/* ----------------------------------------------- Comment out annoying Snap... ----------------------------------------------- */

Tuesday, August 28, 2007

H3G UK – One Step Forward, Two Steps Back…

Hutchison Whampoa reported last week and the 3G operations seems to have improved significantly on a cashflow basis in general and the UK in particular. The H3G UK & Ireland operations quoted “recurring LBITDA after all CACs reducing by 96% compared to the same period last year”. Hutchison Whampoa do not break out the financial results of the various 3G operations so it is impossible to determine the absolute number of the UK&Ireland outflows but suffice to say it is a vast improvement on the figures from last year.

Over the last twelve months 3UK has radically reshaped its distribution network moving as quickly as possible from a reliance on indirect distribution to direct distribution, whether by owned stores which have increased dramatically in number or by online and telesales channels. 3UK are sufficiently happy with the progress to announce postpaid churn of 2.5% which presumably is a dramatic improvement of churn rates in the past.

The standout headline figure was the reduction in SAC costs by £160m to £212m - some of this will have come from the lower level of contract net adds (139k vs 226k), but there will also be real savings from both the change in distribution strategy and reduction in churn. Whilst this is extremely healthy for 3UK going forward, it will put the independent distribution channels under even more intense pressure going forward.

I also think that the power of the X-Series offer is starting to show in the customer numbers – despite having a severely limited marketing budget and restricted distribution compared to the other mobile networks, the X-Series appears to be selling well. This to me shows the power of word of mouth, especially amongst the tech-savvy community of mobile users. I have yet to hear one person who is disappointed with an X-Series choice.

The prepaid base seems to be going nowhere with revenues only 10% of total H3G revenues of £811m for the half year. The prepaid “active” ARPU figure of £18.82/month and the inactive rate of 75% implies the active prepaid base is somewhere between 600k and 700k customers which is absolutely nothing in the overall scale of the UK market. In my opinion this is hardly surprising given that 3G is a premium service compared to 2G and something that should not worry people too much.

However, allied to the lack of presence in the corporate and fashion sector, it does show that H3G UK is heavily exposed to a single mobile market segment – Mobile Geeks. If another mobile operator wanted to cause H3G UK some serious pain, all they would have to do is to be ultra-aggressive in this market segment.

This really is the first of Hutchison’s strategic problems – how does H3G UK gain scale? Because they are still seriously sub-scale – the first half revenues were probably 50% of the smallest UK operator – T-Mobile and around 33% of the big two – Voda and O2. Hutch can probably halt the cashflow pain but they are never to going to generate a return on capital at current market share.

The second strategic problem is the forthcoming OFCOM termination rate settlement which will knock a huge dent in H3G profitability. The settlement will reduce H3G inbound revenue from around 11p/minute to 6p/minute while not having an associated reduction in outbound fees – this could easily take £100m per annum from H3G’s bottom line. I believe termination rates for H3G is basically a life or death situation and this will mean that every legal and lobbying avenue has to be fought to either reverse or delay OFCOMs decision.

All of which means that H3G destiny is basically out of the UK management control: they can’t attack another segment to gain market share, because which ever operator stands to lose the most will just fight back targeting the H3G geek customers; and although they can delay the imposition of termination rates through the courts, they really need to achieve the impossible by convincing the politicians to overturn the OFCOM termination decision.

For the other operators, they can just sit back and watch: they all know that one of the four buying H3G UK will radically improve the profitability of the overall UK market and they know that the termination rate settlement will probably reduce the value of H3G UK, but they also know that T-Mobile has the most to gain from buying H3G UK. A purchase of H3G by T-Mobile will probably put the UK market in oligopolistic heaven and allow a period of relative market calm and profit maximisation. However, others will be tempted to take a risk and give a little impetus to their UK operations - I can make a case for all of the other three buying H3G UK.

Personally, I suspect the market rumours from last year about a possible China Mobile bid were just an attempt to force the hand of one of the UK operators. Similarly, I expect the current round of conversations about network sharing is also an attempt to force one of the UK operators to get their wallets out. Hutchison seem to be in a bigger rush to say Goodbye to the UK mobile scene than the others are to bulk up their operations.