Ntl: Positive Spin on Overleveraged Assets
This afternoon, I was listening to the ntl 3Q conference call and reading the press release at the same time. One was sounding great and the other was reading badly - Executive positive spin in action.
It looks to me as the only way anyone would invest in ntl is if they think the management has the skills to turn the business around.
Virgin Mobile although a public company, did not release any financial information after the interim covering the period to Sept ’05. They did release some KPIs for the quarter to Christmas ’05 but that is it. In effect, we have a Virgin Mobile black hole for 9 months.
In the six months to Sept ‘2005, Virgin Mobile had a turnover of £274.6m with service revenue of £250.8m. Operating Profit was £45.5m, EBITDA was £54m and Free Cash Flow was around £53.3m.
In the period from July 4th to Sept 30th 2006 (ie the majority of the ntl 3Q), Virgin Mobile had turnover of £140.4m, Service Revenue of £132.5m and Operating Income before Depreciation, Amortization and “Special Charges” (OCF) of £16m. In other words, it looks as if turnover is slightly up, but profit is substantially down.
For Q4 it gets even worse, ntl are forecasting that OCF will drop to £6m because of the heavy investment in subscriber acquisition costs for the quarter. “Normal” treatment of SACs in the UK accounts is that prepaid SAC’s are immediately written off, whereas postpaid SACs initially capitalized and written off during the length of the postpaid contract. Who knows what the ntl treatment is?
Virgin Mobile is trying to build a contract base, but I can’t see how they can make any money at the game. If ntl are selling the phones themselves as part of direct sales operations or even via the Virgin Mobile website then I can see them managing to keep the SACs under control. However, they are selling them through Virgin Megastores, WH Smith and the ultra-expensive Carphone Warehouse which is not going to be a cheap proposition. In fact during the conference call, ntl mentioned the high commissions that specialist mobile phone retailers (ie Carphone) require and they planned to build their own retail network to avoid these costs.
It seems to me as if Virgin Mobile is offering comparable service bundles and handsets to the networks whilst renting capacity. I just can’t see how they are making money, unless T-Mobile is effectively giving them really, really cheap wholesale termination costs. I’m also unsure of the effectiveness of the quad play, because no details were provided of take up.
The strangest deal of the lot is the MobileTV deal with BT. First of all, if the BT MobileTV product is so good why doesn’t BT launch it on their own MVNO? Next, if the ntl content is so good, then why doesn’t Virgin broadcast it on the MobileTV service? To be less flippant, the deal was probably struck before the acquisition of Virgin Mobile, but given the direction of BT into the TV arena competing with ntl – I don’t think it’ll be long the divorce papers are served on the relationship, I just hope for both parties there is a good pre-nuptial drawn up.
The real problem with Virgin Mobile is that all the networks have refreshed and renewed their offers in the pre-pay arena which is the core profitable part of the Virgin Mobile base. Even if Virgin score heavily on customer care, they know without a shadow of a doubt that they cannot match either the tariffs, marketing budgets or subsidies that the networks are prepared to offer. The MVNO prepaid business model is doomed, hence the move into contracts, specialized content and quad play.
In short, I think ntl bought Virgin Mobile at the peak of its worth and they will struggle ever to make a decent return from the asset. I’m sure ntl are horrified privately at the speed of the decline in performance as Virgin Mobile has expanded into the post-paid market
It also must be said that ntl seem to have a cost advantage compared to the average LLuers. First they have a significant backbone network and quite a few competent engineers. Also, the tentacles of this network spread deep into the UK network of BT Exchanges. It looks as if there is plenty of spare capacity in more than a few LLU DSLAMs whose owners are desperate to get a few wholesale customers – think Tiscali and C&W. ntl do have a good sized telephony network whose capacity seems to growing every quarter as customers flee the on-net service. Ntl state that the incremental capital requirements are quite small; probably extending to a few IT projects and perhaps a VOIP Media Gateway. Most importantly, ntl have very well defined set of prospects who apparently leave the on-net service every quarter because of moving into an area not served by cable.
The downside of this proposition is loss of management focus and potential confusion of customers. But this can be minimized and all would be forgiven if the ntl executives could build an asset of reasonable value. All told the logic behind the off-net proposition seems compelling, I doubt whether the revenue would be significant for quite a while though.
It was also mentioned that Cable ARPUs were improving to £42.48, which is significantly higher than BSkyB’s of £32.08. However, given that Sky was a one-trick TV pony until recently the differential is hardly impressive. Even with the Mobile and Business Arms factored in, total ntl quarterly revenues (£1024m) are slightly lower than the BSkyB revenues (£1071m)
The good news is that ntl is selling more products into the declining base. Once the network is connected to a home, incremental products must be incredibly profitable and this is key to the short term success of ntl. The net decline of 55k voice customers is slightly confusing, unless ntl had a lot of voice-only customers moving house in the quarter, perhaps they moved into SkyLand who managed to add 49k voice customers in the quarter. The broadband net adds of 78k also is hardly impressive especially when compared to BSkyB’s 44k in 6 weeks. The worst news for me is the meagre TV adds of 22k. I question the quality of this figure especially if it includes customers who are not paying premium for TV content (ie basic channels included in the bundle), we know from the Sky figures that Sky lost 12k ntl wholesale cable subscribers who previously paid for Sky's premium content.
The figure that stands out to me is the amount of movers. I just struggle to comprehend an annualized 10.5% of customers leaving the cable areas. If it is a genuine figure and not customers telling the call centre anything to get them off their backs when canceling the service, it is frightening for investors. The only conclusion I can draw is the overall weakness of the cable coverage – there must be huge holes in the urban networks. Worst still, I don’t see ntl having the cash to in-fill its network.
Whenever I see a Balance Sheet like ntl’s, I always think the company is really working for the bondholders. I do think the Virgin Media is an extremely good idea and could give ntl a little momentum in the market place. Ultimately ntl just does not have the balance sheet to make the necessary investments over the next couple of years as the communications map of the UK is completely redrawn.
The UK Cable Industry History is littered with the bodies of talented enthusiastic executives who see the potential of the industry especially when they make comparisons with the USA Cable Industry performance and wealth generation. Cable in the UK has always struggled to compete against BSkyB and the various telecoms companies especially BT. Unfortunately, I can see no further than a few more bodies being added to the pile over the next few years.
I. Overall
Comparatives with ntl are really difficult because of the acquisition of Telewest, Virgin Mobile during the year and the resultant restructuring of the Balance Sheet. The 3rd Quarter Operating Loss was £9.6m and Net Loss was £104.2m on turnover of £1,024.9m. Net Debt stands at £5,905m with an average interest rate of 7.6%. No cash flow information was provided for the quarter; however Net Debt has risen during the quarter by £500m. Most of this Cashflow would have been caused by partial cash payment for the £962m acquisition of Virgin Mobile, however no breakdown was provided.It looks to me as the only way anyone would invest in ntl is if they think the management has the skills to turn the business around.
II. The Virgin Mobile MVNO
Frankly the disclosure on this recent acquisition is feeble. Ntl refuse to break out the split between pre and post paid customers and there are no comparatives to see how Virgin Mobile is doing either year-on-year or quarter-on-quarter.Virgin Mobile although a public company, did not release any financial information after the interim covering the period to Sept ’05. They did release some KPIs for the quarter to Christmas ’05 but that is it. In effect, we have a Virgin Mobile black hole for 9 months.
In the six months to Sept ‘2005, Virgin Mobile had a turnover of £274.6m with service revenue of £250.8m. Operating Profit was £45.5m, EBITDA was £54m and Free Cash Flow was around £53.3m.
In the period from July 4th to Sept 30th 2006 (ie the majority of the ntl 3Q), Virgin Mobile had turnover of £140.4m, Service Revenue of £132.5m and Operating Income before Depreciation, Amortization and “Special Charges” (OCF) of £16m. In other words, it looks as if turnover is slightly up, but profit is substantially down.
For Q4 it gets even worse, ntl are forecasting that OCF will drop to £6m because of the heavy investment in subscriber acquisition costs for the quarter. “Normal” treatment of SACs in the UK accounts is that prepaid SAC’s are immediately written off, whereas postpaid SACs initially capitalized and written off during the length of the postpaid contract. Who knows what the ntl treatment is?
Virgin Mobile is trying to build a contract base, but I can’t see how they can make any money at the game. If ntl are selling the phones themselves as part of direct sales operations or even via the Virgin Mobile website then I can see them managing to keep the SACs under control. However, they are selling them through Virgin Megastores, WH Smith and the ultra-expensive Carphone Warehouse which is not going to be a cheap proposition. In fact during the conference call, ntl mentioned the high commissions that specialist mobile phone retailers (ie Carphone) require and they planned to build their own retail network to avoid these costs.
It seems to me as if Virgin Mobile is offering comparable service bundles and handsets to the networks whilst renting capacity. I just can’t see how they are making money, unless T-Mobile is effectively giving them really, really cheap wholesale termination costs. I’m also unsure of the effectiveness of the quad play, because no details were provided of take up.
The strangest deal of the lot is the MobileTV deal with BT. First of all, if the BT MobileTV product is so good why doesn’t BT launch it on their own MVNO? Next, if the ntl content is so good, then why doesn’t Virgin broadcast it on the MobileTV service? To be less flippant, the deal was probably struck before the acquisition of Virgin Mobile, but given the direction of BT into the TV arena competing with ntl – I don’t think it’ll be long the divorce papers are served on the relationship, I just hope for both parties there is a good pre-nuptial drawn up.
The real problem with Virgin Mobile is that all the networks have refreshed and renewed their offers in the pre-pay arena which is the core profitable part of the Virgin Mobile base. Even if Virgin score heavily on customer care, they know without a shadow of a doubt that they cannot match either the tariffs, marketing budgets or subsidies that the networks are prepared to offer. The MVNO prepaid business model is doomed, hence the move into contracts, specialized content and quad play.
In short, I think ntl bought Virgin Mobile at the peak of its worth and they will struggle ever to make a decent return from the asset. I’m sure ntl are horrified privately at the speed of the decline in performance as Virgin Mobile has expanded into the post-paid market
III. Off-Net Venture
The surprising bit about the call was the plan to expand into the LLU business. I find it interesting that Virgin.net has managed to build a base of 243k customers with next to zero marketing. Turnover was only £17.6m and therefore immaterial in the overall ntl context. Probably profits are also minimal as a BT Reseller, but it does prove to me that the Virgin brand does attract custom.It also must be said that ntl seem to have a cost advantage compared to the average LLuers. First they have a significant backbone network and quite a few competent engineers. Also, the tentacles of this network spread deep into the UK network of BT Exchanges. It looks as if there is plenty of spare capacity in more than a few LLU DSLAMs whose owners are desperate to get a few wholesale customers – think Tiscali and C&W. ntl do have a good sized telephony network whose capacity seems to growing every quarter as customers flee the on-net service. Ntl state that the incremental capital requirements are quite small; probably extending to a few IT projects and perhaps a VOIP Media Gateway. Most importantly, ntl have very well defined set of prospects who apparently leave the on-net service every quarter because of moving into an area not served by cable.
The downside of this proposition is loss of management focus and potential confusion of customers. But this can be minimized and all would be forgiven if the ntl executives could build an asset of reasonable value. All told the logic behind the off-net proposition seems compelling, I doubt whether the revenue would be significant for quite a while though.
IV. Core On Net Business
Ntl spent most of the call trying to convince the listeners that the core on-net business was improving, but the figures do not seem to tell the same tale. First there is the net loss of customers 37.3k in the quarter. The Executives tried to explain this away by saying that Gross Adds were good, but they are cleaning up the problems of the old base with bad credit risks and there was unseasonably high movers out of the cable areas. The target churn rate mentioned was the Telewest rate of 1.4% which is claimed to be a world class metric, however the target is higher than BSkyB’s current churn rate of 11.8% annually.It was also mentioned that Cable ARPUs were improving to £42.48, which is significantly higher than BSkyB’s of £32.08. However, given that Sky was a one-trick TV pony until recently the differential is hardly impressive. Even with the Mobile and Business Arms factored in, total ntl quarterly revenues (£1024m) are slightly lower than the BSkyB revenues (£1071m)
The good news is that ntl is selling more products into the declining base. Once the network is connected to a home, incremental products must be incredibly profitable and this is key to the short term success of ntl. The net decline of 55k voice customers is slightly confusing, unless ntl had a lot of voice-only customers moving house in the quarter, perhaps they moved into SkyLand who managed to add 49k voice customers in the quarter. The broadband net adds of 78k also is hardly impressive especially when compared to BSkyB’s 44k in 6 weeks. The worst news for me is the meagre TV adds of 22k. I question the quality of this figure especially if it includes customers who are not paying premium for TV content (ie basic channels included in the bundle), we know from the Sky figures that Sky lost 12k ntl wholesale cable subscribers who previously paid for Sky's premium content.
The figure that stands out to me is the amount of movers. I just struggle to comprehend an annualized 10.5% of customers leaving the cable areas. If it is a genuine figure and not customers telling the call centre anything to get them off their backs when canceling the service, it is frightening for investors. The only conclusion I can draw is the overall weakness of the cable coverage – there must be huge holes in the urban networks. Worst still, I don’t see ntl having the cash to in-fill its network.
V. Summing Up
The level of debt within ntl is huge - £5,905m – at least relative to the cash it generates. Once £30.9m of other charges and £133.6 of cash capital expenditures is added to the £317.8m OCF and if we factor in the approx. £110m interest bill for the quarter, there cannot be a lot of headroom before more borrowings is required.Whenever I see a Balance Sheet like ntl’s, I always think the company is really working for the bondholders. I do think the Virgin Media is an extremely good idea and could give ntl a little momentum in the market place. Ultimately ntl just does not have the balance sheet to make the necessary investments over the next couple of years as the communications map of the UK is completely redrawn.
The UK Cable Industry History is littered with the bodies of talented enthusiastic executives who see the potential of the industry especially when they make comparisons with the USA Cable Industry performance and wealth generation. Cable in the UK has always struggled to compete against BSkyB and the various telecoms companies especially BT. Unfortunately, I can see no further than a few more bodies being added to the pile over the next few years.
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