Customer Migration And Open RAN Build Will Improve Operational Efficiency

Key Takeaways

• Service revenue growth is expected from customer migration and network control, improving future revenue and subscriber stability.
  
• Cost reductions from virtual RAN network and RAN sharing aim to enhance cash flow and net margins, boosting long-term profitability.
  
• Continued customer migration challenges and high upfront network costs, alongside risks from regulatory and spectrum negotiations, could strain revenue growth and profitability.

Catalysts

Operates as a telecommunications provider in Germany.

• The company is undergoing a customer migration process moving 50,000 customers a day to its own network, which may stabilize subscriber numbers post-migration and lead to potential service revenue growth from increased network control and efficiency improvements. This could impact future revenue positively.
  
• The ongoing construction of a virtualized, open RAN network with plans for full fiber connectivity is expected to lead to lower future production costs compared to purchasing services. This can enhance net margins and earnings once the network is fully operational and economies of scale are realized.
  
• Investments in the 1&1 Mobile Network are projected to decrease in the near term as the initial phase concludes, potentially increasing free cash flow and supporting future profitability as operating expenses for customer migration and network setup decline.
  
• The company is considering RAN sharing to expand from 25% to 50% coverage, which could lead to a more asset-light approach, reducing CapEx requirements and potentially improving cash flow generation and net earnings.
  
• Completion of the national roaming migration and a subsequent reduction in expenses related to third-party network use by 2026 should improve EBITDA for the mobile network segment, positively affecting overall earnings.

1&1 Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming 1&1's revenue will grow by 1.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 5.2% today to 5.5% in 3 years time.
• Analysts expect earnings to reach €234.3 million (and earnings per share of €1.52) by about April 2028, up from €212.8 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting €315 million in earnings, and the most bearish expecting €128.2 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.1x on those 2028 earnings, up from 13.0x today. This future PE is greater than the current PE for the DE Wireless Telecom industry at 13.6x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 4.55%, as per the Simply Wall St company report.

1&1 Future Earnings Per Share Growth

Risks

• The company's revenue declined from €4.0967 billion in 2023 to €4.0643 billion in 2024, with high-margin service sales also dropping, which indicates a potential risk to future revenue growth if these trends continue.
  
• The 1&1 Mobile Network segment operates at a loss, with an increased net loss from €166.8 million in 2023 to €359 million in 2024, driven by rising expenses, which could negatively impact earnings until the network becomes profitable.
  
• High upfront costs and capital expenditures related to network expansion, including a planned €450 million CapEx in 2025, could pressure free cash flow and delay profitability if returns on these investments are slower than anticipated.
  
• Continued customer migration challenges from Telefonica to the company's own network have resulted in increased churn and reduced customer acquisition, which could impact revenue and net margins if not resolved efficiently.
  
• The ongoing need for negotiations around spectrum leases and potential complexities in regulatory processes could introduce uncertainties and potential costs that may affect profitability and delay strategic goals.

Valuation

• The analysts have a consensus price target of €16.375 for 1&1 based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of €30.0, and the most bearish reporting a price target of just €10.4.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be €4.2 billion, earnings will come to €234.3 million, and it would be trading on a PE ratio of 14.1x, assuming you use a discount rate of 4.6%.
• Given the current share price of €15.72, the analyst price target of €16.38 is 4.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.