Deutsche Telekom’s biggest headache is not going away. In fact, it has gotten worse. Its subsidiary T-Systems, which operates computers, networks and software for corporate clients, has run up losses totaling almost €4 billion over the past decade. That includes an operating loss of €330 million ($361 million) last year alone.
For Europe’s largest telecoms group in terms of market value, the success of its IT business (or lack of it) matters for the whole. T-Systems made up more than a 10th of Deutsche Telekom’s 2016 revenue of €73.1 billion and its ongoing struggles have become an increasing source of frustration for the German firm’s supervisory board, which has the power to hire and fire executives and decide on strategy changes.
The situation is dire enough that heads at the top may be about to roll, according to Handelsblatt's sources, and there's even speculation of a merger to stem the bleading. T-Systems Chief Executive Reinhard Clemens in an interview insisted the board still backs his strategy, and pleaded for more time to turn the firm around.
“The business must become profitable. Period. And at the present time it is not, this is no secret. But we have a strategy," he told Handelsblatt.
Some of Deutsche Telekom's non-executive board members are reportedly losing patience with Mr. Clemens, who has been the subsidiary’s head since 2007. Although his contract was extended in December to the end of 2022, supervisory board members told Handelsblatt he may have to leave earlier if T-Systems’ performance continues to sag. “He has to deliver now,” said one of the company's supervisors, who declined to be named.
And then there's speculation in the industry about the possibility of a merger with the IT subsidiary of British competitor BT, which is larger globally and has higher revenues. Deutsche Telekom is the largest single shareholder in BT after it sold its stake in mobile operator EE to the British peer in exchange for BT stock. Britain's decision to exit the European Union will not make the merger any easier, however. BT declined to comment when contacted by email by Handelsblatt Global.
If the supervisory board didn’t believe in our strategy, it would never have come about. This is no simply solution that lies before us. Reinhard Clemens, Deutsche Telekom board member, head of T-Systems
The challenges facing T-Systems are tremendous. Indeed part of the reason Mr. Clemens may not have gotten the axe before is that finding a successor to take it on has been difficult. The rise of cloud computing, which allows companies to access software over the internet rather than run their own data centers, has affected the very core of T-Systems business – its IT service area. In its annual report, Deutsche Telekom said: “The IT segment in particular came under price pressure from cloud providers such as Amazon Web Services, Google, and Salesforce.”
T-Systems has been doing its best to expand into the lucrative cloud operations to attract new customers, but so far it has only managed to deliver small profit margins in the area. Its profitability was already low to begin with: In 2016, its adjusted operating profit margin was a mere 0.4 percent, unadjusted it was minus 4.2 percent. It's a crowded space to operate. Traditional rivals in the telecommunications and IT markets include IBM, HP, Japan’s NTT, Britain’s telecom firm BT and French IT firm Capgemini.
To be fair, Mr. Clemens has worked hard to turn the IT business around. T-Systems has invested over €3.8 billion ($4.18 billion) in restructuring during his tenure, which has included staff cutbacks, reorganizing business units and closing facilities. In 2007, the subsidiary employed about 35,000 people in Germany. Today it's not even 18,000. Cutting staff was never an easy task at the former state monopolist. After privatization in the 1990s, many employees held on to their civil servants status, meaning it was difficult to lay off people and more expensive to restructure T-Systems than other IT service companies. Even today, a sixth of the staff is still working under public servant contracts.
This apparently is scaring off potential buyers. For years it has been said that Deutsche Telekom, majority-owner of T-Mobil US, wanted to divest itself of all or part of its T-Systems subsidiary. Last September, Handelsblatt learned Deutsche Telekom was mulling a restructuring of the entire group, including a partial sale of T-Systems. However, any buyer would have to achieve what Telekom itself could not – namely, make the business profitable.
Deutsche Telekom CEO Timotheus Höttges has so far backed Mr. Clemens and the business. About a year ago, Mr. Höttges told shareholders that the restructuring of T-Systems was not yet finished. His goal: “Every business unit must contribute a positive cash in-flow.” In other words, losses are not wanted. So far, however, he has backed his colleague on the executive board. “Reinhard Clemens is a long-year colleague of mine who is leading a large company in a difficult market environment,” Mr. Höttges said. Mr. Clemens has put together a new, strong team of internal and external managers who are pushing forward with restructuring and developing new business models for digitalization, the CEO said.
Mr. Clemens told Handelsblatt that he blames last year’s losses mainly on extraordinary circumstance. “Last year we had to take precautionary financial measures, primarily for two customer contracts that will not generate profits in the near term. Without that, the results would look better,” he said. At the same time, he acknowledged the need for improvement: "We are looking to use scalable platforms, reduce complexity and are applying our efforts at the right places. There is some gamble here, but I firmly believe that you sometimes have to do this.”
Mr. Clemens remains convinced that the non-executive board still believes in T-System’s strategy. “If the supervisory board didn’t believe in it, it would never have come about. This is no simply solution that lies before us. Everybody knows this. Things aren’t as black and white as a look at the results may seem. Our transformation is taking hold, even though there are still setbacks here and there,” Mr. Clemens said.
Later this week, investors will learn exactly how T-System’s has performed at the start of this year. Deutsche Telekom will present its first-quarter results on Thursday.
Ina Karabasz writes about telecommunications, IT and security issues for Handelsblatt. Gilbert Kreijger, an editor with Handelsblatt Global, contributed to this article. To contact the author: [email protected]