The telecoms sector has been significantly less hit by COVID-19 fallout than many others. To date, S&P Global Ratings has not lowered its ratings on any telecom company in Europe, the Middle East, and Africa (EMEA) as a direct result of the COVID-19 pandemic. The fast-moving situation is difficult to predict, but we believe telecoms will remain resilient.

Telecoms Are Relatively Insulated From COVID-19 Credit Implications

The sector's low cyclicality and significant utility-like demand characteristics limit its correlation to weak macroeconomic conditions.

Communications will likely be one of the most important services during the pandemic

In uncertain times, health, food, utilities, and basic services gain in importance as priorities narrow. With the current restrictions on mobility and human contact to contain the spread of the virus, demand for telecom services is sharply up, underpinning communications' significance during this time. The key reasons are the rising number of professionals electing or required to work from home, as well as an increasing scarcity of leisure activities steering people online to stay in touch with friends and family and to seek streaming entertainment options.

Initial reports from a sample of large telecom players indicate traffic increases in the 30%-70% range across mobile broadband. The jump has been even more pronounced for fixed voice and broadband at 50%-100% for countries with more severe mobility restrictions (shelter-in-place requirements). The duration of this upswing remains to be seen, but will likely hinge on the span of the COVID-19 outbreak.

Increased demand will yield pockets of opportunity, and lower churn could improve pricing and reduce costs

We do not expect an immediate monetization from increasing traffic, particularly as some operators may relax limits and out of bundle charges, or even offer complimentary features given the emergency nature of the current health situation. But should the demand increase prove durable, it could prompt increasing migration of customers in the consumer segment to more premium packages. In the enterprise segment, there is already greater demand for virtual private network (VPN) capacity in order to handle more connections from remote workers.

Churn levels are also likely to moderate in the short term, since both the ability and demand for service porting is impaired. This could hurt growing challenger telcos by depressing net adds. However, this should lower incumbent customer losses and potentially benefit pricing in the broader market by reducing the incentive for promotional activity. The net effect may well be a modest rise in average revenue per user (ARPU) and mobile margins as competitive pressure on front book pricing eases. Subscriber acquisition costs and success-based capital expenditure (capex)--investments dependent on customer wins--will also fall with reduced customer movement between carriers. For example, the Spanish government has halted mobile and fixed portability by Royal Decree-Law 8/2020 to limit resulting home visits and in-person contact, and the U.K.'s Openreach has asked its wholesale clients to minimalize the movements of end customers between networks. More broadly, with many retail locations shuttered, the equipment needed to change service providers, and a popular channel for customer adds, may simply not be available.

Will Potential Opportunities Offset Emerging Risks?

Operators may need to respond to tighter capacity

There have been some concerns over network reliability after temporary mobile connectivity issues in the U.K., and after Spanish fixed broadband operators and the EU Commissioner for the Internal Market issued warnings on fixed broadband capacity coming under strain. Still, networks have so far proven resilient. Part of this is because the influx of remote work traffic is largely distributed over working hours, and is manageable compared with the evening's peak streaming (including gaming) hours. Additionally, because content delivery networks typically cache recorded video on edge-based servers for localized streaming, much of the incremental traffic can be efficiently managed to relieve network loads and bottlenecking.

Chart 1

But if broadband demand continues to strengthen--particularly if evening streaming loads expand into working hours, given the amount of people at home due to governments' confinement measures--we think operators can respond. In the short term, telcos can shape bandwidth for certain applications that are particularly network intensive, though this will need to be done in conjunction with governments and content providers to avoid violation of net neutrality rules. For example, reducing bandwidth for streaming services and bumping viewing settings down to lower resolution can ease congestion, albeit with a degradation of quality on larger hi-definition devices. On March 19, Netflix announced it would voluntarily lower its streaming bitrates in Europe for 30 days to help ease bandwidth utilization. Amazon and Disney+, among other platforms, as well as social media like Facebook, have followed suit. If network loads increase beyond the scope of these short-term solutions, network upgrades and debottlenecking may be needed, requiring additional capex.

A lengthier COVID-19 outbreak could lead operators to readdress financial policy priorities

Companies may revisit capex or shareholder return plans to better protect their networks and financial flexibility in case of a longer pandemic situation. We believe many operators are already conservatively scaling capex back toward maintenance levels and conserving cash, driven by increased uncertainty and reduced mobility. While they could reaccelerate spending and quickly catch up to their capex budgets if the pandemic is brief, the longer it lasts, the more financial priorities will change. We could see a budget triage, with longer-term strategic objectives shelved to address short-term needs. For example, a prioritization of capacity upgrades over coverage expansion projects, or fixed over mobile, depending on where demand spikes more heavily and capacity is tightest. Specifically, this could push 5G spending back several months to a year, especially as some upcoming spectrum auctions could be delayed (the case in Spain, France, and Austria already) and the arrival of 5G handsets is likely to slow. Given the size of telco capex budgets (averaging 18-20% of revenue over the last three years), even modest reductions could materially support free operating cash flow and financial flexibility. The same applies to shareholder remuneration; a negative hit to share prices from lower dividends or buybacks may be viewed as immaterial compared with the recent volatility in equity markets, and a modest price to pay for preserving additional cash cushion.

Some Telcos Will Face Greater Risks Than Others

We expect downgrades as a direct result of COVID-19 in our EMEA telecom portfolio will be limited compared with other sectors. However, as the situation evolves, we will assess individual companies' sensitivity to economic and credit implications of the pandemic, particularly relating to the following risks:

• Lower revenue;
• Liquidity challenges due to short-term funding needs; and
• Exposure to, or rating links with, sovereigns with dimmed macroeconomic prospects.

Various Revenue Streams May Jam

The current decline in mobility--international, domestic, and even local--will disproportionately impact some telcos. This includes satellite mobility applications, roaming services, and revenue linked to equipment sales. While these business lines are not material to the sector overall, companies with outsized exposure to them could suffer.

Satellite operators with material mobility business, including connectivity for air travel and maritime, are among the most exposed sub-segments

Inmarsat's current situation is a key example of the credit implications of revenue hampered by the COVID-19 pandemic. The group generates nearly all of its revenues from the mobility segment of the global satellite communications market, and we anticipate it will see a near-term deterioration in its operating performance because of COVID-19 repercussions. We consequently assume the group's 2020 revenue will be $50 million-$100 million weaker (over 5% lower) than in our previous base case, potentially jeopardizing the group's creditworthiness (see "Connect Bidco Ltd. (Inmarsat) Ratings Placed On CreditWatch Negative Due To Operating Risks From COVID-19," published March 25, 2020).

Inmarsat earned almost 40% of its 2019 revenue from maritime, and over 20% from aviation. While most of these revenues are contracted, Inmarsat bears volumetric risk as well. About a quarter of the group's revenue within its maritime segment is volume dependent. In the aviation segment, in-flight connectivity revenue from commercial and private jets is about 35% dependent on airtime volumes, which we expect will decrease sharply.

Furthermore, Inmarsat faces counterparty risk within these sectors. It sells capacity to satellite service providers like SpeedCast Communications Inc. (CCC/Negative/--) that in turn sell remote telecom services to companies like Carnival Corp. (BBB-/Watch Neg/--). Inmarsat is also exposed to the airline sector more broadly (see "The Coronavirus Pandemic Could Reduce Global Air Passengers By Up To 30% In 2020," published March 17, 2020).

By contrast, peer satellite operators SES S.A. and Eutelsat Communications S.A. have significantly less exposure to mobility (between 5% and 10%), and we do not see material strain on their credit quality at this point. (For details on satellite service providers, see "As COVID-19 Cases Surge, Pockets Of Risk Emerge For Certain U.S. Telecom And Cable Providers," published March 17, 2020).

Lower roaming revenue due to reduced travel won't have a marked effect

Although companies could lose roaming charges, such revenue was largely curtailed by European regulation eliminating roaming fees within the EU/EEA in 2017. This also includes the U.K., where operators continue to adhere to the EU roaming regulation. Roaming fees therefore tend to only be relevant for subscribers traveling outside the EU, or for European operators in non-EU countries, like Switzerland. There are also net roaming benefits in European markets with high visitor traffic due to wholesale charges. Markets with higher net inbound business and travel typically see operators generating more wholesale roaming revenue than they have to pay out in fees when their customers are abroad. With both falling in tandem as travelers decline, we think operators in Southern Europe and in non-EU countries stand to lose the most, but that any fall in earnings will not materially affect ratings.

A fall in equipment sales will hurt revenue, but only modestly constrain earnings

We recently cut our forecast for 2020 smartphone shipments by 10%-11%, compared with our prior forecast, as a result of COVID-19 (see "Global IT Spending Set To Slide As Coronavirus Hits Hardware Sales," published March 19, 2020). This stems from supply disruptions in China, as well as demand declines from reduced retail activity in consumer markets. These dynamics are likely to lower in-home customer premise equipment sales as well. While equipment sales can amount to a meaningful portion of revenues--as high as 15% in some European markets--the low margin on equipment sales (largely a pass through) means lower revenue is not likely to translate into a material loss in earnings or ratings downgrades.

Canceled sporting events and lower advertising revenue could become costly

Some operators have already spent heavily on rights to major sporting events that have now been canceled due to confinement measures and other mobility restrictions. In addition, some operators have media segments with material advertising exposure. For those with pass-thru access rights, the loss of live sports should not weigh significantly on earnings. But for operators like Telefonica, BT, and Altice that won exclusive package rights with leagues like La Liga, the EPL, and Champions League, renegotiated agreements or paused installment payments will likely be necessary. Worse still, operators that have already paid for upcoming events may be left attempting to claw back fees for rights they will no longer be able to monetize. Similar dynamics apply to telcos with media businesses that will suffer from lower advertising revenue, as already highlighted by Telia's recent guidance for a material negative financial impact on its TV & Media unit, and our commentary on effects on the media sector (see "COVID-19 Increases Pressure On Global Media & Entertainment Ratings," published March 26, 2020).

Most Telcos Should Be Able To Manage Their Short-Term Funding Needs

Companies with sizable short-term funding needs, including large debt refinancing requirements or less than adequate liquidity, could come under pressure as lenders pull back and spreads move out. Nevertheless, we believe the telecom sector is well positioned overall.

After years of loose credit and increasing leverage, telcos are suddenly facing much tighter market conditions. Higher borrowing costs could weigh on credit measures, and market access could narrow for some. Positively, maturity walls have been pushed out with opportunistic refinancing. Debt maturities are back-ended with over 80% of repayments due beyond 2021, so this liquidity risk should not be a widespread concern for the sector. And for high-yield companies like Liberty Global and Altice, the amounts spent over the past few years on call premiums and transaction costs to de-risk their capital structure now appear particularly well spent.

Chart 2

Companies with large debt maturities, either by total amount or as a percentage of their capital structure, will face greater-than-average exposure in volatile capital markets. In a comparison of the 10 European telcos companies with the most debt maturing in 2020, most are well capitalized and rated in our investment-grade category ('BBB-' or higher), with robust liquidity to fund repayments (see table 1).

Table 1

We expect telcos will take a tactical approach to managing additional calls on liquidity. Working capital could rise if operators accelerate payments to support some of their suppliers, or due to a delay in bill collection. These factors are unlikely to drive a pronounced net increase in working capital, however, considering that companies may slow capex and equipment purchases.

Sovereigns' Weaker Growth Prospects Could Trickle To Some Telcos

The combination of oil market and COVID-19 stresses could constrain EMEA sovereign ratings, particularly in Africa and the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates). A number of our telco ratings are linked to the credit quality of the sovereigns in which they operate. While this is nothing new, our sharp downward revision to GDP growth forecasts could constrain sovereigns' creditworthiness and lower the ceiling for local companies with rating linkage (see table 2). In cases where government relationships currently cap a telecom rating, the exposure is more immediate as any sovereign change will be mirrored at the corporate level. For example, on April 1 we revised our outlook on Bahrain Telecommunications Co. to stable from positive to mirror a similar action on Bahrain. Where government relationships boost companies' credit quality, the risk is more remote as multiple-notch sovereign downgrades would need to occur before the corporate rating is affected.

Table 2

Economic Cycles Are Less Likely To Affect Telco Ratings, But B2B Revenues Are At Risk

Although enterprises could cut spending on telecoms in a recession, we believe that economic cycles are less likely to affect our credit ratings on telcos. On March 26, 2020, we lowered our eurozone GDP forecasts to a contraction of 2%, with further risk to the downside. An extended macroeconomic downturn and recession environment highlights risks beyond the immediate consequences of the current coronavirus outbreak. Notably, telecoms have historically not suffered markedly from weak macroeconomic conditions. Still, lower corporate spending and higher unemployment can drag on enterprise revenues for telecoms. The sector has recorded declines of up to 5% in revenue and EBITDA in the steepest recessions over the past 40 years. This can hit small and midsize enterprises earlier, with closures leading to the cancelation of telecom services, or delayed payments that could hinder operator cash flows. For large enterprises, revenue and EBITDA declines stem from deferred or cancelled projects, workforce cuts and a reduction in associated telecom needs, and a focus on cost-cutting. We incorporate more conservative assumptions during recession cycles--while less significant than sector-specific drivers--that could add headwinds to our B2B forecasts, particularly if we further negatively reassess our macroeconomic projections and assume business cutbacks intensify and consumer spending on telecoms falls.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

• Coronavirus Impact: Key Takeaways From Our Articles, April 3, 2020
• COVID-19: The Steepening Cost To The Eurozone And U.K. Economies, March 26, 2020
• COVID-19 Increases Pressure On Global Media & Entertainment Ratings, March 26, 2020
• As COVID-19 Cases Surge, Pockets Of Risk Emerge For Certain U.S. Telecom And Cable Providers, March 18, 2020
• Economic Research: COVID-19 Macroeconomic Update: The Global Recession Is Here And Now, March 17, 2020
• COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure, March 17, 2020
• Coronavirus A Wide-Ranging Ill For Tech Supply Chain, Feb. 12, 2020