incumbents are classified. At a time when yield inversion from short to long term rates is taking place, the European telcos are squeezed into a corner, from which they can only escape with “out of the box” solutions. Investors are waiting for answers and have shown patience, thus far: but it is unlikely that they will stay this way too long. Investors are increasingly concerned that the management’s resistance will represent the main obstacle to change, as it is most of the times. Soon, as early as next spring (Q1/Q2 2021), it will be clear who has the chance to stay in the game and who does not. Until then, we will navigate by sight, in the uncertainty and volatility currently characterizing financial markets. In a nutshell, we may expect to live the “Days of a Future Past” (X-Men).