Dawn of a New Era

Well at least for me, as today I’m joining the Telco 2.0 team over at STLpartners. STLpartners share my appetite for dissecting industry business models and trying to discover where the economic benefit in communications and content industry product and services arises.

I’ll still be blogging but on an anonymous basis over at the Telco 2.0 blog. I’ll also be contributing towards paid for research work and consultancy assignments.

I want to thank all of my readers from over the past couple of years and hope that you will continue reading my work over at the new home.

Geo sells same network to both Carphone and Tiscali.

It looks as if both Tiscali and Carphone Warehouse have bought an identical dark fibre backbone for the UK from Geo. Obviously, when lit this fibre adds plenty of capacity to both networks and more importantly provides plenty of PoPs for interconnection with their unbundled exchanges and presumably will involve a drastic reduction in backhaul costs.

Geo was originally built alongside old British Gas pipes and was called 186k, before being sold to Hutchison Whampoa and renamed Geo. They have an even more interesting London Metropolitian Network which is built in the sewers of Thames Water. Carphone have leased fibre in these sewers to connect up their core sites in the capital.

BSkyB – Bulking Up

The sheer scale of BSkyB’s investment in broadband barely ever gets a mention, but I reckon it is currently around £720m. This is broken down into:

• the two major acquisitions: Easynet of £223m and 365Media of £105m of which I estimate around £60m was broadband and the other being the betting assets.
• the fixed capex of £130m and success-based capex of around £45m
• the operating losses of £232m in Sky Broadband and £40m in Easynet, less around £10m of depreciation of the capex.

Losses and Investments are expected to continue until 2010, when I estimate that total investment will be around £1bn and that is a big number for people who think that access providers will be relegated to a future role of being mere bit shifters.

Broadband Progress

Net adds of both Sky Broadband and Sky Talk are currently doing extremely well in a very competitive market and if the current pace is continued the goals of 3m broadband and 1.5m Talk customers should be easily achieved. I estimate that at the current pace, Sky will have around 3.4m broadband and 2m talk customers. Although, these figures sound a lot they will still leave Sky in the #3 position behind BT and Virgin Media. I do not think it is in the DNA of Sky to languish in third place, so I expect the onslaught to continue post-2010.

Operating losses of £51m in Sky Broadband, which includes SkyTalk, are extremely high, but probably have peaked unless the pace of subscriber acquisition picks up. Sky writes off the approx. £80/customer SAC costs as they are incurred and with 233k net adds in the quarter the total SAC charge to P&L will be around £18m. Average ARPU of £16/customer is slightly ahead of target. However, what is not known is the rate of churn within the Sky Broadband service and this is the key statistic on such a low ARPU.

B2B

One element of the Easynet acquisition which is slightly disappointing is the seeming lack of progress on the Enterprise side. Easynet made losses of £6m on overall turnover of £40m in the quarter.

One thing that I have noticed is that David Rowe (the CEO of Easynet) is also now responsible for the Sky Business division which sells TV into pubs, clubs, hotels and businesses. I would imagine Easynet to start leveraging these relationships and cross selling voice and data into this customer base.

The frightening thing about the B2B voice and data market is that it isn’t very profitable; companies such as Colt and Thus have been around for years without making much money. I am really struggling to see where Easynet see that they have an edge in this market in the medium term. I wouldn’t be surprised to see the Enterprise division being sold in the medium term.

Massive Local Storage

The Sky platform architecture is not just about adding an always on broadband capability to the satellite download capability; it also requires a big fat hard disk with plenty of storage integrated into the set top box. This is delivered via either the new Sky+ boxes or the HD boxes. In total Sky have just over 3m homes with storage in the front room out of a total of 8.7m or just over 35% of homes.

This can be seen as another financial investment for Sky because every Sky+ box requires an approximate £100 SAC charge to P&L. The problem here is that for most customers it is not just a question of sending out a box, because a second feed is required from the satellite dish and this requires a visit from an engineer. The best solution for Sky would be if existing customers either purchase the Sky HD service or purchase a multiroom service and thereby reducing the payback period.

The Sky multiroom service is probably the only service that seems in danger of missing its target of 3m homes by 2010 at current takeup rates. I can imagine the pace picking up slightly as Digital Switchover occurs in the main populated regions and people start to discover that indoor coverage on second and third TV’s is poor without connection to an external aerial. However, I expect this service to miss its 2010 targets without further action such as a price drop.

Sky+ has already met its 2.5m homes target and I suspect that even Sky themselves are surprised at the popularity of the product. It has definitely crossed the chasm into a mainstream must-have consumer product and I suspect that demand in the next quarter will be extremely high. Some families this Christmas will be worried whether the Sky engineer will arrive before Santa.

Next year will present an interesting dilemma for Sky as the tired looking EPG gets a makeover. Customers with old Set Top Boxes will probably not have the capability of receiving an EPG upgrade and therefore they will need either a new box. Sky with its anti-churn policy of treating its most faithful and longest serving customers fairly will probably have to offer them a better deal on the Sky+ boxes which will involve an even greater subsidy. I expect this rollout to happen next summer when engineering demand is lightest.

All told, the investment in Sky+ will probably be a drag on earnings for the next couple of years. I can easily see Sky investing £25m per quarter in Sky+ until 2010.

DTH

DTH is on target for 10m homes by 2010, but it is not doing exceptionally well in the UK.

In Ireland, DTH is doing much better and I think Irish home penetration (approx 34%) is now higher than the UK (approx 32%). The reason for this is that Ireland still has a lot of analogue cable (268k) compared to digital cable (297k), whereas Sky had 513k subscribers as at Sept 2007. Analogue Cable is a bit of a misnomer because a lot of these analogue customers are actually rural and limited channels is delivered via a wireless technology called MMDS. It also helps that the Irish economy is growing at a greater pace than the UK and doesn’t currently have a DTT service.

In the UK competition is fierce with Virgin Media, Setanta on DTT and BT aiming for the low end Sky customers. The fact that Sky managed to add 67k in this environment is testament to the strength of the Sky brand. Although, it is hard to disentangle all the working parts of the Sky machine, the majority of the new adds seem to be See, Speak and Surf subscribers which probably add more weight to the timeliness of the broadband strategy.

Cost Base

Apart from the economies of scale inherent in the content business and more especially the premium sports, there are another couple of extras benefits which should start filtering through in the next couple of quarters. The first is the completion of the EDS trial, through this will probably be offset by extra costs from the regulatory and legal battles that Sky will need to keep fighting with OFCOM, Virgin Media and the rest. The second is that the USD:GBP exchange rate is definitely moving in Sky favour, currently because of their hedging strategy benefits (or costs) actually lag the actual exchange rate. Performance in the current quarter was a £3m gain with a hedged exchange rate of around 1.86.

Potential Downsides

The main potential downside is that Sky will lose its various regulatory battles handing an advantage to its competitors. Although a negative outcome in the ITV enquiry could cause some short term financial pain, the payTV DTT OFCOM is I believe of far more long term strategic importance. Also, I wouldn’t be at all surprised if Virgin Media drop their content carriage case with the appointment of a new CEO and some sort of face saving settlement is worked out.

However, an increase in investment could also spook the stock market and there are four main broad areas which could involve a lot of money:

1. launching broadband in Ireland
2. increase of exchange footprint above the current 70%
3. more investment in the B2B market; and most expensively
4. Fibre investment

All told, Sky is currently executing well on its plans and its plans should be a big concern for the rest of the market. Long term, the only really dark clouds on the horizon is the DTT enquiry and potentially a BT-led FTTH programme which could leave Sky with a lot of stranded assets unless they launch a fierce political and regulatory fight.

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

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.

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.

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.