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Monday, October 29, 2007

BT Regulated Accounts for 2006/7: Scary Stuff

The results are finally published and hidden amongst the 126 pages are some potential time bombs for non-BT UK investors.

First, it is becoming apparent why no-one will publicly discuss broadband churn figures and that is because they are straight out of a Hammer Horror Movie:


MPF churn of 33% and assuming a mass migration Openreach charge of £27.54 gives monthly amortization of 75p/customer. If churn increases to 50% and a single standard line transfer for £34.86 is used then this equates to a huge monthly charge of £1.45 which needs to be amortised.

Of course, in some unbundlers accounts this hardly matters because in this “we-have-not-learnt-anything-from-the-tech-bubble” era amortization is below the EBITDA line and therefore does not count in some analyst eyes. In fact, churn is really, really crucial in a capex intensive game and there are far more charges than OpenReach connection charges to be factored in with broadband customer acquisition. In my broadband model, I factor in another £30/connection for marketing and another £10 for CPE, but that was before the era of “free broadband and free laptops”. And that is before the kit, backaul and back-office systems…

The next interesting snippet from the OpenReach accounts is the breakdown of revenues:


The recurring revenues are currently immaterial compared with the one-off revenues: not for BT the typical customer opex driven hosting model, BT has learnt over the years how to tempt customers into a spending spree with front loading of costs which the customers can capitalize and analysts can pretend they don’t affect the companies valuation.

OpenReach booked 4.4k hostel builds at an average cost of £17.2k and sold 88k tie cables at £500/100 copper pairs. When an unbundler abandons its retail strategy and decides to sell wholesale with a customer whose territory has a huge overlap with your unbundled area, it can’t be long before a huge write-off and loss of face is about to be forthcoming.

Even more interesting is that OpenReach is earning £3k/annum rental for the average hostel – it is pretty obvious that at the current low utilization rates the unbundlers need to scale fast. A certain marketing driven mobile operator plans to have the least aggressive approach to marketing broadband in the history of consumer launches whilst at the same time having a large exchange footprint - this is going to cost it dearly in ongoing losses. In fact, when the Post Office has more aggressive broadband marketing plans than the mobile operator, it just goes to show how rapidly someone can lose their mojo.

There is another line is the OpenReach accounts which is of interest to the unbundlers and that is the metro Ethernet business which is predominately used for broadband backhaul:


Here the breakdown of connections in 2006/7 is revealing:
  • 100 meg – 1,854 connections
  • 1 gig – 833 connections
  • Other – 117 connections
It doesn’t take a PhD in maths to figure out that in busy hour, it won’t take many punters browsing, streaming and p2p’ing to fill up a 100-meg backhaul pipe. I think once someone solves the problem of unbundlers misleading advertising with “up-to x-meg” claims, it is time to move onto forcing unbundlers to publish their backhaul capacity from each exchange. It is just too easy for some companies to blame poor peak hour speeds on excessive p2p’ers when in fact it is a feature of their failed-GCSE maths driven network design.

On a more serious note it is important to note that most of regulated revenues of OpenReach still is generated from 20th century analogue copper pipes. And most importantly there is only 10% (switching and transmission) of the asset base which could claim to be acquainted with Moores Law.


This last graphic should send shivers down the spine of every unbundler in the country and that is because OpenReach are declaring only an 8% return on mean capital employed; OFCOM guaranteed them a 10% return on the “Regulated Asset Value”. A mere £187m of profit shortfall.

I am 100% sure that there are definitional differences between the OpenReach 8% and the OFCOM 10%, but the fact of the matter is that BT have an obligation to their shareholders to get the required 10% return and if 1990s history is anything to go by can argue for years and years proving their point. I will need a lot more time and motivation to examine where the real differences are and the potential area where BT will look to raise prices.

However, I believe all this is just a mark in the sand from BT , before the debate over 21CN expenditure really kicks in… and we are entering a period where as a country unfortunately we need to grovel to BT to get FTTH rolled out… and even worse OFCOM is still gloating in the apparent regulatory brilliance of the creation of OpenReach and is busy running to Brussels saying how it is a model which needs to be forced on the rest of Europe. Meus Deus...

It is going to be a difficult couple of years for the unbundlers and I would advise them to hire some regulatory specialists and political lobbyists as soon as possible...

Hat Tip: YKWYA

Friday, October 26, 2007

Gobi Chipset: Raising the Temperature

Qualcomm yesterday announced a new chipset, the MDM1000 (aka Gobi) which combines broadband modem technology (supporting both EV-DO Rev. A and HSPA) with GPS functionality. This product is aimed squarely at the embedded notebook and promises to be a market changing technology when shipping in 2Q2008.

The inclusion of GPS functionality is I believe a stroke of genius. This will not only generate a new generation of real time mapping applications for the corporate field force integrating with web based applications such as Google Earth, but also offers the potential of providing a new type of laptop security applications for misplaced notebooks or even their users which can phone home with location data.

The endorsement from both Vodafone and Verizon Wireless is noteworthy because the chipset combines their previously incompatible technologies (3GPP & 3GPP2) to no doubt make the different network technologies irrelevant for the end-user. Although roamers are a small part of the broadband notebook market providing a solution which deals with the Vodafone/Verizon roaming issue almost guarantees orders for Qualcomm from the largest players in the corporate market. Economies of Scale play a huge role in the chipset market and therefore I wouldn’t be surprised if Qualcomm is going to dominate this niche market for some time to come with this family of chipsets.

Finally, the chipset provides an early wake up call for those people who have been buying the embedded Wimax story. If people were expecting companies as powerful as Verizon, Vodafone and Qualcomm to roll over and cede market share to new players, especially in the developed markets of USA and Europe, they are basically living in cloud cuckoo land.

Thursday, October 25, 2007

iPhone: US numbers and meaning for the UK.

Apple in its earnings call revealed that 1.4m iPhones had been shipped in total and 1.1m in the quarter. Personally, I think this is a great start and makes the Apple estimate for 2008 of 10m shipped in total to look really, really conservative.

Also revealed was the estimate that 250k was bought for unlocking. I don’t think this is a problem for either Apple or AT&T. If the handset is bound for overseas markets then presumably once distribution is established then the unlocker will just sign up with th relevant Apple operator or buy a new handset. Also, if the unlocked handset stays within the US and the user really likes it then presumably next time they get around to buying one it will be on AT&T’s network. Given that the handset is not subsidised and AT&T only pay share of revenues on activated handsets then it is not causing any financial pain. I think this US data all bodes well for the imminent launch in the UK.

The Telegraph has regurgitated results of a YouGov survey in todays edition. Basically, they are trying to say only 1% of people are expressing a desire to buy the handset before any sort of marketing campaign kicks in is a bad thing. I think it is a testament to the product people in the UK will buy it even with the handset costing £269 and requiring a £35/month subscription. The sample was only 1,000 which yields a 95% confidence level of +/-3.1% on a population of 60m – in other words the survey is a load of rubbish. All the survey really tells us is that people prefer subsidised handsets which all the mobile operators have known since time immemorial.

The survey interestingly said only 4% of people were aware that Apple was a mobile phone supplier. I can honestly say that once the boys from Acton put their sales burners onto full throttle, there will be few people left on this green and pleasant Isle who won’t know about the iPhone.

Full Disclosure: The Author does not own an iPhone nor intends to buy one for personal consumption, but is getting serious earache from his teenage daughter about acquiring one.

Wednesday, October 24, 2007

AT&T + Satellite Buy = Huge Endorsement of BSkyB Model

Rumours are flourishing across the pond that the next course on the menu for the 800lb gorilla of world telecoms is a satellite broadcaster (Echostar, DirectTV or both)

Personally, I think this is a huge endorsement of the BSkyB model triangulating Downstream Satellite Broadcasting, a broadband path for interactive and long tail content and a fancy featured Home Gateway with a big fat local storage array.

It also is huge nail in the coffin of IPTV which apart from the being the most over-hyped technology since WAP features a single channel being served with switching within the network. Verizon, another US-based 800lb gorilla, when faced with a choice of their architectures on their FIOS network decided to broadcast all channels on a dedicated fibre wavelength. It is noticeable that when BT is faced with a choice of architectures on their FTTH experimental networks also follow the Verizon path and not the current architecture of their BT Vision service.

Which brings us to the real question: which is the better solution FTTH or the hybrid BSkyB triangulated dsat/dsl/stb solution?
  • In terms of cost, I suspect the BSkyB model wins hands down.
  • In terms of speed to deployment, I also think the BSkyB model win hands down.
  • In terms of universal service, FTTH will provide a much more consistent service, however is much more expensive on a per home basis and therefore runs the risk of price discrimination in a much more extreme hit to pocket than the current unbundling regime.
  • In terms of upstream capability, FTTH will absolutely crucify the BSkyB model. It will be interesting to see across the world how FTTH operators leverage this capability, because it not only puts the BSkyB model to shame, but also the cable model. However, everything depends on the applications...
  • In terms of UK political acceptability – anything bar a model with “BSkyB” in the title seems to be preferable these days.

Carphone: Yet Another MVNO

Carphone was in the news yesterday launching another MVNO onto the UK population.

If disclosure within Carphone’s fixed line services business is poor then disclosure within Carphone’s current prepaid MVNO’s, Fresh and MobileWorld, must rank as appalling. There are no publicly available statistics on churn, ARPU or SAC costs and in fact the metric used for determining what actually a customer is (eg 90 days of activity) is not even declared. In other words, it is just impossible to determine how the current MVNOs are performing.

It is therefore surprising that Carphone has actually launched a postpaid MVNO. I am of the impression that this is yet another step for Carphone in the direction of being a fully fledged Service Provider and away from being an independent retailer. It will be extremely interesting to see how much marketing effort Carphone put behind the new MVNO. I am surprised that Carphone say there is a gap in the market for shorter contracts, especially when Virgin Mobile tried shorter 6-month contracts and appear to have pulled pushing the deal. And anyway, if Carphone were so certain of demand for the 9-month contracts, they wouldn’t have launched 18-month contracts at the same time.

The other surprising aspect of the MVNO is that it is on Voda’s network and not on T-Mobile, who currently provide capacity for Fresh and Mobileworld. This MVNO deal in fact rather than being new could just be a reincarnation of the old onetel MVNO deal which has been lying dormant since Carphone acquired onetel. Also, I don’t think that it necessarily means the thawing of relations with Voda on the consumer distribution side. After all, Voda would be just complete morons to turn away some high margin wholesale business at very little risk to them. I would imagine however that T-Mobile would be feeling more than a little piqued and wondering why they haven’t got the wholesale business when they pay Carphone a lot more SAC’s than Voda and probably receive far less interconnect revenues from the AOL/TalkTalk fixed line operations.

All in all, an interesting development, but not one that means any fundamental reassessment of my bearish stance on Carphone is necessary.

Monday, October 22, 2007

Playlouder: The first "Media Service Provider"

One of the more interesting people that I met at the recent Telco 2.0 event was Paul Sanders of Playlouder who are in the process of launching a specialised ISP targeting music lovers who want to stay on the right side of the law. The Unique Selling Point of the service is that for the price of your ISP connection (£18/month) you can legally download as much music as you like from the service.

Even better is that the format of the download is VBR (high quality MP3) and contains no DRM protection, so you can easily transfer it from your PC to your mobile or iPod or even burn to CD for listening on the go. This is a much better concept than the DRM loaded, only while you subscribe, Omnifone model. The only potential downside I can see for the service is if the music catalogue is limited: Playlouder has already licensed EMI back catalogue and Paul hinted at more deals in the pipeline.

This fits very much in with the general premise that the industry is on the verge of seeing niche focused ISPs emerging (see also the recent launch of a gaming service from Plusnet) and the explosion of wholesale opportunities in the BSP (Broadband Service Provider) space. In fact, Playlouder doesn't refer to themselves as an ISP, but a Media Service Provider (MSP). This obviously reflects the value-add Playlouder are providing in the sphere of digital music management.

First of all, Playlouder are the people dealing with licensing of music from the record companies and performing rights society. Although Paul was extremely diplomatic, I suspect this aspect of the business is about as pleasant as root canal treatment at the dentist - without the drugs to nullify the pain. Second, there is the problem of dealing with potentially a multi-million digital record collection. Here, Playlouder has past form and operate another company, State51, which deals with digital distribution for independent record labels. Finally, it appears that Playlouder are building community software for their punters with playlists, recommendations and chat facilities.

Playlouder performed an independent survey of 800 UK Broadband users to see if there was demand for the service:
  • 75% agreed that the MSP service is “a great idea”
  • 61% agreed “it is unique”
  • 32% said that they “have been waiting for a service like this”
  • There was strong appeal across the board but some segments showed stronger intent (Younger females and students, Online purchasers, Early adopters and Regular file-sharers); and
  • Of those who found the service appealing, at least 25% regularly buy CDs, DVDs, gig tickets and music merchandise online
In terms of the price point:
  • £10 per month (€14.30) was considered to be the most reasonable price (using an unprompted analysis method)
  • Even at much higher price points a significant proportion said that they thought the price would be “reasonable”
  • 15% said they would definitely or almost certainly sign up at a £10 per month premium to standard broadband cost
  • This equates to a current UK customer base of more than 2 million
  • This would generate £250 million per year (€360 million) in revenues for just the UK
  • 70% said they would consider switching to another ISP that was offering the service
  • 61% said that if their current ISP offered the service it would definitely/almost certainly keep them loyal
The last two points illustrate to me that there is potential for wholesaling of the service to other ISPs.

The beauty to me of the service is the timing - these days the Music Industry seems to be full of really desperate companies and therefore it should be of no surprise that it is a constant source of business model innovation. Usually Innovation brings its partner, the law of unintended consequences, along to the party. When Apple launched the iTunes store service in 2003, it was met with almost universal acclaim by the record companies as the perfect antidote to the free downloading curse. Four long years on and the record companies are feeling the effect of unbundling the album in their pockets - people are just now buying one or two tracks instead of the whole album.

The crazy part of the situation is that as the record companies suffer, music today seems to be more important than ever for consumers. In a great article which puts the case for flat price licensing, Gerd Leonard, explains the dilemma:
Basically, what’s happening is that a much higher percentage of the total population is actually buying music today (32% of the U.S. population in 2006, versus 20% in 1980), BUT (and this is a very big but) the amount spend per capita has been almost halved – and that does not even account for inflation since $100 is obviously worth a lot less now than it was in 1980. In fact, what cost $100 in 1980 would cost $267.76 in 2006 so $198 back in 1980 would be $530 today - I guess one could safely summarize that if we adjust for inflation it has actually shrunk by 75%!
Desperate Times = Radical Rethinking of the Business Model = Opportunity.

As an aside, the work on broadband business models is one of the more interesting pieces of work I have ever been involved with and I am particularly proud of the current work which is due to be published in Nov 2007.

Virgin Media: at last some sense…

Neil Berkett, a candidate for the CEO post at Virgin Media, is actually making a lot of sense in interviews with the Times and Guardian.
"Despite our technical advantage we are still not really standing out from the crowd," admitted Mr Berkett. "I really do want to re-focus our energies onto the broadband platform."
If I was being a pendant, I say the advantage is really a theoretical technical advantage and encourage him to turn a theoretical advantage into a real one. This means investment in areas where the broadband cable network is currently overloaded, completing the conversion of old analogue TV customers into digital ones and thereby freeing up capacity to allow investment in supa-fast DOCSIS 3.0 technology.

I also agree with his idea of upselling cable TV into Freeview homes:
"Think of Freeview as a nursery and you have millions of kindergarten kids who once they have got the taste for multi-channel TV may upgrade an element of the service."
There are around 9.1m Freeview households in the UK and it will only take a small percentage of these to be converted to basic Cable TV to provide plenty of revenue upside and more importantly plenty of households to upsell additional broadband and telephony services. All investment in TV content should be aimed at differentiating the base cable TV product from Freeview and thereby increasing the gap in value and entertainment in the eyes of Freeview customers.

I cannot emphasise how much I agree with the strategy of focussing on improving broadband and upgrading Freeview customers, but I would also move forward on another initiative and withdraw from another.

I would start to extend the cable footprint again. It is ridiculous that mega new developments such as Ebbsfleet will only have BT Openreach facilities and not be served by cable. Similarly on smaller developments up and down the country within existing cable franchises only BT Openreach facilities are being built. If necessary Virgin Media should lobby the government at the national level to ensure that cable connectivity is part of the UK planning laws within existing franchises. Not only would this strategy increase the footprint to be sold, but also have a huge positive psychological impact on the workforce after years of stagnation and being on the back foot.

I would also give up on the off-net strategy – it is never going to be a significant profit centre and only serves to confuse the customer. Cable should be selling itself to customers as a premium technology and getting round the legacy baggage from the analogue and digital conversion days. I would sell the offnet base to an existing player and also negotiate a commission for leads generated from offnet cable movers.

This would be the basis of my quad play strategy: cement and extend broadband advantage; sell TV to Freeview upgraders; start to expand the cable coverage again; and terminate the offnet strategy.

Of course with Virgin Media there is the continual problem of funding for any new investments. If I didn’t have the balance sheet capacity available to invest in the cable network, I would seriously consider selling the prepaid mobile base to get a quick injection of cash. This to me would be far more preferable than selling the B2B or content sides of the group.

Friday, October 12, 2007

Carphone Trading Statement: iPhone & Distribution

After an overseas business trip, I’ve finally got round to listening to the Carphone Trading Statement and I found the only interesting parts to be the comments on the iPhone and distribution in general. The real key for the broadband side of the business is the profitability which wasn’t disclosed.

Carphone securing some of the UK iPhone distribution rights was a huge feather in their cap and was not a total surprise for me. Personally, I think that Carphone will sell a lot more iPhones in their stores than either o2 or Apple; retailing is the core strength of Carphone and I think no-one doubts that Carphone are far more advanced and successful at phone retailing than anyone else in the UK market.

Charles Dunstone remained very tight lipped on the commercial details of the deal, but provided a few clues about the process. As in the US, activation of the IPhone will not be done in-store, but instead via the net at home. This effectively means that Carphone will not be performing any credit vetting at the Point of Sale and the transaction will be relatively simple to complete in store – Charles Dunstone himself compared it to a Prepaid sale.

How Apple and O2 are going to ensure the phone is going to be activated on the O2 network and not unlocked is unsure, but it seems that Carphone will play little role in this activity. Also, how O2 and Apple will deal with people who fail credit checks is unsure, but again it appears that Carphone will play little role. It looks as if Carphone liability ends with the person walking out of the store.

The net effect for Carphone will surely be a lower margin for an iPhone sale than a traditional contract sale. In FY07, Carphone made a gross profit of £26 on prepay sales and £99 on subscription sales. I would be very surprised if Carphone was making more than average prepay margin on iPhone sales. However, there are other opportunities for Carphone to make margins – I think the insurance angle could be particularly lucrative.

The overall impact of the iPhone on the Carphone gross margin depends upon on the degree of cannabilisation of “normal” Carphone contract customers; Carphone will be hoping that iPhone buyers will be people who normally buy contracts direct from the operators and not from their stores. It is very simple to play with the variables: for instance 1m iPhones sold in the UK in the next 12-months, Carphone selling 50%, Cannabilisation 60% and loss of margin £75/sale (versus a gain of £25 on the 40% of new business) gives a loss of gross margin of £17.5m for Carphone.

The Distribution business made an EBIT of £141m in the FY07 so this scale of margin loss would have a impact on the overall business. It will take a lot of insurance policies, accessories and extra footfall (ie other non-iphone sales) to make up this shortfall. It should also not be forgotten that at first glance it appears to be far better for Carphone to have some iPhone business than none at all.

Whether having iPhone distribution is better than none at all is not only dependent on the gross margins and cannabilisation, but also on the pound of flesh that o2 has extracted in allowing Carphone to become a distributor. If I was in O2 shoes, I would have definitely looked at reducing my two biggest nightmares: churn and cashback.


The churn on O2 contract base (diagram from Voda) is much higher than Vodafone at 21.5%, furthermore the gap has grown despite the Vodafone exit from Carphone and the introduction of 18-month contracts. Vodafone is also outselling O2 on contract customers. Obviously, incentivising Carphone to reduce churn on O2 contracts will be seen as a current priority for O2.

The easiest way of doing this is to reduce the upfront cash commission and increase the share of on-going revenue. This not only moves the risks from O2 to Carphone but also alters the cash flow especially given that Carphone will pay for the handset cost upfront. There will become a point on the mix of upfront and ongoing commissions that Carphone effectively just becomes a Service Provider on the O2 – a very similar model to Germany.

The downside of Cashback is becoming more and more apparent to all operators. Carphone, especially through its online subsidiary, e2save, is still aggressively pushing cashbacks deals. In fact, its cashback terms are still more severe than the recommendations from operators which have been endorsed by OFCOM.
For example, in relation to a cash back offer, the following terms should be regarded as unreasonable:
  • a requirement that the customer submits their original statements – copies of statements should be acceptable proof;
  • charge for processing a cash back claim;
  • a requirement that cash back claims are submitted within an unreasonably short period (such as anything less than 60 days, for example);
  • terms stating that a cash back payment will not be made if the customer has an outstanding balance on their account.

Basically, the Carphone price match terms currently break every single condition, albeit you only get charged a processing fee if there is an error in your documentation.

I have a sneaking suspicion that the reason that off-the-page contract sales are falling is because cashback is being clamped down upon and therefore the deals just aren’t as appealing or more importantly affordable or it is simply a case of "once bitten twice shy". Probably ex-cashback customers are either returning to the prepaid market or going direct to the mobile operators.

As the Operator backoffice systems are becoming more and more sophisticated, Operators are becoming more sophisticated in retaining the high value customers inhouse and this leaves the average customers connecting via third parties becoming less and less valuable. The big risk for Carphone is that they enter a downward spiral where operators put off their most valuable customers, the remaining customers have a lower average value and therefore Carphone gets less commission.

I feel that this twin threat of shifting the risk to Carphone and the average customer being less valuable is much more threatening long term to the Carphone distribution business model than losing the Vodafone contract business.

Monday, October 08, 2007

Carphone Home Division – The wheels on bus...

..appear to falling off.

Two interesting stories appearing in the press over the weekend.

First, we have the Daily Telegraph reporting from Charles Dunstones yacht in the South of France:
And this Tuesday, when Dunstone updates the City on trading, improved profitability in broadband should help soften concerns about lower numbers of sign-ups.
Hmmm that is interesting, because profitability was always planned to have a HUGE jump in this year, but sales were not planned to drop off.

Then we had the following comment in the Times:
is expected to disclose in a trading update on Wednesday that net additions for broadband in its second quarter have dropped to as little as 95,000, from 126,000 in the last quarter…
Carphone’s slowing customer numbers are expected to be offset by strong progress on transferring customers on to its own network – a key test of the profitability of the service. The communications group makes a loss of around £5 per month on each customer who takes on the BT wholesale product. It becomes profitable only when these customers are connected to Carphone’s own network.
These net add figures would be a huge disappointment to me especially as the Carphone broadband target is 3.5m customers by 2010. There has been much written this month about Carphone and its potential churn problem as the TalkTalk base start to come out of the 18-month contracts, but Carphone face a much bigger problem here and now and that is the churn on the AOL base. Carphone do not disclose the churn figure, but given that most of the AOL base is not unbundled, I expect the figure is huge. By huge, I mean much higher than mobile churn figures and of sufficient size to possibly make the acquisition of AOL look like a poor decision.

The other obvious question is how the Free Laptop offer is going for AOL? It is pretty obvious to me that it is not going as well as expected and I base this judgement on two key facts:
  • Carphone would not be investing as much in marketing if the offer was flying out of the door; and
  • Carphone would not be bundling a free laptop with mobile contracts if they were not worried about the stock levels.
Basically, if you cannot sell broadband with a free laptop with your premium brand (AOL) and with the lowest prices in the market on your value brand (TalkTalk) – how much trouble are you in?

If I was an investor in Carphone, I would be looking for real clarity in the home business going forward – not only with churn figures, but just as importantly with amortisation breakout of SAC costs and capitalised investments – because I would be extremely nervous.

Friday, October 05, 2007

OFCOM: DTT Headache

Nearly all the UK population haven’t a clue about the UK DTT platform. They do know about the TV channels moving to digital and the choices available. In fact, there is only 15% of the population who remain with just analogue TV in the home. The UK, probably more than any other country in Europe, has a very healthy mix of consumer options for TV.

UK viewing

The problem for OFCOM is that most UK consumers associate the DTT platform with the traditional Public Sector Broadcasters (ie BBC, ITV, Channel 4 and five). This is completely borne out by the BARB statistics: 70% of viewing is for the five analogue channels (BBC1, BBC2, ITV, Channel 4 and five) and over 90% of viewing is the main PSB channels and their derivates in a “Free to Air” mode.

A detailed look at the evolution of channel line-up shows just how much PSB output dominates the DTT airwaves: in Oct 2002 when Freeview was launched there were 22 channels of which only 7 (Sky Travel, Sky Sports News, Sky News, TMF, The Hits, TV Travel Shop and QVC) were from non-PSB sources; whereas today there are 41 channels with only 12 being from non-PSB sources.

Please note, I am including the state funded Community Channel and Teachers TV in the PSB sources. I am also including the jointly owned BBC and Virgin Media channels, UKTV History and Bright Ideas in the PSB source.

Of the non-PSB channels, six fall into the t-commerce category (QVC, Thomas Cook TV, Ideal World, Smile TV, PriceDrop TV and Bid TV), two are music channels, TMF and The Hits, one is from the Virgin Media and three are from the Sky family.

Furthermore for non-PSB owners, it appears that life is really tough: The Disney owned general entertainment based abc1 channel has been withdrawn; emap has sold 50% of all its TV business to the allegedly skint and needing a further public subsidy, Channel 4, for £28m (this includes payTV channels The Box, Smash Hits, Kerrang!, Q, Kiss and Magic as well as the DTT channel the Hits) and Sky wouldn’t be considering withdrawing its channels if they were profitable.

It is appears to me that it is very difficult to make a channel pay on the basis of advertising funding alone, especially when you are competing against the PSB for advertising spend. ITV plays on this point in presentations to the City – advertisers pay a premium for mass market audiences. Of course, it helps even more when the PSBers are gifted their spectrum and non-PSBers have to pay for their capacity.

Basically, over time more and more of the DTT capacity is being used by the PSBers and diversity is shrinking rather than growing on the platform. OFCOM answer to this is to put its head in the sand and instead ask questions about whether Channel 4 needs yet more state subsidy, when it is using allegedly scarce and incredibly valuable capacity to run channels like C4+1, E4+1 and F4+1. Also, whoever regulates the BBC allow them to bleat about budget cuts (the actual licence fee increased) whilst they are busy buying travel content company, Lonely Planet, and blowing millions on an fatally flawed internet distribution platform.

The real problem is that OFCOM is absolutely terrified that 15% of digital refuseniks are going to kick-up a tremendous fuss when their analogue Tellies stop working over the next few years. Let’s be perfectly honest and state the chances are them running out before digital switch over and taking a DSat or Cable subscription are next to zero.

OFCOM and the BBC Trust are also really interested in rapidly pushing through plans for FreeSat, the DSat equivalent of Freeview on DTT. I’ve always been extremely baffled by this, especially when Sky offer an equivalent service which is fairly priced, but the recent furore in Whitby, which has piqued my interest but not hit the national press yet, provides a clue for the true motivation.

Basically refarming of any spectrum is difficult: even playing with power levels and mast position will not give the same coverage as before. This could develop into a huge PR nightmare as digital switch over occurs, especially as a lot of channels will just not be available outside of the main 80 DTT masts. DSat will basically be the only economic alternative for people suffering poor reception and the BBC just does not want BSkyB to be seen saving the DSO.

People should also not forget this use of the DTT spectrum is version 2. Version 1 was the bankrupt ondigital financed by ITV. It should also not be forgotten that BSkyB wanted to be part of ONdigital, but was barred on competition grounds. ITV has obviously admitted defeat on payTV and nowadays seems to take a 100% ad-funded model for all distribution channels including the internet.

However, Channel 4 is still confused: it sort of admitted that selling subscriptions for Film 4 was a big failure; it also seems to want to get out of the game of encrypting its other channels and therefore earning revenue from Sky; yet it is still trying to get consumers to pay for content on the internet.

It such also be remembered that for however much the PSBers whinge and whine, their past and continuing failures in PayTV are completely of their own making and the state subsidised channels have been cross-subsidising these failures for many a year.

Out of ashes of version 1 of DTT raised the fatally flawed TopUpTV service. TopUpTV require a different kind of Set Top box which is not compatible with the main Free To Air boxes. In fact, Set Top Boxes which have cracked the TopUpTV encryption are freely available on the internet and eBay if anyone does not want to pay the subscription charges. It should also be noted that the current version of TopUpTV is one that has just emerged from liquidation. Even with the addition of Setanta content, which is the best shot in the arm for TopUpTV for many a year, I suspect that TopUpTV will not around in the medium term with its current subscription/technology mix.

The lessons to OFCOM are clear: the DTT platform is currently unhealthily dominated by PSBers, there is a huge barrier to entry to new content ownerss and there is already a flawed PayTV platform using the DTT spectrum which is basically going nowhere fast.

Basically, I believe Sky is the last hope before the whole of the DTT platform becomes subsumed by the PSBers, which is the outcome that the BBC have wanted all along. This is the question that OFCOM should be considering; instead of wasting its time on preventing Sky’s entry it should be actively encouraging entry.

Wednesday, October 03, 2007

Telekom Austria Bags Another Risky Bargain

Telekom Austria has completed the buy-in of the number #2 Belarusian mobile operator, Velcom. They have paid €730m for 70% with an option for the other 30% priced at €320m. There is a performance related deferred consideration which looks as if could be quite substantial based upon a multiple of 2010 earnings rather than the multiple of estimated 2008 earnings that the deal was based upon.

So for around €1bn, Telekom Austria has bought 100% of a mobile operator in an underpenetrated (77%) market with a market share of 42%, revenues of €262.6m and an EBITDA margin of €158.8m in 2006 for a price which is 6.6x 2006 Earnings. Of course, the capex/sales ratio is quite high at 29%, but this is to be expected in a fast growing market.

The real downside is that the operation is in Belarus. There is no telecoms regulatory framework and the state owns a controlling stake in the other 3 licensed mobile operators. The Russian mobile operator, MTS of Russia has a 49% stake in the largest operator with 54% of the market by customers.

Velcom has been up for sale for quite a while and I fully expected Vimpelcom to end up being the owners. However, all become clear when it was revealed that Martin Schlaff had an interest in Velcom. Martin Schlaff had been the previous owner of the Bularian operator which Telekom Austria took over. He had also tried to help Telekom Austria acquire an operator in Serbia until Telenor came along and ruined the party.

tel-aus footprint

I am wondering where Telekom Austria will go next. Obviously Bosnia is a big hole in their map and I would expect something to happen there in 2008. Another possibility is in Lithuania and Latvia where the ex-TDC Bite operations are now owned by private equity and presumably will need refinancing in the medium term. Other than that, Telekom Austria will be running the risk of treading on the toes of its much larger partner footprint, Vodafone.

Monday, October 01, 2007

Nokia & Navteq – A Tricky Course to Steer

A great ballsy, albeit expensive, move by Nokia today, in buying Navteq. I am a huge bull on the prospects for mapping products in general and mobile location based services in general.

I don’t suppose many of Nokia mapping competitors will be surprised, after all it appears that a hush-hush kind of auction was conducted and that probably accounts for Nokia paying top euro or to be more precise €5.4bn euros. The real question is what are the current and future Nokia competitors going to do about it?

For data aggregators and enhancers like Webraska and Networks in Motion, who use the Navteq data to supply services across a range of handsets to mobile operators such as Orange UK and Verizon Wireless respectively, it is probably time to have a long hard look at strategy and decide whether they have the stomach and deep pockets for a new course of action.

For the poster boy of the standalone GPS device market, TomTom, who is already in the process of acquiring the only real competitor to Navteq, TeleAtlas, for the relatively cheap €1.8bn, there is definitely a gap appearing in the market for mobile manufacturer independent mapping software and services.

For the internet mapping giants, Google and Microsoft, they’ll probably have to go and collect their own data, "improve" on TeleAtlas and Navteq collection quality and contextual richness and then cut a deal directly with the mobile operators. Vodafone UK already has a deal for Google Maps.

The added complication is that the optimal business model is nowhere near being decided:
  • is the profit going to be from bundling the software in with the handset?
  • is the profit going to be charging for service or bundling the service in with access?
  • is the profit going to be from advertising? or
  • perm any of the above?
However, despite the uncertainties of the business model, I am absolutely sure that there is a huge latent demand: maps on the PC have taken off in the last couple of years and PC’s are not generally available when people really need directions. The beauty is the timing with the handset rapidly catching up with the specification of PC not only in terms of internet bandwidth, but also in raw processing power. Perhaps the pc-handset lag is currently only a mere 3 years.

Even better for Nokia is that they will actually own the mapping content and not have to deal with the crazy intermediaries of content as with the other major OVI service already announced - music downloads.

Sky: Defensive Picnic

Sky have released details of a forthcoming service called Picnic.

Much of the information about the TV element of the service is already in the public domain: Sky wants to encrypt its Freeview capacity and broadcast in MPEG4 to add extra capacity. This is already subject to a delayed OFCOM consultation and even with a fast tracked approval in 10 weeks. I can’t realistically envisage a customer launch before Christmas 2008.

Personally, I can’t see any reason why OFCOM would want to refuse anyone permission to use MPEG4 and encryption technology. Although MPEG4 is new to the UK DTT platform, OFCOM are actually suggesting that this is a potential solution for HD broadcasting. Encryption is not new and dates back to the original failed launch of ITV digital. I suspect the only reason for delay is that because the proposals come from BSkyB.

Unfortunately for Sky sometimes logic is of little relevance to broadcasting decisions as was witnessed by the EU decision to force the Premier League to have a minimum of two broadcasters for UK rights, whereas in Scotland and France one is suffice.

The new information is full details of the content: a 24-hours Sports Channel, an evening Movie Channel and an evening general entertainment channel from Sky’s own channel portfolio were pretty obvious choices. A daytime Children Channel and a daytime factual Channel were more surprising: however Sky already has within its joint ownership stable Nickelodeon UK, National Geographic and The History Channel. Dependent on MPEG4 adoption, 24 Hour Sky News for the fourth channel is also a pretty obvious choice.

Given that most content is already broadcast on the DTH platform, then incrementally the content costs have obviously been kept to a minimum and the main service costs are going to be the subscriber acquisition and ongoing management costs together with the transmission costs. The subscriber acquisition costs are going to be minimised with no Set-Top Box subsidy or distribution costs. Sky already has a long term contract for the transmission capacity and therefore no new money is required there.

The big question in my mind is whether the “Free to Air” advertiser funded model of the Freeview platform is under real strain and associated with this is whether some of the minor channels will survive and more immediately whether transmission capacity prices have peaked. There currently is very little programming outside of BBC, ITV, Ch4 and five: with three t-commerce channels (Virgin & QVC), two music (Viacom and Emap) and one “new” general entertainment (Virgin). Whatever happened to the original concept of Freeview encouraging new entrants to broadcasting?

Of course, the biggest risk for Sky is that it cannibalises DTH revenues: I think this is inevitable and where I’m struggling with the whole concept. I think there is a big percentage of the population who would never pay any extra subscription fees above and beyond the beeb’s annual telly tax. Admittedly this refusenik percentage is shrinking year by year and this is the natural target of growth that Sky will see in its subscriber numbers year on year.

However, the landscape is getting much more complex with the entry of a budget Sports payTV channel and budget movies available over the internet. Arguably, if Virgin Media ever get their act together they could also cause a little market disruption. I suppose the equation which drove the payTV DTT decision is how much cannibalisation would have occurred from these new entrants versus the self cannabilisation from launching their own services.

I also expect that standalone services for broadband and voice are also of dubious economical value for shareholders. To be fair, we have to wait for pricing, distribution and the all important bundling strategy before we can definitively deliver the thumbs down.