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Summary

IFRS 16 (ASC 842 in the US), a new accounting standard governing leases, takes effect for annual periods beginning January 1, 2019, one year after the implementation of IFRS 15 (ASC 606 in the US). Ovum tracks quarterly financial results of the world's largest telecoms service providers in World Telecoms Financial Benchmarks (available by subscription).

New accounting for leases appears likely to increase profitability, capex, and indebtedness

IFRS 16 replaces existing IAS 17 rules for the treatment of leases within financial accounts. One of the material changes relates to operating leases. A lease generally entails the ability and right to control the usage of a specific identified asset, and this is particularly relevant to service providers "renting" capacity, servers, or data centers, or engaged in wholesale, enterprise, or carrier activities, and other private bilateral agreements.

Complex rules determine whether substantially all the risks and rewards of owning the asset are conferred to the "lessee" company renting the asset, in which case it is a finance lease. Otherwise, it is an operating lease, where payments have been expensed as incurred. Where such "right-of-use" operating lease assets exist, depreciation and interest expenses will now be charged to profits over time, instead of being expensed directly at the outset. Furthermore, such leased assets and associated commitments are to be recorded as assets on the balance sheet. Cash flows are not directly affected by the accounting, but some lease cash flows that were previously considered "operating" in nature would be considered related to "financing."

IFRS 16 (unlike IFRS 15) does not concern revenues but effectively reclassifies expenses relating to certain operating leases (if they were not already being capitalized) from opex to capex, thereby improving EBITDA profitability and increasing reported capital intensity. Some measures of indebtedness may also rise significantly because of these changes. Large companies can have hundreds or thousands of agreements covered by the rules. The changes are particularly complex where companies have options to extend or reduce the length of time for which they use an asset.

Some companies, such as MTS and Turkcell, have implemented IFRS 16 already (early adoption is permitted). However, the financial impact is combined with other accounting changes. Turkcell considers that the new accounting additions to capex are "non-operational" and excludes these from its operational capex guidance and three-year plan. Millicom has issued a preliminary assessment that the standard will likely increase reported EBITDA 6% to 8% and increase net debt by 15% to 20%. Others are yet to provide detailed guidance. Telefónica, for example, has stated that IFRS 16 "will have a material impact on the Group's financial statements and may make comparisons between periods difficult and less meaningful." Deutsche Telekom has confirmed "an improvement in EBITDA" and an "increase in net debt." Every company is different, of course, but accounting confusion looks set to continue into a second year.

Appendix

Further reading

Telecom Industry and Operator Benchmarks by Key Financial Metrics: 2Q18, PT0016-000008 (September 2018)

IFRS 15 will encourage deeper scrutiny of the business of handset subsidies, GLB007-000028 (January 2018)

Author

Upin Dattani, CFA, Principal Financial Analyst

upin.dattani@ovum.com

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