Dial-up

European telecoms: European telcos are working hard to make amends for the spate of profit warnings they inflicted on investors last year. Improving operational trends helped France Telecom, Spain’s Telefonica and Britain’s BT beat expectations for the quarter ending in June. Vodafone, Europe’s largest telecoms group, did the same last week. But while the sector demonstrated progress financially, economic and strategic headwinds persist.

Vodafone’s big surprise was a return to organic service revenue growth, a key operational measure. France Telecom and Telefonica also demonstrated revenue improvements across a number of European markets, even in Spain, where the rate of decline has slowed. BT also surprised investors with a return to positive free cash flow in the quarter, after stripping out costs faster than expected. Reinforcing the feeling of confidence, an increasing number of telcos are making three-year dividend commitments. France Telecom shares soared seven per cent after it pledged an annual payout of ¤1.40 per share up to 2012. That follows similar promises made in recent quarters first by Telefonica, and then by Deutsche Telekom and BT. While telecom stocks have traditionally been expected to maintain high dividends, the specific pledges are new.

For investors nervous about the economic uncertainty, these displays of financial discipline are especially welcome. France Telecom’s stated desire to expand its footprint into Africa has weighed on the operator’s share price. While the new payout pledge doesn’t rule out big M&A – the group has previously said it could spend ¤5-7 billion on acquisitions – it sends a clear message that management is putting shareholders before empire building. But, strategic questions may curb investors’ enthusiasm. Telefonica’s deal to buy Portugal Telecom’s stake in their Brazilian mobile joint venture, Vivo, raises questions about what the Spanish group might now do with its stake in Telecom Italia. The success of BT’s ambitious, and potentially costly, pay-TV drive also remains to be seen. Vodafone, meanwhile, needs to address investor concerns over its sprawling portfolio. With the sector now trading on a forward price-to-earnings multiple of 11.5, up from single digits last year, the scope for further re-rating may be limited.