Eircom holds its own among European peers

During the recent flurry of activity in the telecoms, media and technology (TMT) sectors of the stock market, one set of companies that saw their share prices quickly lose momentum was the telecom stocks.

Although share prices bounced off their low points, telecom companies did not see the follow-through buying that drove up the share prices of companies such Baltimore Technologies and other New Economy stocks.

The fall from grace of the telecom stocks is highlighted in the accompanying table. In a week where Eircom is holding its highly contentious a.g.m., the data in the table does at least put the decline in the Eircom share price into perspective. The telecom stocks shown in this table are representative of the European telecoms sector and shows that price declines since the February/March peak range between 30 per cent and 60 per cent. Therefore, the decline in Eircom's share price over the past year has indeed been typical of the European sector.

Despite the extent of these share price declines, the recent rally in the telecoms sector proved to be a modest affair. This suggests that the negative factors affecting sentiment towards telecom companies still have the upper hand. The key negative factor would seem to be the huge funding requirements that are facing virtually all of these companies.

The medium/long-term growth expected in the demand for the products and services offered by telecom companies is projected to rise at an extremely rapid pace. Technological developments point to an explosion in the volume of traffic carried over the operators' networks.

In particular new mobile technology is expected to open up a huge range of new opportunities. Optimism regarding these growth prospects was a key factor in driving telecoms share prices to what proved to be unsustainable levels.

What investors failed to recognise was the sheer magnitude of the investment programmes that would be required to build the infrastructure to provide these services. Ironically, it is the very attractive growth prospects for the sector that has proved to be its downfall, as telecom companies compete aggressively with each other as they jockey for position.

This competition seems to have developed into a frenzy with regard to the bidding for third generation mobile phone licences (UMTS). In Britain and Germany, government coffers have been boosted as a competitive auction process forced companies to pay large sums for the right to provide third generation mobile services.

As well as the cost of each UMTS licence, companies will have to engage in enormous further expenditure to roll out these services in coming years. Already companies have borrowed extensively to fund these commitments, which has pushed balance sheet gearing ratios to very high levels.

As a consequence the international rating agencies have downgraded telecom company debt. This is forcing companies to sell non-core assets and to issue new equity. For example, British Telecom recently announced that it was not going to engage in any further strategic developments until it had reduced its current borrowings. KPN, the Dutch company is planning to raise up to €10 billion later this year through a secondary placing of new shares.

Analysts predict that, of an estimated equity issuance in Europe of over €100 billion, telecom companies will account for more than 50 per cent.

Compared with its European peers Eircom is, in fact, in a relatively good position and has a much healthier balance sheet than many of its larger peers. Although it did enter the bidding process for a third generation British mobile phone licence it dropped out at an early stage. Therefore, whenever the issues surrounding the overhang of stock held by KPN and Telia are resolved, Eircom's share price could well outperform its European peers.