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Monday, November 06, 2006

Sky Still Standing

I. Broadband Results.

Sky reported Q1 figures last Friday and announced broadband losses of £42m on turnover of £48m. This compares unfavourably to Carphone losses of £40m in the first half year. In fact, if the old Easynet Business is stripped out the situation is even worse: Sky Broadband lost £35m on turnover of £10m.

This is the downside, the upside is that provisioning seems to be less of a heartache than with Carphone. However, in 10 weeks since launch to the end of October, Sky has only managed to add 65k LLuers with an additional 9k as IPStream. I’m not sure whether this figure includes the old UKOnline base acquired with Easynet. Apparently provisioning capacity is now at 20ksubs/week with a hope of getting to 30ksubs/week by Christmas. The pipeline looks good with 39k orders somewhere in the process and in total 1m expressions of interest. Realistically the deal is so good that Sky will be targeting the whole of the Satellite base (around 7.4m homes), the expressions of interest merely serves to narrow the pipeline to make life easier (initially) for the Sky Salesforce. To put this in perspective, if Sky is to reach the target of 3m broadband customers by 2010, then they need to provision around 13.5ksubs/week on average. Personally, I think 5m would be a more challenging target.

James Murdoch claimed extreme happiness with the figures, but I remain a triple play sceptic especially on the financial front. I suspect we are going to have to see the story unfold over the Sky Fiscal Year to allow more meaningful comparatives with BT, Carphone, Orange & ntl to get a better understanding of what is really happening in the UK bazaar.

II. Advertising

I was extremely surprised to see the Advertising Revenues drop to £78m from £81m in the quarter, especially given the increasing share of multi-channel in the overall TV market. However, Sky claimed to have outperformed the overall UK ad market which has dropped 10% year-on-year. This could spell real disaster for ITV, Channel4 and Five who are totally reliant on Advertising Revenue. The playing field is going to be radically altered if the Free-to-Air broadcasters have suffered such a huge drop in revenue and the BBC is going to get an above inflation rise in the Licence Fee – the consequences could be quite far reaching.

III. Wholesale Cable Revenues.

The lead indicator for ntl broadcast revenues always seems to be the Sky Wholesale revenues and these have dropped again year-on-year to £53m from £54m a year ago – this is more bad news for ntl. I am continually surprised at the relative weakness of cable compared to satellite in the UK, but I can’t see this changing over the next couple of years as ntl digests telewest and virgin mobile whilst struggling under a mountain of debt. Sky is going to put another couple of nails in the coffin with its’ attack on the unique selling point of cable which is the triple play and this is before BT joins the game. The outlook has never looked worse for ntl.

IV. Main DTH.

Subscription DTH Revenues seems to show a healthy growth of 6.1% y-o-y with £792m compared to £746m. This to me is the undoubted good news of the Quarter for Sky. The product pipeline looks good with Sky MultiRoom selling an additional 46k @ £10/month and Sky HD selling 58k @ £10/month. Both of these are high incremental margin business and at the end of the day are much more profitable than a £10/month top-end LLU broadband customer.

The most surprising metric was the most profitable with 82k/ net adds which is the highest growth since 2003. James Murdoch mentioned the “halo effect” from Broadband (10% of new sign-ups) and Sky+ (30% new sign-ups) in the call. Again I’m not so sure, because I think it is a no brainer for a new subscriber to get a Sky+ box (no incremental cost) and Broadband connection. Contrary evidence was seen from the churn figures which inched ahead by 10bps to 11.8%, however in a quarter with a price rise it is hard to decipher the churn figures.

This “halo effect” could be the start of a virtuous circle for Sky, with increased DTH subscribers and revenues coupled with lower churn leading to increased cashflow which is then invested in triple play infrastructure and customer acquisition. If this plays out, it will be the Triple Play equivalent of Dante’s nine circles of Hell for ntl.

V. MobileTV.

There is a radical different approach in strategies between ntl and Sky in MobileTV:
• Ntl acquired an MVNO, Virgin Mobile, and subcontracted to BT to build a broadcast TV network and provide content; and
• Sky leveraged its content to provide the major UK network, Vodafone, with a “mobilised version” of the content which they have also recently sold to Orange and 3. In all instances, Sky is using excess capacity on the operators 3G network as the delivery mechanism.

Nothing was mentioned on the call about the relative success of Sky MobileTV, but it has already been divulged that Vodafone has in excess of 100k subscribers paying £10/month for the Sky content. I don't know the revenue split, but wouldn't at all be surprised if it was 50:50. I’m sure this is the first Sky step of many in the mobile TV market.

Time will tell which company has the best strategy, but early doors I’m backing Sky.

VI. Retail Distribution.

I was surprised to see the expansion into building a Retail Network with the acquisition of “You Me TV”. I completely missed this at the time, but in my defense there was not much reporting in the press and I'm not big on spending leisure time in shopping malls. "See Me TV" at the time of purchase in July had 59 shops in major UK Shopping Malls, this has grown to 80 today and will be 100 by Christmas.

I find it really revealing to see how Sky thinks outside the traditional distribution box. Sky has a huge problem in seeding the HD market – you can’t see the benefits without buying the product on faith, having an acquaintance with the service or seeing a demostration. A low-cost kiosk solution in the UK shopping malls provides a great method of demonstrating the product. The same story can be told for Sky+.

“You Me TV” is also a low cost hedge against the growing presence of the triple play competitors – Carphone, Orange and the plans of ntl on the UK High Street.

VII. Cash Flow.

I was shocked to see the Sky Cash Generating Machine go into reverse for the quarter with net debt in the quarter shooting up in the quarter by a huge £236m to £997m. However, there are a couple of mitigating factors: the share buyback programme consumed £211m which really is an optional return to shareholders and a seasonal working capital outflow of £165m due to the timing of payment of sports rights.

It will be interesting to see the situation next quarter.

VIII. Future.

Sky has an interesting set of products on the market which will definitely deliver incremental revenue and profitability – HD TV, MultiRoom and MobileTV - spring to mind. Personally, I love the Gnome product given my personal vendatta against the waste of spectrum by analogue radio, but realistically it is less than insignificant in the overall game. I am still totally unconvinced of the business case for broadband, voice and the triple play, because so much of the business case is dependant on the reduction of churn and increase in DTH subscribers. However I think the CFO, Jeremy Darroch, has enough tools in the accounting box of magic tricks to ensure that the case for failure will never be proven. Having said this if anyone can deliver on the triple play in the UK – it is Sky even if they are giving ntl several years head start.

Also, I believe that Sky has quite a few cards still up their sleeves. I believe that soon Sky will have a product linking the EPG, video-on-demand, broadband and Sky+ (PVR) functionality. I note that Sky is in the process of recruiting an extra 600 installation engineers – they know the challenge of building home networks for the masses and personally I don’t believe that WiFi will cut the mustard. It is very noticeable that Verizon in its’ FiOS project seem to be betting on MoCA – watch this space in the UK.

The real scary bit for the competitors is the amount of personal investment by Rupert Murdoch in his son’s triple play vision and the way this seems to dovetail with the overall strategy for the Murdoch empire. The evidence is in the recent BSkyB AGM statement. If the triple play plan doesn’t succeed it will not be for a lack of effort or resources.