Tech

Leila Abboud is a Bloomberg Gadfly columnist covering technology. She previously worked for Reuters and the Wall Street Journal.

Billionaire Patrick Drahi spent the past year showing up rival European telecoms bosses on cost-cutting, turning his holding company Altice into a model of margin and cash flow improvement.

Now he's attempting a harder feat on network investment, seeking to prove that operators can thrive through better service and exclusive content like sport. The tycoon plans as much as 800 million euros ($888 million) in extra capex in the next two years at Altice's biggest unit, France's Numericable-SFR. Capex will rise there to about 20 percent of sales in 2017 and 2018 (from 16.8 percent in 2015). The money will be spent on catching up with competitors on mobile, where SFR's network is awful, and to extend fibre broadband to 22 million homes by 2022.

Drahi doesn't have much choice. Investors have severely marked down Altice and Numericable-SFR shares since mid-2015 because of customer losses, as well as its alarmingly high debt. Altice revenue fell 3.2 percent last year to 17.5 billion euros on a constant currency basis, and it hasn't said when growth will return.

Called to Account
Altice shares have had a wild run versus the European telecom index
Source: Bloomberg

A recovery depends on Drahi showing he's as good at building as he is at demolishing cost. The vaunted Altice playbook got a lot of attention last year -- buy companies using debt, slash costs on everything from pencils to limos, deliver big savings -- but investors forgot about the second phase, which needs big network investments to support prices and keep customers. That's where Drahi is now.

The issue is acute in France, where Numericable-SFR lost 1.1 million mobile customers last year because its network lags Orange and Bouygues on speed and quality. It did add 140,000 contract mobile customers in the last quarter, the first increase since Altice took over SFR in 2014. But extra marketing and discounting pushed average revenue per mobile user in the quarter down to 22.20 euros per month versus 22.50 euros year-on-year.

Mobile Exodus
Since Numericable-SFR was created in late 2014 merger, it has lost mobile contract customers to rivals
Source: Arcep, company data, Jefferies estimates

Even in broadband, where Numericable-SFR has a decent cable network, it lost 224,000 customers, although average revenue improved.

Drahi is not alone in putting faith in capex. The best European operators are jacking up network investment, especially in fibre to replace aging copper lines. After years of competing on price, they see service quality as the way to seize competitive advantage. 

Back when mobile phones were the most important part of the business, European telcos spent about 10-12 percent of sales on capex. In a deflationary price environment, investors were skeptical that investment led to higher returns, so they favored big dividend payers. Now, with fibre critical, executives think capex-to-sales should probably be in the high teens.

Operators from France's Orange to Spain's Telefonica have flagged higher investment. While top-line growth is returning slowly after years of decline, Nomura analysts reckon sector capex will be 5 percent higher this year -- leading to an average 11 percent drop in free cash flow .

New Normal
European telecom operators are investing more to build out fibre broadband, 4G
Source: Bloomberg

At Altice, the extra capex comes at a cost. For 2016, it predicts "mid-single digit" growth in adjusted Ebitda and that operating free cash flow will be flat or fall slightly. That compares with an 18 percent rise in adjusted Ebitda last year and a 33 percent jump in operating free cash flow.

Some relief might come in France if Orange can hammer out a deal to break up Bouygues Telecom. Numericable-SFR will probably buy some assets from Orange to ease competition concerns. At the right price, Drahi can buy back many of the mobile customers he lost last year.

To make sure they don't desert him for a second time, he needs to show he can use a spade to dig networks as well as he wields a knife.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Leila Abboud in Paris at labboud@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net