We are downgrading Deutsche Telekom (DT), the incumbent telecom carrier in Germany , to Underperform in light of the recent lower-than-expected operating results and management’s tepid outlook for 2010. Reported earnings and revenue for fourth quarter 2009 have missed the Zacks Consensus Estimate.
 
Deutsche Telekom continues to face a sluggish economy with further declines in Germany’s fixed-line telephony business due to intense competition. The carrier lost a total of 2.1 million fixed voice lines in 2009, largely due to higher customer migration to all-IP lines.
 
The lackluster performance can be attributed, in part, to general economic weakness. It also appears that Deutsche Telekom is losing share to other players in this market.
 
The company’s domestic and UK operations remain significantly challenged by regulatory pricing pressure. Termination rate (inter-operator fees) cuts by the German and UK regulators have resulted in sustained revenue erosion across these segments.
 
Deutsche Telekom’s Greek operation (“OTE Group”) faces challenges as Greece suffers from a severe financial crisis. Moreover, regulatory pressure coupled with adverse exchange rate fluctuations may continue to impact revenue and earnings of the “Europe” and “Southern and Eastern Europe ” segments.
 
Deutsche Telekom’s US unit T-Mobile USA is struggling with declining sales as it contends with aggressive price competition. Aggressive tariff cuts by the entity in response to competition are largely contributing to the decline in ARPU (average revenue per user).
 
T-Mobile USA faces a consolidating industry and is struggling to compete with its larger peers like AT&T (T) and Verizon (VZ). Deutsche Telekom is mulling over spinning off T-mobile USA or launching an initial public offering for the unit.
 
Given the economic volatility across its key markets, Deutsche Telekom has released a cautious outlook for 2010. The projected free cash flow and adjusted EBITDA for the year represent annualized declines.
 
While Deutsche Telekom remains committed to its cost-cutting initiatives, we remain concerned about the high debt exposure and increased capital spending levels. The company is spending heavily on acquisitions/mergers which have contributed to higher debt levels. Additionally, efforts to expand its high-speed network have accelerated capital spending, which may constrict free cash flow moving forward.
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