Sometimes telecom companies are akin to sharks: they need to keep swimming, staying in constant motion. That often is quite true for small startups, who rely on financing to supply cash flow as they build their businesses. These days, it also is true for tier-one service providers.
Consider only the shift that has to be made in describing “profit.” According to Ericsson, global revenue will climb about 2.4 percent each year to 2018, with growth of earnings “before interest, taxes, depreciation and amortization” of one percent to 2018.
That shift from “generally accepted accounting principles” to EBITDA tells the story: the global telecom industry no longer is “profitable” in the GAAP sense. So now tier-one service providers are like smaller startups: they have to keep cash flow high, even if some other traditional “profit” metrics no longer make sense (or even can be obtained).
Companies that operate in capital intensive, such as telecom, “do not give investors accurate depictions of performance through the EBITDA margin,” says Investopedia. In other words, in capital-intensive telecom, EBITDA is inaccurate as a measure of operator performance.
That is why “generally accepted accounting principles, or GAAP, do not include EBITDA as a profitability measure, and EBITDA loses explanatory value by omitting important expenses,” the site says.
Revenue is important, but the more-telling shift is the use of “EBITDA” rather than “profit.” EBITDA is a measure of cash flow, or operating efficiency. That is important, but it is not the same thing as “profit,” commonly understood.
“Earnings can be a tricky issue when analyzing telecom companies,” says Investopedia. “Many companies have little or no earnings to speak of.” Conversely, reported earnings also can mask a decline in cash flow. So cash flow matters. But it is not the same thing as “profit.”
All that noted, would a telecom executive prefer high EBITDA and low “profit?” Yes, if that means it can invest and upgrade networks, make acquisitions and pay dividends.
To be sure, there are reasons for using EBITDA: it isolates operating performance, without the potential distortions of financing activities. At the same time, positive cash flow does not necessarily mean a firm is “profitable.”
That is not always a long-term problem. The entire U.S. cable TV industry, in its major urban growth phase, always had high cash flow (EBITDA), but zero profits, as all available cash was plowed back into growth. Eventually, when the construction phase ended, cable operators shifted to actual GAAP “profits.” So cash flow matters. A lot.
The problem for the global telecom industry is that while there is growth, that growth is heavily to be found in Asia and Africa. In most other regions, the business is quite mature or getting that way. Where there is not high growth, use of EBITDA arguably masks some structural issues.
Mergers, acquisitions, new products and operating cost reductions are reflections of the underlying trends. In one clear sense, telecom clearly is a declining industry: all its legacy products are in a mature mode, while some have been declining for more than 15 years (international long distance, voice).
To survive, much less prosper, completely new products, at massive scale, will be needed. That is why “internet of things” and “connected cars” are so important: they hold the promise of supplying those big new revenue sources.
But we have to recognize that the shift to “EBITDA” instead of GAAP “profit” tells you something very fundamental about the business.
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