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Thursday, May 31, 2007

Milan, Italy: TI, Metroweb & Fastweb - Strange Goings On


Telecom Italia announced today a 15-year deal to use the metro fibre of Metroweb to deploy its next generation 50-meg VDSL service to 70k homes in the city of Milan.

This isn’t so funny for Fastweb investors who use the same fibre to deliver triple play services to the same residencies in Milan that TI are targetting. I hear on the jungle grapevine that the Fastweb CPE only allow a max of 20-meg internet to the home. In some areas of Milan Fastweb has a market share in excess of 50% and that is a lot of customers for TI to churn. The Italian triple play is especially attractive because there is no CableTV competition; the only other PayTV is from Sky Satellite and mighty News Corporation.

The Metroweb network does not enter the buildings. It is safely buried under the pavement in ducts about two metres away from the buildings. Fastweb connects the fibre/duct network to the risers in the building – if there is enough demand. The barrier to entry to the rest of the industry players has always been the acquisition of permits to hook up the buildings and of course access to the Metroweb network. However Telecom Italia appears now to have broken that stranglehold.

It should not be a surprise to any student of the Italian communications market that the history of Metroweb and Fastweb is a tangled affair bringing together private entrepreneurs and the city of Milan.

Fastweb originally started as a brand name of e.Biscom which was 66% owned and led by a group of Italian entrepreneurs including Silvio Scaglia (ex-Vodafone Omnitel and now owner of Babelgum), Alberto Trondoli and Francesco Micheli. The other 33% owner was the City of Milan through its electric utility, AEM.

Fibre was laid throughout the City of Milan and this fibre was owned by Metroweb which in turn was owned 66% by AEM and 33% by e.Biscom. The fibre was leased to Fastweb and others, although Fastweb made up 80% of the revenues of Metroweb. e.Biscom was hit hard by the bubble and eventually plans had to be scaled back.

Eventually in a complicated transaction AEM exited Fastweb and bought Fastweb out of Metroweb. By this time, Metroweb had built a 3,200 km fibre optic network spanning every street in Metro Milan and selected backbone routes throughout Northern Italy. In Aug 2006, Private Equity in the form of Sterling Square took majority control of Metroweb for €230m and surprise, surprise Alberto Trondoli returned to head the company.

At around this time it was rumoured that Fastweb was up for sale: Vodafone and Sky although presumably having huge synergies allegedly looked at the company and decided not to bid. Eventually, Fastweb found a buyer offering a decent price in the form of the Swisscom who offered €3.1bn plus the assumption of another €1.1bn of debt for 82.4% of the company. The Swiss PTT had money literally burning a hole in their pockets after being turned down by their main shareholder the Swiss government in several Euro acquisitions. The deal was completed on 18th May with Swisscom taking 82.4% ownership and Silvio Scaglia exits with his millions.

It strikes me as more than a slight coincidence that less than two weeks later the stranglehold of Milanese Fibre held by Fastweb was broken. Someone has won out big time here and my guess it is not the shareholders of Swisscom or the Milanese citizens. Fastweb is currently trading at €40.74 well below the €47 that Swisscom paid.

Hat Tip to Stefano Quintarelli for his more than valuable recent assistance and by the way his campaign for FTTH in Italy is more than brilliant.

As an aside, one of the more interesting characters for UK readers to emerge out of Fastweb was the ex-CEO of Bulldog Emanuele Angelidis who I presume was recruited to solve the customer service issues and launch IPTV.

Private vs Public Mapping

There is a very interesting story in the Guardian about the rise of Google and fall of Ordnance Survey (OS) in mapping for the public sector. I suspect the picture in the private sector is even grimmer for OS.

For as long as I can remember, I have always thought that the price of OS hard copy maps has been overpriced. I think that OS also seems to have missed out on a huge opportunity to digitise the data and make it available on the net for a reasonable price to the public. It is hardly surprising that Google is steeping into the void with an ad-funded model, albeit currently subsidised by annoying little search adverts.

OS is effectively the government’s preferred cartographic service owned by the Great British Public. In the 2005/6 OS accounts turnover was £118m with a surplus of £5m. OS had net assets of £60m. As far as I am aware no direct subsidy is provided and OS instead relies on trading to keep the wolves from the door.

Of course, the Guardian being the Guardian has a socialist view on the brewing troubles – make the data opensource and fund OS by general taxation. However, I have a more simple market-based solution – privatise Ordnance Survey and run periodic Dutch auctions for the any data collection which is still deemed necessary by the government or local authorities.

I suspect that many of the OS current problems are going to impossible to address whilst it remains as a slow moving quango – the likes of Google will always run rings round it commercially.

Wednesday, May 30, 2007

Connecting the unconnected

A great cartoon from this weeks Mobile Today:

Nokia and Motorola have pledged to 'connect the unconnected' in the developing world with low-cost handsets.

Cheapest Broadband in (lucky parts of) Britain

Virgin Media is currently offering 2-meg broadband for £10/month on a twelve month contract with no line rental and a free modem. It is the perfect home communications package for someone who makes the majority of calls from mobiles and just needs broadband or is willing to experiment for VOIP.

A self-install also means the £25 installation fee is waived, although an up-front advance payment is required. A self-install is only possible for houses who already have the Virgin Media coax to their homes, but has the added bonus that you do not need a ticket for the "decent installer" lottery. Although, unpublished it also means that the unencrypted TV channels can be viewed on the parts of the Virgin Media network that still carry the analogue signals ie the majority.

All I can guess is that Virgin Media must be desperate for the headline customer numbers before reporting figures to the end of June.

Monday, May 28, 2007

C&W UK – Still a Disaster Zone

C&W released their results last week and it looks to me as if C&W UK had a complete nightmare of a year, despite dispatches to the contrary.

The presented results looked as if the revenues were holding up with a reported £2,119m in 2006/7 vs £2,028m in 2005/6. However 2005/6 included only 4 months of Energis figures. If we included the full year of Energis revenues (£709m), the comparison would be £2,119m in 2006/7 vs £2,471m in 2005/6 or a drop of 14%.

A drop of 14% in revenues sounds a lot, but when the stated policy is the axing of as many so-called unprofitable customers as possible, it could be justified. However, the drop in revenues has been accompanied by an even greater fall in EBITDA. Again on the surface all looks good with declared EBITDA growing from £149m in 2005/6 to £159m in 2006/7. It is necessary to strip out the 4 months Energis EBITDA of £35m and replacing with full year EBITDA of £93m.

We also have to add in the less than transparent attempt of reducing staff costs by £17m by placing the LTIP charge below the EBITDA line. So the net EBITDA for 2006/7 was £142m vs £207m in 2005/6 or a truly awesome drop of 31.4% in a single year.

Things do not look much better, when we look at the substantially reduced depreciation charge of £104m in 2006/7 vs £123m in 2005/6. Obviously we have the Energis effect, but we also have to take into account that C&W UK wrote off £237m of assets in the 2005/6 accounts, so of course the depreciation would fall in the following years.

Even stranger rather than cleaning the accounts being a one-off in 2005/6, C&W UK is at it again in 2006/7 this time writing off another £60m which amazingly includes £28m for the exit of the Energis HQ in Reading. Surely someone should have realized at the time of acquisition that only one HQ would be needed and the appropriate charge made then and there.

It is noticeable that C&W is still spending far more on capital expenditure than the depreciation and amortization charge: £204m vs £104m in 2006/7 and this is reflected in cash outflow for the year of £162m. I seriously doubt that C&W UK has much value operationally until this cash burn is reversed.

This would not be too much of a problem if the future was looking really bright, but it isn’t. By C&W UK own admission in the 2H2006/7 figures, 57% of the C&W UK revenues were legacy voice and 9% were legacy data. There is a huge balancing act to accomplish in transitioning these to new wave products and services. Seemingly every operator in Western Europe apart from BT with a huge legacy base is struggling to make this transition. Personally, I see zero evidence that gives me even the slightest confidence that C&W UK will manage to jump the growing void in anything other than a painful manner.

The future risk is made even worse with the forthcoming event of the whole of UK interconnect regime being reworked with the advent of the BT 21CN. I don’t think anyone is seriously analyzing how much this could cost the UK altnet sector and specifically C&W UK. Also, I suspect that BT is far more advanced in analyzing the profit opportunity (for BT) than the regulator OFCOM or the altnets.

C&W UK are forecasting a leap in EBITDA to £210-£220m in 2007/8, however for me the important metric is that a cash outflow of £80m is still planned. Admittedly, this is less than in 2006/7 but this still means that operationally C&W UK is worth very little.

Things look even worse at C&W Access with EBITDA losses of £75m in 2006/7 and a forecasted drop to £35-45m in 2007/8. The first thing that is mysterious about the C&W Access business is the Pipex contract. At the time of the deal on 7th Sept 2006, it was announced to be worth £250m over 5 years. However in 2H 2006/7, which represented a full six months of the deal, total revenues at C&W Access were only £14m which is a run rate of £140m over 5 years. Of course, if the Pipex broadband business were to grow things would look better: but Bulldog is not being marketed as a brand, Pipex is unbundling its own exchanges independently of the C&W wholesale deal and the company is on the auction block. Pluthero even admitted to the Guardian that there was very little protection if a takeover takes place and C&W would probably lose the business. This does not attract a lot of confidence in the new management’s ability to negotiate contracts.

The next problem is the new latest and greatest contract with Virgin Media. Pluthero admitted that the revenues from this will not kick-in until 4Q2007/8 which sounds a long time to get ready to me. The other thing that surprises me is that C&W UK seems to be planning to still be putting more capital into C&W Access – approx £30m. This could either be for more coverage or new equipment and the only possible equipment that I can think of Video-On-Demand or IPTV kit. My hunch is committing more capital is seriously questionable, especially given the force of the competition that Virgin Media is going to be facing in the future. I just hope that C&W UK have negotiated a better contract than with Pipex.

To me the writing on the wall for C&W Access was when they lost the Vodafone and Post Office contracts to BT. I also guess that given the historical links between Pluthero, Freeserve, Energis and Orange that there was a lot of effort to convince Orange to use C&W wholesale services rather than build out their own LLU network.

Theoretically, C&W UK could get the access business to pay with an assault on the business market. But, I suspect they don’t have a strong enough reseller channel to attack the SME market. Also, the problem with the larger corporates is that they want guaranteed bandwidth, something that is unknown until an ADSL circuit is provisioned. ADSL is a difficult sell for the CIO.

I don’t see a light at the end of the tunnel for C&W Access.

However all is not lost for C&W shareholders. There is £3.8bn of tax losses which has a potential benefit of £1.1bn for some acquirer who is paying a big tax bill and I suppose puts a floor on the value of the UK business. Unfortunately, the obvious purchaser – Virgin Media - has tonnes of its own tax losses. This leaves the remaining possible purchasers as Vodafone and O2 who could potentially utilize the tax losses.

In the valuations used for the LTIP estimates, the UK business was valued at £1,620m and the international business at £2,140m. Obviously I think the UK business is overvalued, however I have a hunch that the International business is undervalued.

In 2006/7, International net cash inflow was £220m after proceeds of £256m for the Bahrain disposal. I suspect that the assets in the Caribbean would demand a high price from Vodafone’s partner, Americas Movil & Carlos Slim, if they were put up for sale. In fact, I wouldn’t be surprised if more than one investment bank was exercising their slide rule in trying to solve the conundrum that is C&W.

UK Broadband – Unbundled Exchange Analysis

One of the big questions that crosses my mind whenever I hear companies quoting the number of exchanges unbundled is how this is reflected in coverage and number of homes marketable. The answer of course lies in a deep analysis of the data and there is no better source of unbundling statistics than Samknows, who kindly authorised my access to his database.

The source of the data is an analysis of residential and non-residential properties per exchange, sadly there is no data for Northern Ireland so the 668k NI residences are excluded. If anyone has this type of data (royalty free), please get in touch on the tittle-tattle line. This data is then correlated against BT exchange & post code coverage. This data is validated anytime someone makes a query against the samknows database and given over 4m queries have taken place the data is pretty accurate.

unbundled - distrib1
(Source: Samknows)

An analysis of this data gives that it is possible to cover 65% (approx. 15.8m) UK households by unbundling the 890 exchanges with more than 10k households. If all exchanges with greater than 5k households are unbundled, an additional 590 exchanges would yield 4.3m households – in total unbundling 1,480 exchanges gives 82% coverage or 20.1m homes.

Of course not all exchanges will be economic to be unbundled especially if the backhaul costs are pretty expensive. This will be dependent upon distance of the exchange from the local pop’s and availability of dark fibre at the exchange.

Sky Network
(Source: BskyB presentation for Morgan Stanley – 22nd March 2007)

For instance, a quick look at the Sky fibre backbone network explains why exchanges such as Exeter (38k) and Scunthorpe (32k) haven’t yet been unbundled by Sky despite the large volume of households. For Carphone, the situation is even worse with them only having three pops in Brentford, Birmingham and Irlam – the backhaul costs will be a limit on profits until a larger backbone is built.

unbundled - distrib2

Much more important than the backhaul costs is the expected number of connections. As a ball park figure, Carphone say the breakeven figure is around 250 customers. For most unbundlers this will involve an estimate of internet penetration and market share. Again someone like Sky who is only marketing broadband services to its own PayTV base the risk will be reduced because they will know exactly how many payTV customers they currently have per BT exchange.

Also a big factor is this is whether there is a cable network in the area – cable has a high market share when it competes head on with ADSL services.

The other big consideration is how many other unbundlers are at each exchange:

unbundled - distrib3

Analysing the top 3 unbundlers shows a huge overlap in the exchanges that they are unbundling as represented by the Venn diagram above. The situation when combined with the household data is even more extreme:

unbundled - distrib4

I suspect that the data from the other large unbundler (C&W Access) would not be radically different from the above. The big question for the C&W coverage is how much of it overlaps with the Virgin Media cable network, because one would assume that Virgin Media will not market ADSL services where they have cable.

It also brings a big questionmark over the late unbundlers such as Tiscali and Orange – as more unbundlers are present in each exchange, the probability of them achieving the required minimum level of subscribers for profitability are reduced.

Thursday, May 24, 2007

Another Cracker from OFCOM

It looks as if OFCOM has been honking away at the anti-Murdoch pipe with a vengeance. This time - a staggering conclusion drawn on the news market:
Ofcom is concerned that there may not be a sufficient plurality of persons with control of the media enterprises serving the UK cross-media audiences for news and the UK TV audience for news.
This being OFCOMs justification of referring BSkyB's minority interest in ITV to the Competition Commission.

Looking at the market share for TV news:

ofcom-1

Sky currently provides news to Five in addition to themselves. ITN provides news to ITV; ITV owns 40% of ITN.

Amazingly the market share for Radio News shows a similar dominant player:

ofcom-2

Sky News apparently provide news to the equivalent of 10% of listeners. IRN (Independent Radio News) provides news to another % which is withheld for commercial reasons. ITN own 20% of IRN. ITV owns 40% of ITN.

The UK Newspaper market shows a completely different picture.

ofcom-3

Interesting: no state subsidy, no dominant player.

OFCOM quotes data from an internal survey on the relative importance of each channel:

ofcom-4

It is pretty obvious that most people use the TV as their main source of news. Interestingly the fastest growing distribution channel is the internet, where the dominant player is also the one with a state subsidy.

Conclusion

If there is really a problem with plurality in the provision of news, surely the only sensible remedy is to break up the huge market share that the BBC have in news provision?

Perhaps the optimal solution is to have outsourced independent producers for each news and distribution channel at the beeb? - including BBC1, BBC2, BBC News24, the various radio stations and the internet site - that would add tonnes of plurality.

Wednesday, May 23, 2007

CPW/AOL UK – What is going on?

Some people have expressed surprise that AOL is raising the prices of its ipstream products for NEW customers by £10/month and extending the length of contract to 18 months, personally I’m not surprised in the slightest – the whole basis of the stock market valuation for Carphone’s broadband division is that it makes large profits in fiscal 2007/8 and even though Carphone has not announced full results yet for 2006/7, we are already two months into 2007/8. Carphone in 2007/8 will be chasing profits wherever possible.

The easiest way of making short term profits in broadband is stop large marketing bills (AOL did that months ago) and stop acquiring customers (AOL looks as if they have just turned the tap off in the non-LLU areas). Obviously there is a short term cash benefit as ipstream activation costs are not paid to BT and no more expensive bandwidth (BT Centrals) is needed to be ordered. But more importantly there is lower and more predictable support costs and the initial surge of new customers calling the call centre and provisioning efforts are halted.

For sure, some customers will want to churn to another supplier but TalkTalk should have by now a very experienced retentions team to try and hold onto them. Also, the churners will actually make the service better for the remaining customers as there are fewer customers to share the bandwidth.

So it seems to me, the current strategy with the AOL base is as follows:
  • 0.5m acquired dial-up customers – run for profits, accept the churn and try to convert to unbundled broadband;
  • ipstream in a non-LLU broadband area – run for profits
  • ipstream in a LLU broadband area – unbundle to SMPF as the coverage is rolled out.
There seems to be very little marketing spend or attempt to acquire new customers. Personally, I think this is quite a sensible strategy. If in twelve months Carphone are finding that they have plenty of spare ipstream and support capacity or the economics of the market have improved they can move to being aggressive once again.

Remember also that the Carphone roots are in the mobile space and they will be quite used to operators turning the acquisition tap on or off according to budgets and available cash.

The more interesting question is how aggressively Carphone is going to compete in the fully unbundled (MPF) and partially unbundled areas (SMPF). Carphone currently has around 1,100 exchanges (16.5m homes within 5km) fully unbundled and is targeting 900 to be partially unbundled by March 2008. Note they are not raising the prices on ipstream where the exchange is planned to be unbundled.

The TalkTalk fully unbundled double play is still extremely aggressively priced, but the AOL partially unbundled is not currently looking especially cheap compared to the Sky and Orange pricing.

The latest evidence from the Openreach show an upsurge in unbundling activity to 55k gross and 42k net in the week ending 20th May. This is good news for someone and the upsurge is not necessarily all down to Carphone. The most worrying unbundling statistic is the churn percentage which is approximately 32% on an annualized basis. This is just far too high and will be ruining the economics of some players.

It is noted that TalkTalk is still offering its 30-day trial and someone who is unbundled and then quits would count in the Openreach generated churn numbers but probably not in the declared churn figures from TalkTalk. People who partake in the trial but do not sign-up for the 18-month contract will be massively unprofitable for TalkTalk, after all they will pay all the unbundling charges and only have one month of revenue.

Speaking of churn, 12th Oct is the 18-month anniversary of the launch of TalkTalk almost-free broadband and the date that customers go out of contract. Carphone will be hoping that there is not a mass exodus.

In summary, the initial 12-month land grab is over and Carphone is facing the same pressures as all the other operators – show us the profits…

EU Roaming - Law of Unintended Consequences

I’m off to sunny Spain later this summer for a spot of rest and recreation, unfortunately under today’s EUs proposals my cost of calling home is actually going to up.

Vodafone Passport Tariff:
Calling Home: 75p call setup charge + UK bundle charge
Inbound: 75p call setup charge + free
EU proposal:
Outbound: €0.49/minute (33.5p) Inbound: €0.24/minute (16.5p)
So if my outbound calls are 3 minutes or longer and my inbound are 5 minutes or longer – I will end up paying more.

It is even worse for my Irish friends who frequently travel back to the UK – they will now be paying roaming fees whereas in the past they weren’t – and that covered all networks.

Roaming Moaning Reding can shout as much as she likes about the benefits to consumers of the recently imposed roaming regulations, but unfortunately for her the law of unintended consequences are about to kick-in and some people are going to start paying more rather than less. I hate to think about the potential increases that some multinationals are facing.

I would recommend to all mobile operators that they as a group be particularly spiteful to all MEPs who are currently on reduced international call packages and up the price to the EU sanctioned level.

Tuesday, May 22, 2007

New Emerging MVNO Business Model

The most successful MVNO business model to date has been: build up a base by slashing prices and then sellout at a premium to some poor incumbent sap who thinks they can bring peace in the ensuing price war. The poster boys for this movement have been Telmore (Denmark) and Saunalahti (Finland) and have literally breed hundreds of imitators.

Now a new business model is appearing on the horizon with the potential of similar success: use a MVNO to seed new technology onto the market circumnavigating the need for initial operator investment and then rollout to operators if and when the application niche is proven.

I’m talking of course of the proposed US MVNO, Lifecomm, which is focused on healthcare.

The company behind the MVNO is the US Wireless technology giant, Qualcomm, and a clue on the type of applications to be forthcoming are seen on the affiliated website, the Wireless-Life Sciences Alliance.
  • monitors for glucose, EKG, body temperature, heart rate, respiratory rate, calorie burn, activity level, and body mass index
  • weight management/dieting pedometers
  • dermatology diagnosis
  • video teleconferencing
  • EMS cardiac monitors communicating with cardiologists in hospitals
  • RFID technology to ID patients
  • storing and reading medical history in RFID implants
  • patient, staff and asset tracking
  • implanted pacemakers and defibrillators
  • smart bandages (power, RF and processor on disposable bio-sensor pad) for EKGs, heart rate, skin temperature, pulse oximetry
  • 24/7 EKG monitoring
  • heart attack detection
  • smart medication bottles
  • medication dispensing
  • ultrasound
  • clinical trial diaries
  • wound management via digital cameras
  • medical devices to find patients, staff, Alzheimer's patients and kids
I actually think some of the applications are pretty neat and that is not just because of my advancing years. I can also immediately see why mass market operators would have trouble in serving this market. I seem to remember a lecture given by the great Dr Irwin Jacobs to Cornell University last year in which he discusses health applications which is still available online for anyone who wants to see the great man in action. As an aside, there is actually another very good segment in the lecture explaining MEMS technology which potentially is another completely disruptive technology and seems to gaining a little momentum in the market.

Actually, a MVNO is quite a cheap and relatively low risk route for Qualcomm in seeding the market – think of the current money being pumped into building a US wide broadcast network for MediaFlo technology. Historically, Qualcomm has also taken an equity share in operators in new areas think of the investment in Reliance when CDMA was taken to India. Not all these investments have been successful either: my memory banks are still etched with Vesper in Brasil and the early struggles of Leap Wireless in the USA.

Of course, if the rumours are to be believed there is an even bigger US technology giant who is sniffing around the MVNO business model. I’m speaking of course about Google and if anyone is going to get advertising funded applications, such as voice and content, working I think it is Google with its core expertise in flogging ads at a premium price. Personally, I’d pick a smaller market than the UK to experiment in, such as Ireland, where my financial exposure would be more limited, but I like the concept.

BBC HDTV - Yet more Hypocrisy

Remember when Sky proposed converting some to their DTT channels to MPEG4 encoding and therefore requiring viewers who want to see the programmers to purchase a new set-top box? Of course, Sky being a commercial company proposed to charge for the service and presumably add their own flavour of encryption technology.

One of the more pathetic arguments against the Sky proposal was that MPEG4 transmission could cause problems with consumer confidence about the wonderful ongoing process of Digital Switch Over and potentially there are incompatibility problems with the existing set-top boxes.

Yesterday, the beeb released its plans for a High Definition channel on DTT and sure enough it is with MPEG4 encoding requiring a new set-top box.

The 9-page beeb produced HDTV product description document (pdf file) does not mention a single word of potential confusion for Digital Switch Over or even potential problems with the older generation MPEG2 set-top boxes.

Funny that...

Telenor: Political Risk coming home to Roost

Telenor owns 70% of the #2 Mobile Operator in Thailand, DTAC. A coup d’etat took place in Thailand in 2006 overthrowing the allegedly corrupt Prime Minister and previous owner of the #1 Mobile Operator.

Yesterday, the military ruled that all the mobile concessions are illegal and have to be renegotiated. The Communications Minister was quoted in the Bangkok Post:
“We expect the entire process to be completed within 180 days. It's my dream that all concession contracts be made the same. In reality of course, that might not be the case. But at least, each player will pay 30% in revenue sharing. The incentive we are offering is to make everything comply with the law. No one will be able to request money [under the table] from the operators again.''
Comments like this make me wonder if Telenor were involved in the “under the table” practices. More importantly, yet again it highlights the political risk associated with many of Telenor overseas assets.

Amazon DRM plans

Well, I laughed...

NewsFlash! - Amazon Now Has DMR Free Mp3s

Virgin Media Developments

A couple of events from the Virgin Media – BskyB battle field over the past week have kept me amused and thinking about the consequences.

The first of these events was the announcement that Virgin Media and C&W are getting into bed with one and another to offer an ADSL unbundled based product set. “Beyond Cable” is probably the Virgin marketeers biggest challenge, well, since they signed up to help turnaround a financially challenged cable group with a historic reputation for appalling service.

The key problem for me is the message: “Beyond” implies an improvement in cable, where the offering obviously isn’t. Cable broadband is sold at a premium price to ADSL on the basis that it is better – the success in the marketplace of the product despite the extra price implies the Great British Public also view it as a premium product. Admittedly bundling Freeview with a PVR is appealing to a certain segment of the population, but these people would not have been subscribers to the cable TV triple play in the first place – I cannot see anything in the TV element of the package which would stop a cable TV customer moving into a new area from churning to Sky.

After all this is the published raison d’etre of the service – to stop people who are moving house churning onto Sky. The Virgin Media supplied monthly estimate of movers is 1% which equates to a potential movers market of around 144k/quarter on the customer base of 4.8m. If we now look at coverage: total UK households were 25.3m at Dec-06 according to the latest OFCOM digital TV takeup figures; Cable Triple Play Coverage is around 11.8m households (47% coverage); the additional coverage provided by “Beyond Cable” is 4m homes (16%) coverage; and therefore 37% remains non-Virgin territory. Assuming a normal distribution of movers amongst the areas, the maximum number of potential sales is 23k/quarter. Even with a 100% conversion which is doubtful given the inferiority of the product and the almost blanket coverage of payTV from Sky, 23k/quarter will hardly set the uk communications market on fire. The logic of “Beyond Cable” as an anti-churn mechanism obviously doesn’t stack up.

The other big problem in the service is non-C&W covered areas – what does Virgin Media do in this case? How does a customer know which area he is in? I think this lack of coverage issue is probably the main reason why BT Wholesale won the Vodafone contract rather than C&W. C&W announced plans to cover 800 exchanges by Sept ’06 and given the sale of Bulldog, I seriously doubt whether the footprint has extended beyond this. Given that Sky has already unbundled more exchanges than this, Sky probably has a larger coverage right now and also has a clearer marketing message on the non-bundled exchanges – the payTV and phone elements are exactly the same, but you have to pay extra for broadband and the speed is not as fast (8-meg max) It is all very messy before we get into the complexities of provisioning and support.

We should also not forget how much investment C&W has placed in the unbundling network: cash outflows for C&W Access of £57m, £163m and forecast £155m in 2004/5, 2005/6, 2006/7 respectively is a lot of investment. Excluding the cumulative EBITDA losses of £218m still leaves around £167m on the C&W balance sheet. C&W must have been close to shutting down C&W Access without the Virgin Media win and even with the win there must be a big questionmark over certain of the overlapping coverage areas.

However, the deal certainly is of interest in tying the fortunes together of the #2 and #3 fibre networks in the UK together. Where dark fibre is available at UK exchanges, the backhaul options are usually limited to either C&W or Virgin Media – BT prefers to rent expensive circuits. Given that all the unbundling competition: Sky/Easynet, Carphone/Opal, O2/Be, Orange and Tiscali will all be asking for dark fibre from the same people – I’d certainly be thinking it is about time for an extremely large co-ordinated price increase.

The most intriguing element of the deal is whether the wholesale deal could be a precursor for a full merger. Certainly, a full merger would be appealing to both sides. Strategically for C&W shareholders they have since the beginnings of Mercury in the UK always looked for a reasonable sized consumer segment to balance the business segment and provide enough scale to compete with BT. For C&W management, it offers a great opportunity to cash in now on their huge bonus packages without actually having to complete the hard work of turning the UK business around. For Virgin Media shareholders, it offers a great opportunity to shore up the balance sheet and with a bit of financial engineering magic and staggered disposal of C&W international properties frequent cash injections into the business.

My hunch is that a deal with C&W makes a lot more sense than the mooted Private Equity approach: being a natural born cynic – private equity approaches always seem to appear in the press when the Virgin Media share price is under pressure. I can’t see what the added value of a private equity approach is: Virgin Media is already fully leveraged and even with a complete replacement of the management team there is no silver bullet to kill off the UK competition. The biggest problem with a Private Equity approach is Richard Branson himself: he has spent decades trying to get into the UK TV scene and is not going to give up at the first sign of trouble. Richard Branson crossed the rubicon with the ntl:/Virgin Mobile deal and probably knew as well as anyone the size of the task ahead.

In fact the biggest trouble Virgin Media face is Sky. Sky are certainly crafty and yet again released on a Friday evening news which will have ruined many a Virgin Media’s Executives weekend - remember the ITV spoiler investment was also announced at 6pm on a Friday evening.

The offer by James Murdoch to split the difference on contract negotiations which came to £5m was always going to be rejected by Virgin Media, however it probably hit home if the weekend press is anything to go by:
  • it portrays Sky as the party trying its best to solve the impasse in negotiations, whereas Virgin Media is being increasingly seen as being litigious: ultimately the war will be won in the consumers minds not in any court of law or politicians;
  • diverts attention from the “beyond cable” proposals; and
  • provides a nice contrast with the Virgin Media Board decision to increase the dividend by 50% despite deteriorating results – this move alone will cost another US$13m in 2007 -assuming the dividend remains constant in all the other quarters.

Thursday, May 17, 2007

BT, The Post Office and C&W

Along with its results this morning BT announced a record £750m four year wholesale deal with the Post Office. My initial thought was that this was quite a big commitment for the Post Office given that it currently has zero broadband customers and will be launching into an ultra-competitive battlefield.

This is an even bigger commitment when you place in the context of the Orange UK Home revenues in Q1 of only £73m (€107m) from a base of 1095k broadband and 984k dial-up customers. The quarterly commitment on the Post Office deal is £62.5m over the whole period.

However looking into the detail, the Post Office already has 400k customers who are signed up for HomePhone, which is a voice-based CPS and WLR service. These voice customers will be covered by the new BT contract and also offers the opportunity of upselling broadband.

So the contract is perhaps not as great as it first appears for BT as WLR (or line rental) is effectively a pass-through charge service aimed at reduced churn so even if the base doesn’t grow, around £200m of the contract will be already in the BT WLR revenues. Of course, this is before the current usage based voice charges.

BT will also win back the CPS wholesale services from the current Post Office provider – C&W. This probably accounts for the gloating this morning - BT has delivered another wholesale blow to Cable and Wireless.

So much for this quote from Nicky Hall of The Post Office back in Jan 2005:
“We expect this proposition to be around in 5, 10 or even 15 years,” said Nicky Hall. “We’re confident that in Cable & Wireless we have chosen a partner with the expertise, product portfolio, commitment and staying power to continue with us on this journey.”
The quote was taken from one of C&W case studies, which presumably is meant to highlight successes.

DDR Auctions get the Commons stamp of approval

The House of Commons Committee has spoken and the intense lobbying by the broadcasters and mobile operators has come to nought:
100. Although we will continue to listen to the arguments, we do not believe that a persuasive case has yet been made to justify reserving spectrum for High Definition Television following digital switchover, and we endorse Ofcom's approach in not favouring any particular technology or application in the framework being drawn up for re-allocation of spectrum under the Digital Dividend Review. However, we do recognise the special case of the programme-making and special events (PMSE) sector which risks losing access to spectrum it has traditionally enjoyed as a result of switch-off and we believe that it is essential that an acceptable solution to their difficulties be found.
OK, the luvvies in the theatre world look as if they are going to get some free spectrum, but this was always the least costly for the taxpayer of the three groups of spectrum beggars.

Mind you, it does help that our upcoming Prime Minister, Gordo, is completely skint at the moment and the auctions offer a route for the replenishment of the empty government coffers.

State of UK Broadband Britain

With the release of BT’s Annual Results this morning, the overall picture of the broadband market is rapidly emerging:

uk broadband

Inevitably with the huge marketing budgets and aggressive pricing of some of the larger players the smaller resellers seem to be getting squeezed. Also, it should be bourne in mind that BT Retail acquired Plusnet in the quarter and therefore 196k customers were transferred from the "others" to BT in the quarterly net adds.

The amazing output to me is that despite only marketing to their own base, the Sky share of net quarterly additions is huge.

BT & UK FTTH Economics

I am a great believer that fibre to every home and business (FTTH) in the UK is the way of the future and more importantly is desperately needed if the UK is to keep its long term economic competitiveness. I am therefore extremely disappointed today that BT has announced that they would initiate a £2.5bn share buy back programme and instead feel that BT shareholders would be better rewarded by BT deploying fibre to all uk homes.

Regulatory Regime

BT manages the UK local loop through its Openreach subsidiary and OFCOM allows BT a regulated 10% return on its investments, therefore contrary to some beliefs there is little or no risk to BT shareholders on a FTTH deployment just a regulated return at the Openreach level and potential upside at the operating unit levels (Retail, Wholesale and Services) with the sale of additional services, improving margins or market shares.

For a worked example: if it costs Openreach £10bn to deploy FTTH and the cost of borrowing is 6%, then OFCOM will guarantee Openreach an additional £400m of pre-tax profits per annum (£10bn*(10%-6%)). This is also a big tax benefit as an investment of this level will reduce BTs tax bill for many years to come. Even with a full 20% tax charge, £320m of additional earnings for BT with its current PE Ratio of 17.5 adds around £5.6bn of market capitalization for shareholders.

There is a big debate going on throughout the world about open access and regulation of fibre projects. Most of these debates are irrelevant in the UK, because there is already a separation of the network and service divisions of BT. For instance, Openreach, can provide 3 distinct network services at the exchange for all other service providers: a voice, data and broadcast video pipe with an associated tariff menu. Effectively this is only a slight development from current unbundling regime.

Operating Costs

In the 12 months to Mar-07, Openreach had operating costs of £3,289m. I seriously doubt that FTTH would add more costs to this figure. This is because in certain parts of the UK, BT’s copper network is over 70 years old – it is expensive to maintain such old plant. Also in the exchanges, some of the main distribution frames are also extremely old and we know from the local loop unbundling statistics that the fault rates associated with touching any line is extremely high.

Verizon in the US claim that operating costs have been dramatically reduced and almost pay for deployment by themselves. However, the weather in the UK is nowhere near as extreme as parts of the US. Also, Iliad in France claim that margins are higher for fibre than llu which also implies to me a cost advantage.

In the UK regulated environment, OFCOM assumes that operating costs are reduced by 1.5% per annum for regulated prices. This efficiency gain could almost certainly be increased if FTTH replaced the Copper Local Loop.

Incremental Revenue

The Openreach products would effectively be a voice, data and video “pipe”. Effectively the situation could be quite similar to the existing LLU setup with a standalone data pipe, a combined voice and data pipe and an extra product for broadcast video. This broadcast video product would be similar to the current proposal at Ebbsfleet which is the Freeview channels, the DAB channels and the Sky “satellite” channels.

Obviously the video pipe is an additional revenue stream for Openreach. I would guess that the appeal of Freeview and DAB channels alone is limited to customers where reception of Freeview is poor or multi-dwelling units where aerials are not permitted. However, the bundling of PayTV channels would make a viable end-user service. It would also provide a third distribution channel and would probably win some market share from both Sky Satellite and Virgin Media Cable networks. Also, because Openreach is effectively a network provider with BT as its biggest customer – it would provide opportunities for a whole variety of entrants into the UK payTV market.

The speed of the data pipe would also be increased with the current flavour of FTTH being GPON offering 2.4-gig downstream and 1.2-gig upstream shared pipe for 32 connections. This easily allows a 100-meg down and 10-meg up service with probably 200/20 service also achievable. The speed would not be distance related as is the current case with ADSL. Obviously a higher price could be charged for these types of speed.

However, the biggest element of increased revenue is for Openreach to win lines back from the competition or avoid the loss of lines. According to their 1Q results, Virgin Media had around 4.8m customers with various services for Openreach to win back and gain additional revenue. This is before the business market where alternative networks such as C&W have been directly connecting companies for years.

I would expect Openreach rolling out a FTTH project to cause serious damage to both Virgin Media and C&W in the UK. For me this is a not serious concern in either economic or competition terms as long as the Openreach network in truly open and BT Retail does not have special advantages over other service providers.

Capital Costs

For a Greenfield site the cost of deployment for fibre is estimated to be similar to that of copper. The equipment and cable costs are similar and the expensive labour intensive tasks of digging trenches to lay the cable and internal home and exchange cabling have to done for either fibre or copper. For reasonable sized new housing developments, there is no reason why Openreach wouldn’t lay fibre rather copper in the future.

For a replacement of the legacy copper network, digging and internal cabling have to be repeated and this is not only expensive but disruptive to the neighbourhood. Costs can be minimized by using exiting ducts and telephone poles for overhead drops where available. These costs are normally grouped together as “cost to pass home” which are fixed whether one house or the entire street sign-up to the fibre network.

The other component is the “cost to connect” which is lighting the fibre and installing the electronics at the home and activating the fibre at the exchange. This is obvious success based.

In terms of actual costs, Verizon currently provide the benchmark with $800 per home passed and $842 per home connected quoted in their latest earnings call. There is also a recent paper by the Broadband Stakeholder Group which quotes a study by the Enders Group that 90% of UK homes could be fibred for €14bn.

Given this, a nice round figure of £10bn won’t be too far away from the mark for the UK FTTH project.

Cost per Line Estimate

An additional £10bn of RAV (regulated asset value) for Openreach would imply an additional £1bn per annum of earnings for Openreach (before interest and tax).

The additional fibre assets would generate an additional depreciation charge of £500m pa to Openreach assuming a 20-year write-off. However, these charges need to be off-set against the current copper network depreciation because of course the copper network won’t be replaced. This is another big number: I estimated that the depreciation charge is around £250m per annum. The basis for this assumption is because the current £11.3bn of RAV will include quite a few items outside of copper plant such as the actual exchanges and I’m trying to be conservative. This leads to total additional earnings required at Openreach of approximately £1,250m per annum.

We also have to look at the cost savings from operating the fibre rather than copper. With Openreach annual operating costs running at around £3,289m per annum, it would not be beyond the realms of possibility to expect £150m of annual savings.

This leaves the net regulated increased revenue at Openreach of approximately £1,100m. Of course, this is before the incremental revenue from video services, increased bandwidth and increased market share. The £1,100m revenue across the 22 million lines in the UK equates to around £50 per line per annum or £4 per month charge.

Obviously there would be a big debate with OFCOM on how much of the regulated return should be borne by lines on the existing copper network as opposed to new fibre homes. My own thought is that the whole of the UK network should bear as much cost as is politically possible and therefore the costs are spread over as many lines as possible. If a huge differential in price between services delivered over copper and over fibre exists then there is less incentive to people to swap and a big reduction in the possibility of ever sunsetting the copper network.

In my opinion, one way this problem could be solved would be to have a price list for a raw data and voice pipe whether delivered over fibre or copper as under the current WLR and LLU regime. There would be an incremental price for high speed broadband over fibre and another price for broadcast video. These incremental prices should be calculated to cover the success based element of the fibre network, in other words the cost to connect over the estimated life of the customer electronics which would be around 5 years. This would work out with costs to connect of around £500 to £8.33 per month for the network charges for both high speed fibre data and broadcast video which I think is reasonable. This would also mean with around 50% of the costs would be in cost to pass or an additional £2/month to everyone’s line rental.

Rollout

I think one of the better BT ideas over recent times was the registration scheme allowing the aggregation of demand to enable BT to justify enabling broadband in rural exchanges. I would recommend BT adopt a similar scheme for determining the rollout of FTTH across the country – effectively rolling out to suburbs where demand is greatest and thereby reducing the risk of low uptake. It would also provide a comeback against the luddites in neighbourhoods who will inevitably complain when the roads are being dug up.

Conclusion

The recent decisions by the French operators and Verizon in the US to roll out FTTH without large scale government subsidies prove that the economics can be made to work. The special situation in the UK where Openreach prices are regulated, actually mean that the project is less risky for BT Shareholders. BT just requires approval on how the costs are to be apportioned.

The big question in my mind is why BT is not pushing ahead presenting a FTTH project. I can see that BT would want to minimize changes and therefore risk while they are upgrading the core network with the 21CN. Realistically, I can see a big project like FTTH with regulated returns would take around a year of navel gazing and negotiation before OFCOM would approve it. By which time there will be large areas of the country where 21CN is implemented.

The only reason I can think of is that BT does not think there is currently enough political and end-user support for such a project. This support will build over time as more or more cities and homes within Europe are connected with fibre and the UK falls further and further behind. Support will also build as more and more consumers become frustrated by the UK speeds and find that services such as video streaming over the internet only work at low quality.
From my position, it is just extremely frustrating waiting for BT to kick-off the project.

Wednesday, May 16, 2007

O2 Be Broadband and Unbundled Britain

O2 also released their Q1 figures and Be* Unlimited broadband is standing at a mere 24k customers, which is up 7.2k on the quarter. Be* had unbundled 632 exchanges as at 31/3 with 40% UK Population coverage and have continued since apace and the figure currently stands at 735. I think Be* will currently stand as the #3 unbundler in the UK in terms of absolute number of exchanges behind TalkTalk and Sky.

O2 must be losing money with all these exchanges and so few customers. Obviously a launch in needed into the O2 customer base and this has now been pushed out to Sept ’07, which incidentally is the month before the 18-month TalkTalk contracts start to expire. O2 claim the delay of three months is because they want a high quality product at launch and are not currently ready. O2 say they will be launching a converged product from their own direct outlets, but obviously there will be some overlap with the TalkTalk base.

Overall in unbundled Britain, the slowdown continues with another drop in the weekly unbundling statistics according to the Openreach KPIs: 41k gross and 28k net. This is down another 5k week on week and off from the peak of 86k gross and 74k net.

Monday, May 14, 2007

Virgin Media Cashflow Correction

In my article about the Virgin Media results, I stated that the cash outflow in the first quarter of 2007 was £41.9m before interest charges whereas the cash outflow actually includes the interest charges for the period. I could make an excuse about obscure differences between UK & US Accounting Practices, but I won’t: I made a mistake; I was wrong; I apologise and hope it hasn’t caused any inconvenience to any of my readers.

However, I hope that people won’t think the mistake invalidates my argument that a lack of flexibility on the Virgin Media balance sheet is causing an underinvestment in the network. I feel Virgin Media should be investing much more on increasing capacity, sunsetting the analogue TV service, investing in High Def channels, Video on Demand capacity and content, preparing for Docsis 3.0 and extending the speed gap between themselves and the adsl competitors.

Also to deal with another few emails and to make myself perfectly clear I do not think a large amount of debt is a problem for all companies in all situations. After all, there are tonnes of people in the City of London currently making fortunes from the wonders of leverage. However, it appears in the Virgin Media situation that they are not generating enough cash to service the debt AND invest for the future. This is a big problem especially as interest rates are on the rise and competition is starting to bite. This competition is not just from Sky, but also from Carphone, BT, mobile operators and from the Free-to-Air industry. I think that the current Virgin Media Executive Team message that all its current woes lie at the door of Sky fall far short of reality in the UK suburbs.

I would also like to point out that I sincerely appreciate the reader who emailed the tittle tattle line with details of my cock-up – all such communications are welcome. I would also like to point out that the reader had nothing whatsoever to do with Virgin Media, but someone else who values fair play.

Vodafone Espana: Edging ahead with Ya.com

It is coming through on the wires that Voda has won the auction for Deutsche Telecom’s Spanish Broadband Business, Ya.com, with the winning price of €400-500m (£273-£341m). This is a big strategic move in Spain at a price that will hardly trouble the beancounters with Vodafone Espana generating £432m of Free Cash Flow in the first six months of the fiscal year alone.

The Spanish broadband market seems entirely different in its structure to the UK setup with post-Ya deal the big four players being the three mobile operators, plus the Spanish cable network, Ono. I’m also sure that the Voda MVNO partner, Euskatel, also has a big share of the market in the Basque region. This to me seems quite a stable long term market setup, although I’m sure as in mobile Telefonica has more than its “equilibrium” share of the market.

It also helps the Vodafone board in approving the deal that the Spanish management team has consistently outperformed the Spanish market in mobile and has recently been making big inroads in the converged business market.

It also shows that Voda has on the quiet being heavily investing in the broadband market in both Germany (through Arcor), France (through minority interest in NeufCegetel) and now Spain. I’d also be surprised if Voda was not in the runners and riders for the Orange Netherlands auction which includes both a fixed and mobile element. It also makes sense for Voda to become a total communications player in several emerging markets where the land grab has not actually started: I remember in the recent Voda Emerging Markets strategy day, the lady from Voda Romania explaining how they were already a reasonable sized player in the fixed corporate segment.

Of course, this leaves the two big markets with question marks: Italy and the UK. I’m surprised that Voda lost out in the manoeuvring for FastWeb in Italy to Swisscom, but this can be easily explained by Voda knowing more about the true value of Fastweb than an outsider to the market. Swisscom also has been trying to move outside Switzerland for quite some time and perhaps the cash was burning a hole in its pocket. In the UK, given that there is no end in sight for the cut throat competition, perhaps a waiting game is the best strategy. In fact, Voda could just wait until the next financial crisis at Tiscali causes the main shareholder to revise his plans – this will kill both the Italian and UK presence problem in one roll of the dice.

Friday, May 11, 2007

Tiscali UK 1Q2007

The Tiscali Q1 2007 results are in and although not spectacular at least they continue to seem to be making progress.

The UK subs as at 31/3 stood at 1485k of which 437k were unbundled. This is an improvement of 62k net adds and 87k unbundled since 31/12 implying a run rate of around 5k/week and 7k/week respectively.

Perhaps the most disappointing news was that only a further 30 exchanges were unbundled in the 1st Quarter to take the total to 445 exchanges of which 255 could support fully unbundled lines. I’m not sure of the reason for the slow down here, but I wouldn’t be surprised if it was capex containment related.

The other interesting factoid I learnt about the Tiscali figures is that the customer figures include wholesale as well as retail figures. I was given a ball park figure of 30% for the wholesale base – if any reader knows the exact percentage do not hesitate to use the tittle-tattle line to update me.

Overall in the UK, revenues were €128m for the quarter with EBITDA of just €17.1m, which implies to me that Tiscali need to get their finger out and unbundle more customers to improve the margins. No figures on churn were released, but I guess that this was quite high given the general market trends and that Tiscali never feature highly on any customer care surveys.

Openreach FTTH Consultation

Without much fanfare Openreach is currently undergoing various consultations with the industry about providing FTTH services.

They are naming this "Fibre to the Premises at Greenfield Sites", but no doubt will provide the template for any future UK wide FTTH deployments. The consultation looks at a very early stage and very little looks as if it is decided with two big and vitally important exceptions.

First it looks as if GPON Architecture has been decided – this is a similar architecture to one chosen by Verizon in its FIOS project, but a different one to the chosen one by Iliad.

Second, it looks as if Openreach as going to build a dedicated RF broadcast signal for FTA TV, DAB Radio & "Satellite" TV (ie Sky) on the Fibre. Again this is a similar architecture to Verizon FIOS, but a big kick in the teeth for IP-TV.

The consultation looks as if it is being rushed through on the quiet to deal with the Ebbsfleet development, but as I said before will have dramatic long term consequences, if BT ever builds a FTTH network, to all UK ISPs and Service Providers.

Even without a legacy FTTH deployment, BT estimate that 246k new homes and business premises are built every year which will all over time move to a FTTH architecture.

Thursday, May 10, 2007

Yet More Virgin Media/BSkyB and OFCOM

It was noted during the Virgin Media conference call Chairman, James Mooney bragged that they had won every legal battle fought so far. I thought this was extremely premature.

In contrast on the News Corporation call, Rupert Murdoch, expressed his thoughts:
"I'm disappointed simply that the politicians chickened out and punt these things to these quangos."
Apart from fact that Rupert doesn’t seem to have much time for our beloved regulator, OFCOM, he is digging his heels in for a long fight:
"We are not worried by any of these inquiries, however long they take. We have done nothing illegal.”
As Russ Taylor from Ofcomwatch points out the hottest document in the country, which is the actual Virgin Media complaint to OFCOM, is safely under lock and key and most importantly will be kept from the prying eyes of the consumers that OFCOM purports to protect and Virgin Media are also out to protect.

Investors don’t seem to be too impressed with the latest Virgin Media results with the share price down around 10% over the last couple of days. It was a good job for James Mooney then that he sold 54,748 shares on the 30th April @ US$25.49 just before the results were announced saving himself around US$100k.

However, there is good news for the beleaguered Virgin Media shareholders Ed Richards CEO of OFCOM, on a recent jolly to the States, unbelievably said in talking about broadband -
“So we have to encourage consumers to pay more –“
Thanks Ed, glad to see someone is looking after Joe Public.

PCPro perfectly sums up the current status of Broadband Britain for which Ed thinks we should be paying more for:
So, to summarise, broadband customers aren't sure what speed of service they're buying, are suffering from slowdown at evenings and weekends, are left in purgatory when their ISP goes belly-up and, worst of all, there's no real prospect that things will get better any time soon.
In the speech Ed was basically putting forward the case that no taxpayer investment was required in broadband - with which I broadly agree. However at the same time he is still touring the UK trying to drum up support for his ridiculous taxpayer funded £300m injection into the web content industry aka the Public Service Publisher - with which I vehemently disagree.

UK Unbundling Slowdown

The latest llu kpi figures from Openreach covering the week ending 6th May show a marked slowdown with only 45.8k gross unbundled and 35.4k net unbundled. This is down from what now looks like a peak at the quarter end week of 1st Apr of gross 86.5k and net 73.6k.

This is big news as in Q1, Sky were claiming only 33% of unbundling activity with a 26k per week run rate. Carphone were also doing 20k a week. Someone somewhere is missing their forecasted orders and I suspect that it isn’t Sky as they had an order book of over 100k on the 28th April.

Also, I remain amazed that we aren't yet seeing huge bulk unbundles from the likes of Tiscali and Orange from their reseller base on an exchange by exchange basis.

No luck for Carphone either in the ELF figures which showed 28-day fault rates on MPF are still extremely high at 8.1%. Meanwhile, Carphone have upped the price of their resold product by £5/month.

Virgin Media Q1 – The Lady Doth Protest Too Much, Methinks

Another quarter, another Virgin Media conference call, another tantrum thrown at Sky. Personally, I think it is all getting a bit ridiculous especially given that most of the current Virgin Media problems are self inflicted.

Balance Sheet

The Cable Industry loves leverage: this has been the case since the early days of US cable and the model was perfected by John Malone at TCI over many decades. The theory goes that the interest payments eats all the profits and therefore no tax needs to be paid over to the government. The cashflows guarantees the debt and the cashflows steadily rise over time given that monopoly rents can be extracted by addiction to the tube. The leverage leads to greater shareholder returns on a percentage basis than a non-leveraged business model, especially as the business is valued on multiples of cashflow.

The corollary of this is that in times of falling cashflows or rising interest rates the equity can easily and quickly be wiped out and the debt holders take over. This is what effectively happened in the UK Cable Industry a few years ago: ntl ran around buying as many cable systems as possible using bondholders’ money and then didn’t generate enough cashflow to keep the bondholders happy. The bondholders effectively took over the company, installed new management, bought the only other UK Cable system of any serious size, bought a MVNO to give it an ultra-fashionable quad play and more importantly a fresh brand.

So at the end of Q1, Virgin Media had net debt of £5,747m with a weighted average cost of debt of 7.9% which equates to around £454m of annual interest charges. Most of the debt is in US Dollars and floating rate, which probably means the skills of the Virgin Media Treasury department in predicting future interest and exchange rates are far more important than any contract negotiations with Sky.

Cash Flow

Virgin Media love to use OCF metrics which they claim is a good measure of the underlying performance of the business. However, I’m old fashioned and prefer to look at the Cash Flow Statement, which shows net cash provided by Operating Activities of £106m, whereas net cash used in Investing Activities is £147.9m. This implies a cash outflow from the business of £41.9m before interest charges of around £110m.

This is really, really important because if things continue as in Q1 Virgin Media will not be around for much longer without generating some cash or changing the capital structure of the business. Of course, the extremely poor Q1 cashflow could be due to seasonal factors, however if we look at Q1 2006 net cash provided by operating activities was £207.3m and capex was lower than in 2007. So Q1 2007 was not a blip.

The Virgin Media capex statement in itself is extremely interesting because it shows that they are capitalizing the cost of CPE or set top boxes. CPE accounted for £62.5m out of total quarterly capex of £152.9m . Another way of looking at this is that CPE costs do not feature in the Virgin Media OCF calculation as they are depreciated below the line. As far as I aware, BSkyB immediately write-off the cost of CPE as part of subscriber management costs and in fact ownership of the box transfers to the customers. It is hardly surprising that BSkyB charge for their HD and Sky+ boxes, whereas Virgin Media give them away like candy.

Even more interesting is that Virgin Media only spent £3.5m on upgrading or rebuilding systems, with an additional £15.4m spent on “scalable infrastructure” – this is hardly the spend of a cable company busy upgrading its systems getting ready for DOCSIS 3.0 and 50meg to the home. In fact, it smacks of a company spending the absolute minimum to keep things going.

TV

Virgin Media appears to have done extremely well attracting TV customers in the first quarter with 36k net adds on marketable homes of 12.7m. BSkyB added 51k TV Customers in the UK and Ireland on marketable homes of 26.8m.

In fact Virgin Media added 75.2k digital TV customers which are more than Sky added in a much smaller addressable area. However, Virgin Media lost 39.1k analogue TV customers. Sky can hardly be blamed for Virgin Media still having 309k analogue customers, even after a decline of 220k year on year.

I would argue strongly that Virgin Media should be upgrading its network and customers and then we could compare apples with apples in the payTV market.

Telephony

Telephony is an area that Virgin Media are struggling after losing 182k customers year on year. Unbelievably, Virgin Media don’t blame Sky for their problems, but instead focus on Carphone launching the free broadband offer which I think is also missing the mark. Instead they should be focusing on their own actions: to go a full twelve months without reacting and not expecting major churn is more than a little naïve.

I estimate that Virgin Media still have around 398k single play telephony customers which is a drop of around 235k y-o-y (bear in mind some of these customers could have been upsold broadband or TV as well as others churning off the network). Virgin Media were charging these customers £11/month line rental + call charges – obviously there was better deals in the market. These 398k telephony only customers and additionally the 309k analogue TV customers represent the soft vulnerable underbelly of the Virgin Media customer base.

Broadband

Someone on the call questioned the Virgin Media net adds in on-net broadband being quite low at only 89k as a percentage of the overall market - I’m not so sure. The broadband penetration of homes passed of 26.7% is actually really good and I think cable broadband must be outselling DSL in most common areas. I tend to agree with the Virgin Media Executives that broadband is potentially the Virgin Media ace in hole, but I am a little concerned that they will lose the advantage over time through a lack of investment in capex.

First of all, Virgin is keeping quite mum of the roll-out plans for docsis3, but making lots of noise about 50meg to the home. It seems obvious at least to me that in its current state Virgin Media can’t afford a rapid nationwide rollout of docsis3 technology to the UK.

Second, I am concerned about the recent capping applied to heavy downloaders. In a scenario where there is no capacity constraints no capping would be required and obviously caps destroy the urban myth that the cable network is magically different than the adsl network. To be fair, Virgin Media caps are still probably the least restrictive of all consumer ISPs in the UK.

Business

Business is a very important segment to Virgin Media – representing £163m of revenues in Q1 compared to £637m across the whole of the consumer segment. I was extremely interested that there are murmurs that the business might be up for sale. Personally, I just can’t see how the consumer and business segments could be separated. I also think that Virgin Media have never fully exploited their network assets especially in the SME sector.

Mobile

Virgin Mobile has effectively withdrawn from third party acquisition and this accounts for the falling subscriber numbers and the increased OCF in Q1. I actually believe this is a very interesting change of approach, but Virgin Media have to be really quick in building their own distribution network and gaining traction on their base. I am currently a total non-believer in the quad play, but if Virgin Media could minimize subscriber acquisition costs, allied to a very good network services contract with T-Mobile and generate enough traffic, I could be converted in the near future.

I am certain that the prepaid MVNO model that Virgin Mobile operated upon previously has a very short life span. The figures published in Q1 imply there is some pain to come in bridging the gap: a drop in prepaid numbers allied to an increase in contract customers should theoretically indicate a jump in ARPU figures. The fact that Virgin Media’s has dropped by 5% without a big drop in prepaid rates implies to me that there is a large number of people with very low activity – in other words there is a big buffer of churners to come.

Content

Despite the well published drop in Sky payments, the division actually managed to increase OCF. Apparently, the increase was all due to litigation - enough said.

Overall

Virgin Media was struggling before the partially self inflicted wound of the removal of Sky Basics channels from the Virgin Media TV offering. I personally feel that Virgin Media is using Sky as a convenient scapegoat for its lack of performance in the ultra-competitive UK communications market.

The other problem for Virgin Media is that when you examine the BSkyB recent quarterly results especially when you look at their cashflow performance they are also suffering , but the big difference is that Sky are making large infrastructure investments in developing a triple play.

Another problem for Virgin Media is that when the noise abates and the economists have spent months or years studying the UK communications market, I can’t see how anyone can say that that Sky is a monopolist. In fact, I wouldn’t be surprised if Sky gains more flexibility because convergence has actually reduced their historical market power.

But the biggest problem for Virgin Media is that their balance sheet is based upon the premise of extracting monopoly rents from appreciating assets. Unfortunately for Virgin Media, there is no monopoly in the UK market or even a situation comparable to the US cable companies and neither is there likely to be. Furthermore, I don’t believe that even political and media lobbying of gargantuan proportions will change the situation.

Wednesday, May 09, 2007

Tele2 Denmark: Another MVNO Bites the Dust

Tele2 is selling up in Denmark. It has sold all its various assets to Telenor for SEK1025m which sounds a lot but actually only is £76m. Telenor picked up for this bargain price:
At the end of 2006, Tele2 Denmark had according to National IT & Telecom Agency 75,000 broadband customers, 206,000 fixed telephony customer and 227,000 mobile telephony customers of which 100,000 post-paid. In 2006 the Danish business had revenues of MSEK 1,695 and EBITDA of MSEK 68.
Also bear in mind that the Telenor Danish arm, Sonofon, was the carrier for the Tele2 customers and therefore has most to gain from keeping the customers on-net. Telenor also acquired in 2004 another Danish MVNO called CBB Mobil which still to this day trades under its own brand name.

I also presume that Telenor will leave the management of the broadband base to its CyberCity acquisition from 2005.
Cybercity is Denmark's third largest provider of broadband services. The company has approximately 90,000 customers, and a market share of 8 per cent. Cybercity provides services primarily to the consumer and SME markets, and the company's infrastructure covers 70 per cent of the Danish territory.
Telenor paid NOK 1,385 million on a debt free basis for Cybercity. Note that NOK1385m is around £116m in today’s money and CyberCity has grown its base to around 175k customers at the end of 2006.

After this acquisition, the Telenor market shares (by customer at the end of 2006) will be around:
  • Broadband share 14.5% compared to the incumbent’s TDC share of 56.6%;
  • Mobile share 27.9% (including CBB) compared to the incumbent’s TDC share of 40.8% (including Telmore);
  • the leading altnet for the fixed market with 13.8% of outgoing traffic compared to the incumbent's TDC share of 65.6%.
Note: all subscriber statistics from the Danish regulator, whose bi-annual report also contains a lot of traffic data for anyone really interested in delving deeper into the falling values of MVNOs and Broadband assets in Denmark.

Tuesday, May 08, 2007

Telenor: Ukrainian Intrigue

The fight between Telenor and Alfa/Altimo over Kyivstar in the Ukraine is one of telcoworlds most public partnership squabbles. Telenor last week reported falling Q1 earnings primarily due to deconsolidation of the Ukrainian venture from their accounts, so I thought I’d spend a little time examining the history of the venture.

The Second President of Ukraine, Leonid Kuchma, ruled from July 1994 to January 2005. His successor and alleged crony, Yanukovych, allegedly won the following election by fraud and was subsequently overthrown in the so-called Orange Revolution which placed Viktor Yushchenko in charge and the corruption charges that had been murmured during the latter years of the Kuchma regime became very public.

The reason this is important is because Kyivstar was issued its GSM licence in 1997 in a process that cannot under any circumstances be described as transparent. Telenor was an original partner in Kyivstar with a 35% equity stake. One would assume that a state owned company from Norway, well known for its transparency and lack of corruption, would investigate as to whom the other 65% partners in the venture were. It is important to stress here that I do not mean what was the name of the companies in the partnership, but the ultimate owners of these companies. This is standard practice for any joint venture in any part of the world - you do not do serious business involving serious investments with people who you do not know. If they did, Telenor didn’t place the names of their other partners into the public domain. The Ukranian Weekly names the original partners as Telenor with 35%, Storm with 31%, Omega with 20% and Sputnik with 14%.

The CEO of Storm turned out to be no less than the brother-in-law of President Kuchma. A further clue to the connections of Kyivstar was that the Marketing Director from 1997 to 2003 was President Kuchma’s daughter, Elena Franchuk. In Western Europe any such dealings with the Head of a Country would immediately be questioned and subject to microscopic examination: no such examination is in the public domain of the dealings between Telenor, Kuchma and Kyivstar.

The Omega and Sputnik holdings are alleged to be connected to the ex-Prime Minister, Pavlo Lazarenko, who relieved of his position in 1997 and has a very interesting biography. Whatever happened to these shareholdings and who were the ultimate beneficiaries are anyones guess because again the information is deeply buried about Omega and Sputnik. Between 1997 and 2002, both Telenor and Storm steadily increased their holdings in Kyivstar by buying out Omega and Sputnik holdings in various stages.

In July 2002 another multinational, this time from Russia – Alfa/Altimo, appeared on the scene. At the time, Alfa would have been familiar to Telenor from their Joint Venture in Russia, Vimpelcom, and it is unsure whether Telenor welcomed them as a partner in Kyivstar. Personally, I seriously doubt whether Telenor would have been happy and I suspect that Telenor had pre-emption rights over the Storm, Omega and Sputnik rights – this is standard practice for Western companies. Alfa had effectively bought in with 50.1% at the Storm level and seeing that Storm was allegedly owned by the President, I guess that any Telenor complaints would fall on deaf ears.

By 2004, after another series of minor transactions the current shareholding of Telenor with 56.5% and Storm with 43.5% was established. Storm in turn was owned 50.1% by Alfa and 49.9% by Someone Else. It was hardly a state secret of the connections between Kyivstar and the Kuchma regime, because the nickname of KyivStar was KuchmaStar on the streets of the capital. There is even an ironic mention of the positive effect that KuchmaStar played in the downfall of the Kuchma regime in the Orange revolution in studies (warning: 8meg pdf – but interesting study of the potential positive role of the internet for any future revolutionaries)

In 2004, Alfa bought out the remaining 49.9% of Storm from the mystery owner and legal woes for Telenor began. Alfa stopped attending directors meetings and therefore quorums were not established. Also Alfa began pressing in the courts for equal rights with Telenor and initially gained little success.

All changed in 2005 with the Orange Revolution and the changing of the political guard in the Ukraine. In 2005 the new President, Viktor Yushchenko, had an early success against the previous regimes corruption when US$160m was seized by the Ukranian arm of Interpol in German and Austrian accounts relating to the sale of 23.8% of Storm. The ultimate beneficiary of this money was named as Leonid Kuchma. Funnily enough the other money relating to the other 26.1% sold was never recovered. Even funnily, Alfa/Altimo was never drawn into the controversy. These are the sort of deals cut to solve the Gordian Knots frequently tied in John Le Carre spy novels.

Since 2005, Alfa/Altimo has been getting the upper hand in court proceedings both in the Ukraine and New York. People have even blogged that certain court victories came about after meetings between the head honcho of Alfa Bank, Milton Fridman, and the current President of the Ukraine, Viktor Yushchenko, met over attracting foreign investment into the Ukraine.

Of course, Telenor has been crying a lot and trying to gain some public sympathy for their plight, but in my book Telenor should be wary of the old saying:
“People who live in Glass Houses shouldn’t throw Stones”

NetServices / 186k

Netservices and 186k have announced a deepening of their relationship:
Under the agreement NetServices will transfer 174 of its consumer focused wholesale broadband reseller contracts (including approximately 23,000 end user lines) to 186k which will also assume the liability for the required BT central pipes and 5 NetServices employees will transfer with the business. Up to £285,000 of the total consideration receivable will be used to settle user migration charges levied by BT. NetServices will retain ownership of 23 profitable reseller contracts which will be managed by 186k in return for a monthly revenue share arrangement.

I hate to blow my own trumpet but I predicted something along these lines back in November. Note, Dominic Marrocco owns 186k. I still think there are plenty more episodes to come on the Netservices / Dominic Marrocco story.

Virgin Mobile USA IPO Filing

Virgin Mobile USA offered a little insight in the MVNO business model with its IPO filing last week and it appears that red is not only the brand colour, but also the colour running through the accounts – to the tune of US$683m of losses since launch in June 2002.

Venture Start-Up losses are not necessarily a good indicator of future performance, however with Virgin Mobile the future looks decidedly dodgy with the following lowlights gleaned from the IPO filling.

High Levels of Debt

Most of the start-up losses have been financed by debt rather than with equity with total debts of US$553m promising to be a drag on earnings for many years to come, especially one where the business has still not reached cash-flow positive.

Large Losses from Box Breaking

In the UK, prepaid handset subsidies attract box breakers like excrement attracts flies: fortunately for Virgin Mobile USA, they use CDMA technology which is less popular in emerging markets than GSM technology, however they are still suffering losses to the tune of $25.4 million (228k handsets) and $30.4 million (322k handsets) in 2005 and 2006 respectively.

Despite a decade long attempt to crack the problem of box breaking in the GSM market, no long term solution apart from not subsidising non-locked prepaid handsets has ever emerged. Investors should consider how many customers would buy the service if subsidies were not offered.

Strange Customer Count Metric

Alarm bells always ring when a company uses a non industry standard metric for calculating an important metric: Virgin Mobile use an inactive limit of 150-days before taking customers off their customer count – the industry standard is 90-days. This is an overstatement of 60-days and with a churn rate of 4.8% means the Virgin Mobile customer base is “overstated” by around 10%. This is significant on a base of 4.57m subscribers.

Rate of Growth is declining

The net customer growth has declined from 1423k (2004) to 994k (2005) to 729k (2006) over the last three years. This can’t be explained by the general USA cellular market which is still experiencing good growth, but can be explained by more competition for the particular segment which Virgin Mobile is targeting – which is youths with no or poor credit rating and no parental subsidy.

As markets in Western Europe have saturated, this is a keenly fought segment which does not bode well for Virgin Mobile in the 3-5 time frame when the USA market will be saturating.

Rate of Spend is declining

Average Revenue Per User is dropping from US$24.24 (2004), US$22.54 (2005), US$21.48 (2006). To be fair this can probably be accounted for by a growth in the inactive customer base rather than any drop in minutes, texting or rates.

Life Time Spend is low

US$21.48 per month spend with a 4.8% churn implies a customer life time of 20.8 months with a life spend of US$447. This is extremely low, especially given up front cost of acquisition is US$120 and Virgin Mobile doesn’t own its own network and therefore pays higher network charges than network owners.

Shareholders charges appear high

Virgin Mobile USA is predominately owned by Sprint and the Virgin Group with around 47% of the equity each. Related party transactions in 2006 amounted to US$264.1m (including US$1.3m in contributed equity) for Sprint and US$5m for the Virgin Group. (including US$1.4m in contributed equity) This represents a large chunk of total Opex in 2006 of US$1,093k.

It is perhaps the biggest truism in the MVNO game that the network deal is the most important contract and with Virgin Mobile, Sprint seems to be earning a large chunk of mainly high margin wholesale revenue from the Virgin Mobile MVNO. Sprint earnt US$225.3m from serving a weighted average number of customer throughout 2006 of 3,957k or US$4.74 per month on average. No real detail on how these charges are calculated is provided and this is crucial to determining the long run sustainability of the company especially as prices typically drop over time.

Why Now?

The most intriguing question is why are Virgin and Sprint floating the Virgin Mobile now? It make a lot more sense for me to float the venture when it is generating cash rather relying on a leap of faith from investors for Virgin Mobile to bridge the gap. I suspect the real reason for flotation now is that either one or both of the partners aren’t prepared to put more equity into the company and need the IPO proceeds to further finance ongoing losses.

In conclusion, I can’t really see anything at all in the IPO which changes my opinion of all MVNOs basically having zero prospects in the long run. For sure in the short run, there may be money to be made for the speculator playing the expectations game, but as a long term investment hold – no chance.

Thursday, May 03, 2007

Tiscali to buy Pipex?

Rumours are circulating in the Italian press that Tiscali are about to announce that they have bought Pipex. This actually makes to sense to me as Tiscali are probably the only company either brave or crazy enough to take on the integration of the diverse Pipex properties. Tiscali have also expressed an interest in the forthcoming Italian auction 3.5GHz WIMAX spectrum. They also have a medium sized B2B division into which the hosting business would fit quite nicely.

I have a funny feeling that despite huge odds against Tiscali might be the only large scale independent survivor of the Free Broadband Nuclear Bomb that Carphone dropped on the UK ISP market – the cockroach of the UK ISP industry.

Wednesday, May 02, 2007

UK Almost Free Broadband Progress Report

With the BSkyB quarterly reports out this morning, it is extremely interesting to compare how the various almost-free offerings are stacking up as at 31st March 2007.

In terms of overall broadband numbers Carphone is well in the lead with 2271k (AOL 1535k, TalkTalk Free 655k and TalkTalk Legacy 81k). Orange is in second place with 1095k (Mobile Bundle 254k and Standalone of 841k). BSkyB are well in the rear with 489k (Sky 457k and UKOnline approx 32k)

However, if we look at net adds in the quarter a different picture emerges with Carphone adding 116k (AOL 12k, TalkTalk Free 115k and Legacy a loss of 11k), Orange bringing up the rear with an anaemic 32k of net adds and Sky leading the pack with 264k adds.

I don’t think the fact that the Sky service is relatively new and therefore there will be extremely limited churn will account for the majority of difference. Perhaps more of the difference will be accounted for by the heavy publicity that Sky is investing not only to existing Sky customers in the form of TV ads and direct mail, but also to new customers in the form of the seemingly ubiquitous “See, Speak, Surf” campaign. TalkTalk has returned to the TV screens and is heavily advertising on the internet with banner ads, but not to the same degree as Sky. Orange seems to me to be promotional free zone.

In terms of value of the various offers, it is very difficult to ascertain who gives the best price because so much of it is dependant on personal circumstances. For instance, included within the Sky figures are (as at 29th April) 100k offnet customers who as far as I aware Sky charge £17 per month. This is a net increase from 28th Jan of 66k customers. SkyConnect is basically a resold BT Max package of up to 8meg with a 40GB Monthly Cap and a £40 activation charge. This can hardly be called cheap and probably the amount of subscribers is an indication of how many people truly value the convenience of a triple play from a company that they trust.

Similarly looking at the Sky figures as at 29th April, there is only 136k out of 553k who have adopted for the bundled option at no additional cost. There are 317k who are both unbundled and paying either £5/month or £10/month. James Murdoch said in the press conference that a slight majority of the 317k opted for the £10/month package. This was a surprise to me as I though more light internet users would have taken up the free offer.

With Carphone, again on the TalkTalk side there is more revenue upside than I expected with ARPUs of £28/month for an effective base £17.87 (ex-VAT) service. The difference is in additional voice services, such as calls to mobile and call features. TalkTalk is still making progress in the market in terms of net adds, although I would be slightly concerned about the AOL base remaining more or less static. I also think with TalkTalk unbundling 289k in the quarter they are making rapid progress on this vitally important front. James Murdoch said in the call that Sky are unbundling just under 30k customers a week and this accounts for around 33% of total UK unbundling activity. I expect TalkTalk are doing around the same. If I was Carphone I also would be looking at ramping up the AOL unbundling as with only 327k unbundled out of 1535k there is a lot to be unbundled with a lot of potential extra margin still on the table for Carphone.

With Orange, the numbers are a bit of disaster with only 254k on the Free Broadband if bundled with a >£35 per month contract. To be fair some of these will be on the £5 offer and therefore not strictly speaking on a “free” bundle. I do think that mobile and home broadband bundling doesn’t seem to be that attractive to the Great British Public. A greater insight on this should be gained with the release of the Virgin Media figures next week.

Obviously, it is hard to say who is winning on the financial side: the Sky residential losses of £120m for 9 months seem immense, although it should be remembered that they are writing off SACs immediately, whereas Carphone capitalise them and amortise them over the 18-month contract. Also a part of the Sky rationale of getting into broadband was reducing churn, whereas churn is currently on the way up. However, Sky’s overall churn figures of 13.7% is still a lot lower than the Virgin Media equivalent (around 20%) or the broadband industry in general (25%)

Overall, I think Carphone is still ahead of the curve with Sky catching up fast and Orange basically going backwards. James Murdoch refused to be drawn on when a fully unbundled and line rental service would be offered, but this to me is key is doing a meaningful like-for-like comparison in the future.