O2: The Tide is Turning

When an archetypical company is in expansion mode, the staff is happy and has the freedom to take controlled risks and sometimes a risk pays off big time and a general positive cycle of performance through enthusiasm plays out to everyone’s benefit.

When there is a general economic slowdown or sharp competition, staff tends to withdraw into their shells, become more risk averse and paranoid about their jobs. Staff knows especially the front line and accounting teams, when a company is struggling in the marketplace and a destructive circle of underperformance tends to set in.

The result of this circle of underperformance usually ends in cost cutting, redundancies, further paranoia and loss of momentum.

O2 Germany seems to be in this category now announcing 15% redundancies of staff. And this is despite being the stellar performer in the O2 group since O2 was created and very few back in the day thought o2 Germany had the steam to make it on its own. Admittedly Germany is currently a tough market and O2 are sub-scale, but all the problems could be solved by taking out kpn’s e-plus – something that is currently even beyond the wallet of o2’s parent company, Telefonica. Tellingly the redundancy announcement was preceded by a change of the senior executive from old school O2 to new school Telefonica appointees.

The crucial market for O2 is the UK and I personally think that there are embryonic signs that the tide is also turning in the UK. O2 technological innovation over the last few years, apart from a few non-deployed highly publicized controlled experiments with Manx Telecom, appear to have been extremely limited and more importantly part of a high level strategy of minimizing capex. O2 has invested all its money in a slick brand appealing to the addicted to texting youth.

Unfortunately for O2 the market in 2007 is moving away from them:

• H3G is cornering the market for geek friendliness and although showing limited signs of future profits are at least less cash consuming than in the previous incarnations; 
  
• T-Mobile is actually currently the mass market punters friends – they dream up appealing market changing deals like Flext and Web ‘n’ Walk, but unfortunately for T-Mobile UK the head office back in Bonn never seem to provide the investment to keep a constant message (and more importantly commissions) across any channel for any length of time and therefore only the minority attentive observers can jump aboard the T-Mobile train; and
  
• Voda is back in an aggressive manner and they are fighting on two new fronts in the consumer market. The Vodafone Family on-net pre, postpaid mix package shifts the paying field for price plans - if we are all honest the Voda brand appeals to the older and bill paying members of the family who actually make mobile decisions for a big percentage of the population. Next on the Voda target is the mobile internet niche, which despite a completely incomprehensible marketing campaign appears to be playing exactly into the Voda strengths of “imagined” technical strength; and
  
• Orange is still comatose and inward looking but the life support machine is showing signs of activity. Any effort from planet Orange is an improvement from their current state.
  

Crucially, I think that the recent decision by O2 to dump imode in the uk is the start of a cash conservative phase. It is not important on the pluses or minuses of the imode technology but more that o2 have started to fail, again, in the UK market. The last time O2 failed was when they were called Cellnet and part of an UK incumbent called BT. Now they are part of a Spanish incumbent, bureaucracy will seem the same as with BT and blood is bound to flow. It was also noticeable from a Telefonica statement that o2 would be a lot less aggressive in the uk market in the second half.

Obviously a potential ace up the sleeve for O2 UK from recent press murmurs is that O2 have won the iPhone contract in the UK. Personally, I see this as more of a sign of weakness for O2 than strength. However, I appreciate that the jury is still out and that I am part of the awkward squad who dare to question the iPhone economics for the MNO.

Rather than the announcement of a iPhone contract, investors should be looking for a changing of the guard at O2 and then adding 6-12 months while they get their feet under the table and plans potentially turn into reality before O2 will be King of the EuroOperator growth league again.

Carphone AOL Free Laptop Offer

What ever anyone thinks of Charles Dunstone and his Carphone Warehouse Empire, no one, even the biggest cynics, can doubt their ability to change the rules of the game overnight, disrupt the status quo and most importantly shift a huge amount of hardware and contracts. I believe the AOL Free Laptop Offer will do this in the broadband industry.

I can just imagine a pretend chat with his old trading partner, Ron 'Motorola' Garriques, now with Dell.

“Do you remember the old days when we ripped up the UK market for your ex-employer with the spectacular pink RAZR, why don’t we do something similar for your new employer with laptops?”

Allegedly, Carphone have stockpiled 100k Dell laptops ready to be given away alongside a 24-month contract for £19.99 AOL Broadband and a mandatory “Pay As You Go” cps-based voice service.

This is basically, Carphone turning the broadband game into a cellular game, one with expensive equipment apparently given away, but the cost is clawed back over a long contract with excessive service fees. This model has proved incredibly successful in the cellular business and I see no reason why it won’t be successful in the broadband industry.

I estimate the economics of the offer to work out as follows – this is with cost data from 2.5m customer/1.5k exchange unbundling model I prepared ealier with Jonathan Lishawa:

• £270 of SAC: £200 for laptop which admittedly is a decent spec, £15 for the wireless router, £27 for the Openreach data & CPS connection and £28 for marketing. This equates to £11.25/month.
• I assume that the distribution costs are covered by the £19.99 postage and packing fee.
• £72.80 for addition SMPF non-recurring costs, relating to line cards, colo/cable ties, OSS, Backhaul & Core Capex. This equates to another £3/month
• Ongoing Costs of £2.61/month. This includes SMPF line rental, support costs and other ongoing expenses.
• This gives monthly costs of £16.89 vs £17.01 of revenue, which means the offer isn’t too appealing on a data only basis.
• The money is made on the voice element of the package which is mandatory. No details are available of the new AOL “Pay As You Go” package, but I would assume standard sort of industry ARPU’s of £10/month and profit of £5/month are easily attainable.
• So I guess around £5.10 profit/month is achievable or £120/customer over the length of the contract.

Obviously with any model there are upsides and downsides:

• A new line card will not be needed for all connections. This depends on the amount of churn on the existing unbundled AOL base and the availability of “used” cards in the exchange.
• This does not include any revenues from Geek Squad. Many people will require assistance is setting up the computer and home network especially if they are new to broadband and have limited computing skills.
• This does not include any revenues from Software & Hardware Sales. I would expect Microsoft Office, Security Packages and Printers etc are upsides to the model. I’m not sure whether these incremental items will flow to Dell or Carphone.
• The above assumes an internet distribution model. Additional costs will be incurred on direct commissions and indirect costs if sold through the Carphone retail network.
• Most importantly, the above doesn’t include the “Can’t and Won’t” pay element. 24-months is a lot of credit risk and I hope that Carphone have all the vetting systems in place because undoubtedly an offer of this type will attract every “won’t pay” scamster in the UK likes bees to a honey pot. Also, the end of the market who are attracted to these types of offers are the type who are most prone to economic shocks and to fall into the “Can’t pay” category.

This offer will have the effect of either re-invigorating the AOL brand and providing fresh impetus in the marketplace or bringing it down if there are problems with provisioning and support. It should not be underestimated how difficult the task that Carphone is attempting will be to pull off.

Even the more obvious item like demand management can be difficult, because there is the risk of a lot of unsatisfied customers who either fail the credit check, are outside of the unbundled area or are tied to a current contract possibly even with TalkTalk. Provisioning is also a big worry even with Carphone going down the SMPF route, there are lot of moving parts that can wrong and also a lot of initial load on the AOL support centres.

Finally, there is bigger risk to the Carphone business and that is they will be completely upsetting probably their second biggest customer in the UK shops – Orange. Carphone have stolen the thunder from the Orange / Curry deal - £300 discount on a laptop. Personally, I think the Carphone deal is better designed, appealing and easier to understand, but that is besides the point. The Orange deal will have required a lot of internal approvals, been a long time in development and will be designed at reviving the fortunes of the Broadband service – if the offer is not successful, I can guarantee that the poor proposition or marketing will not take the blame – it will be Carphone on its spoiler tactics.

In true Carphone style, they also used their opportunity of being in the limelight to bury a little bit of bad news.

The first item in the Press Release was the interesting factoid that AOL had “over 1.4m customers on broadband and 2.1m customers in total”. On announcing the AOL acquisition in Oct 2006, Carphone said “…approximately 2.1m ISP customers. On completion, it is anticipated that this will comprise 1.5m broadband customers and 0.6m dial-up customers.”
In other words the base appears to have gone nowhere is a growing market since the Carphone purchase. Particularly worrying is that the broadband base appears to have declined from the 1.535m announced at the end of March 2007.

The second was announced on the quiet on Friday afternoon that one of Carphones Internet Properties, OneStopPhoneShop, was to be closed and some of the traffic sent to the E2Save site. OneStopPhoneShop was bought in Mar 2005 for £15m with £6.7m of that deferred according to performance. At the time Carphone capitalised £12.5m of Goodwill. It is not sure whether Carphone will have to write-off any of this goodwill in the current year. Also, I am unsure of the status of the orginal £9.5m of Hugh Symons goodwill which has also been experiencing some difficulties of late.

Overall, I think the Carphone Free Broadband looks quite good for Carphone if the execution is spot on, with the biggest risk being the “can’t pay, won’t pay” brigade.

Sky Right of Reply

James Murdoch has had a response published in The Guardian to a generally positive leader article they published on the Sky KPIs released the other week.

One of the points that James Murdoch makes is worth repeating:

Sometimes this means we do things differently from other broadcasters. For example, we chose not to launch a quiz TV channel, and we use participation TV as an enhancement to the viewing experience rather than a money-making venture in its own right. Public trust in TV has never been higher on the agenda, and Ofcom has commended Sky's approach and suggested that others could learn from our example.

I am in the process of writing about the current participation TV saga, but it noticeable that Sky and Virgin Media are really the only companies who are not having their names dragged through the mud. The companies that actually have a direct billing relationship with their customers seem to take customers a lot more serious than the rest.

Anyway, I have my own confession on an erroneous flippant comment I made the other day which annoyed more than one of my readers:

Also, it doesn’t specific how much of the amount is basically taking money out of one pocket and putting back in another with spending on own channel TV adverts and NewsCorp publications.

The shareholders of BSkyB and NewsCorp are different (although at least one family appears on both share registers) and I’m sure that any investment made by BSkyB in adverts in NewsCorp publications is done on a purely commercial and arms length basis.

Apologies for any offence caused.

LUI: episode V – Return of the Voice Margin

Jeremy described our main broadband product set in episode IV, what was missing was the description of our voice services and our plans for video. This article covers the current state of LUIs voice offer.

In preparation for our voice launch we played the find the money game in the UK residential voice market:

We were really surprised that although the volume was with uk geographic calls, nearly 50% of the value was with access charges (monthly line rental) that most Communications Providers sell line rental at zero margin matching BT’s price. One of our first voice decisions was that we didn’t want to be a zero profit collection agent for BT while taking all the bad debt risk. Therefore we decided to price our line rental at above market pricing - £11.50/month. Despite this pricing policy 16% of our base has taken the line rental option and despite the price it is still only marginally profitable. Apparently people do place a value on receiving just one bill.

Something even more surprising happened when we performed market research with focus groups consisting of existing users of our broadband product on potential voice products:

• people, especially youngsters and students, thought text messaging is an integral part of voice service (yes we know that is nonsensical technically, but LUI only exists to serve) and wanted a cheap way of sending and receiving them from their home as well as from their mobiles;
• people thought the most equitable way to bundle by far was the "T-Mobile Flext" method where different elements were combined and interchangeable in a monthly price with an overall usage limit;
• people were totally confused by non-geographical call pricing and felt like they were being ripped off; and
• people thought calling overseas was really expensive and something to be avoided.

As a result of these focus group sessions we decided we wanted to be as transparent as possible on non-geographic calls and decided to market the calls to our base with a pledge - “LUI will only charge our non-geographic calls at cost with a 2.5p/call transaction processing fee”. At least our customers know we are not the people doing the rip-off.

We also decided to tie in our mail services with a mobile operators SMS gateway, so that we can offer outbound texting. We were really surprised how easy and potentially profitable this was to do and how helpful the tools our mobile operator already had available were. We are experimenting with some voice to text convertors to make the service even more user friendly but to perfectly honest the software seems to have big problems handling the Yorkshire accent and isn’t ready for the mainstream yet. We also white label the BT Text-to-Voice wholesale service to allow people to text our fixed lines and allow our customers to listen to the message if the home handset doesn’t have a SMS client built into it.

We also decided to design a “Flext”-like tariff plan for voice, which currently looks like:

All components in the bundle are interchangeable. Once people reach their bundle limit for the month we send an email informing them of the situation. In this way we are not over exposed to heavy consumption by a group of individuals and people do not suffer from "first bill shock". We provide online tools for viewing the progress of the bundle through the month and also permit our users to receive completely automated email alerts when they reach 50% and 75% of their monthly allowance. We find that people's consumption patterns are pretty stable after an initial couple of months.

The beauty of the plan is that it looks really good value for the customers compared to other offers in the market and our customers are happy effectively managing a monthly budget. We make most margin on Evening and Weekend Calls which is when the majority of our customers are at home. But, basically make our money with what is left over in the bundle every month.

For an example of the profitability of our services, see the attached summary management accounts for June. Please note our advertised prices include UK Sales Tax at 17.5%:

We would love to bundle in the line rental with the service, unfortunately we feel that adding a zero margin product of £11.50 actually detracts from the value message we are offering. However, once we fully unbundle we can cut the umbilical cord from BT and offer a much better package for overall voice, broadband and hopefully video services. 

We are currently testing our softswitch for deployment of the full unbundled voice service. We are negotiating with the other Communications Providers to maximise our share of incoming call termination. Also, we feel that the community effect of our ISP will kick in: we have a lot of calls that are already on-net which we effectively in the future we won’t have to pay BT wholesale charges. We feel confident for a launch of fully unbundled product in Q4 2007.

Episode 6 - video bits and bytes is available from Jeremy’s blog for Monday
Lunchtime consumption ;-)"

Sir Christpher Bland exit interview with the FT

There is a wonderful interview with Sir Christopher Bland, Chairman of BT, in todays Financial Times. He deals with Openreach performance with a couple of lovely put downs:

Sir Christopher insists Openreach has performed "outstandingly", and describes Mr Pluthero as a "serial complainer". He says Mr Dunstone's problems with his broadband business "have been largely of his own making".

But more importantly, he let the cat out the bag with regard to BTs thinking on a post-ADSL2+ uk– it is VDSL2 and I’m disappointed. FttH is the most obvious to me and not some intermediary measure that will require upgrading in a 10-year horizon. I would urge BT to study the Verizon and AT&T situation in the US before making their final decision.

LUI: episode III – The ISP Empires have Technical Advantages

Following on from Jeremy’s second episode of our journey into the life of an imaginary small ISP, I thought I’d explain how technically challenged we are compared to the larger brethren.

The major challenge with software development is that incremental costs of delivery are very slight and having a large user base is actually very good for rapid bug finding and diagnostics. In an ISP this results in favouring those ISPs with a large customer base who can spread development costs over a large number of customers. This assumes that ISPs are equally proficient at software development which is not always the case: there are some very good case studies from the ISP community on how not to develop software and the distribution of these disaster projects seem to be proportional to ISP size. However, even with occasional cock-ups the dice are firmly loaded in the favour of the larger ISPs.

For this reason, LUI has always taken the approach using third parties wherever possible for software services. We bring to the party our customers and our trusted relationship with them. We tend to focus on integrating our customer database and billing software with the third party software, so provisioning and billing are transparent to the end user.

Our software development team is only six strong and that includes a manager who we force to get his hands dirty with periodic bug squashing as well as playing with project plans on Excel and practicing motivational speeches in front of the mirror. One of the golden rules of our product lifecycle is that apps are only launched when self-provisioning is possible and integrated with our portals and all the tools for app monitoring are available online for remote use by our NOC.

LUI also has an allergy for paying for software and prefer to engage in revenue sharing deals when services are sold to our base, open source apps when we need to host our own services and as a last resort we roll our own. LUI buys plenty of hardware, but it is normally off the shelf last quarter’s model rather than the latest, greatest and most expensive bits of kit. LUI even stretch this philosophy to our routers and switches where we have no alternative but to buy proprietary kit. Even with this approach, because of our lack of purchasing power compared to the larger ISPs we know LUI still pays a premium for hardware.

Our Sysadm team is a mere seven strong and includes specialist support for our radius/ldap, proxy, provisioning, billing and traffic management apps. We also have to deal with our third party interfaces and have a specialist in core network traffic planning. The obligatory manager comes along for the ride and who strangely seems to spend most of his time with our third parties doing lunch and discussing theoretical issues.

Our lack of scale also works against us in Operations: our NOC team is seven strong and that includes a manager and a scheduler. Somehow we manage to eke out 24/7 coverage. We have to train multi-skilled engineers who not only can sit and monitor machine performance and occasionally fix problems, but also they need to double up as field engineers who can visit PoPs and upgrade equipment.

A larger ISP doesn’t have these problems and can easily afford specialists in their NOC covering UK wide networks and even have the scale to economically outsource field engineering.

LUI’s twenty strong technical team may not sound like a lot, but costs us plenty: the average salary of the managers is £50k/annum and the other seventeen averages out at £30k/annum. This is £660k per annum just for team, before a training budget of £100k and team equipment and consumables of another £100k. In addition, we tend to spend just on IT hardware for our server farm of around £300k per annum and our server farm incurs maintenance and colo costs of around £40k per annum.

The opex element of these costs (£900k) come straight off our bottom line and work out costing us far more than our backhaul costs on the unbundled side of the operation. When we spread the costs equally over our 47k unbundled and around 53k ipstream customer – it works out at 75p/customer/month. With the capex costs being more or less continuous every year we can add another 25p/customer/month for these.

Basically the only way of reducing our unit technical costs is to gain scale quickly.

T-Mobile comits to BT BNS product for its backhaul

Funny that as soon as our hypothetical ISP, LUI, starts using the BT BNS product then T-Mobile responds by committing to the product for backhaul of all of its Radio Network. Of course, it won’t do anything to improve T-Mobile patchy coverage in certain areas of the country, but it will more importantly provide the bandwidth at a decent price to allow decent mobile internet speeds for the masses. All I can say is that the T-Mobile exec team must have supreme confidence in the take-up of the Web 'n' Walk product to commit to such a deal so early.

BT has cleverly designed a product which provides plenty of upgradeable bandwidth at low opex provided by Openreach and will build a managed service on top of it provided by BT Wholesale which will keep the T-Mobile cost above the EBITDA line under control and lead to plenty of depreciation below the EBITDA line and out of mind of most analysts. The BT offer will also blow away the alternatives which were a build and outsource operations to an equipment vendor perhaps using microwave technology or make a risky committment with the patchwork coverage of the altnets.

I expect to see other wins announced soon from BT with the other Mobile Operators. The Orange and Voda 3G network sharing deal is almost a perfect fit with the BT product. It is also the type of deal that fits with the already heavily outsource H3G UK business model. I'm not sure what O2 are up to these days but they seem to be a laggard in the race to a mobile internet future. 

I wouldn't be in the least bit surprised if in a years time, BT have shiny new mobile contracts for all the operators for the forseeable future.

Sky & Virgin Media Ad Spend

According to Nielsen, Sky spent £70m on ads in the first six months of year compared to £37m from Virgin Media which includes its rebrand costs. In the same period last year, Sky spent £50m and NTL spent £16m. These amounts doen’t include online search and display spend. Also, it doesn’t specific how much of the amount is basically taking money out of one pocket and putting back in another with spending on own channel TV adverts and NewsCorp publications.

Nevertheless, the amounts involved will send shudders down the spines of all but the biggest communications companies: Sky has basically outspent even the mobile networks. There can’t be many people left in the country who don't know that you can buy the triple play “Speak, Surf, See” from Sky. Meanwhile, Virgin Media will also have gained a few brownie points with the army of Uma Thurman fans out there in the country.

As the broadband market moves into one of churn and attracting the non-geeks, brand becomes more and more important and there are few brands in the UK as strong as Sky.

LUI(Leeds Unbundled ISP) - part I Backhaul

Whilst discussing life’s rich tapestry and the shortcomings of generic ISP economic models with my cyberbuddy, Jeremy Penston of IPDev.net, we rapidly came to the conclusion that what was really needed was a real life example and so the Leeds Unbundled ISP was born.

As well as being a wonderful place to live, Leeds has the distinct modelling advantage of being home to a manageable number of BT exchanges (34), a decent mix of residential homes (328k) and business premises (17k) and most importantly a dense urban sprawl with smaller conurbations on the outskirts of the city and good fibre connectivity with the rest of the universe. The ever useful Google Maps presents a geographical view of the city and the BT Exchanges.

The first design consideration for our ISP was that any BT exchange serving more than 5k homes would be unbundled – therefore we plan for only 21 out of the 34 BT exchanges to be unbundled. This straightforward size variable led us to unbundle Ilkey, Otley and Wetherby which although being a considerable distance from the centre of Leeds have the advantage of having high average household disposable income and very few unbundlers currently present.

Upon closer examination of the map it is pretty apparent that in phase II we would look to expansion into Bradford and Wakefield and some of the exchanges would probably cost us less than the outer regions of the Leeds Postal region. We also might consider daisy chaining some of the outlying exchanges.

Another design consideration was that we would use 1-gig links back to a central hub using the relatively new Openreach BNS1000 product. The Central Hub is the main Leeds Exchange which fortunately is only 430m from our main PoP which is situated next to the Train Station at Leeds where a surplus of fibre is currently available to connect with the main UK backbones.

The main link from the BT exchanges to our PoP is a redundant 2.5-gig link which ensures that this key link will keep our customers happy with its availability. This provides a Main Link Aggregation Factor of 8:1 from the 20 spoke exchanges with 1-gig links into the main BT exchange.

The maximum length of these spoke links is 22.7km out to Otley and we have 6 links under 5km with a minimum distance from Chapeltown at 2.5km. We have an average link length of 7.9km and a total radial distance of fibre used of 158.258km.

The price of backhaul is proportional to spoke bandwidth, spoke distance, hub distance from PoP and redundant bandwidth to PoP. In order to minimize prices we have taken the maximum contract length which is five years and leads to the following bills from Openreach:

• Capex - £457,090
• Annual Running Cost - £167,791

Whilst this may seem like a lot of money, it is a dramatic reduction from previous Openreach products and certainly should give us a competitive edge over some of our so-called competitors who unbundled early and alledgely have overloaded 100-meg links, especially at the Moortown exchange.

It is also worth noting that our PoP is extremely close to the Leeds Exchange and this reduces our ongoing bill dramatically. A link of only 15km would push up the Annual Running Cost to £200k per annum.

All this bandwidth without a shedload of customers is pretty much a wasted resource and therefore we have carefully examined our demographics to provide a model of future demand. Although our ISP will undoubtedly be the best in the universe, we have tried to be realistic with our estimates and think we will attract users in proportion to the current number of unbundlers at each exchange + BT + Virgin Media.

Without going into the detail of the model we think that after a period of build-up we expect to finish with a residential market share of 16% of total homes or 47k customers. We have no plans to enter the business market although realize that is an upside to the model. In terms of per exchange data our share varies between 12.5% and 35%. The maximum number of homes who become customers at an individual exchange are 3.6k, the minimum are 1.3k and the average is 2.2k.

The important use of all this demand modelling is to calculate that the average capex per customer is £9.71 and opex per customer per month is £0.35. Of course our sugar daddy is the archetypical manic depressive financier and has insisted that we halve our forecasts and even with capex of £20 per customer and opex of £0.70 per month we think our backhaul costs are under control certainly compared to Openreach quotes of only 12 months ago.

Over the coming weeks, both blogs will be building on this initial model, hopefully with a little help from our friends, to provide insight to other key areas of ISP operations.

Over to you Jeremy…

Truphone: Full Judgment

Truphone have posted the full document on the web – fair play to them.

The interconnect rates agreed that T-Mobile have been ordered to pay are:

Day: 0.3536 pence; Evening: 0.1619 pence; Weekend: 0.1275 pence

And T-Mobile is free to charge Truphone minutes at whatever price they determine – I’ll wonder if it will take them the eight weeks they claimed to alter the price plans?

As I said before a pyrrhic victory for Truphone, but T-Mobile doesn’t come out of it smelling of roses either. To put a message when dialing a Truphone number

"You have dialled an incorrect number. Please check it & try again"

as my cyberbuddy Dean Bubley pointed out is beyond stupid.

Truphone – Pyrrhic Victory

Truphone is claiming victory in the court battle against T-Mobile saying that T-Mobile is now forced by the injunction to interconnect by next week. T-Mobile will undoubtedly argue that it was never refusing to interconnect just complaining about the price and method of connection. Truphone never mentions this in its statement or mentions if the price and method of interconnect has been ruled on in the injunction.

The price of the connection is the most important element of the court case.

If we look at the table the first entry is the standard rate that BT Wholesale applies for connections to Truphone numbers. In the T-Mobile court skeletal they said T-Mobile offered Truphone a reduced rate, which MobileEurope is now saying was as low as 0.21p/minute.

If Truphone have been forced to accept this rate as a temporary measure, until either a full interconnect agreement is negotiated or the court case is resolved or Truphone changes course of action and decides to go to OFCOM for arbitration – it will seriously undermine their business model. After all now, revenues expected from calls to Truphone numbers will be around 30x lower than Truphone originally expected.

I have included for comparison in the rate table how much BT Wholesale charge for:

• Calls to T-Mobile numbers;
• Calls to Gamma Telecom fixed line numbers, which include part of the SkypeIn range. ie an example of fixed-VOIP termination;
  
• Calls to TalkTalk numbers; and
  
• Calls to Standard UK Geographical Numbers with transit of one local tandem (ie multiple physical connections are required onto the BT network)

Of course, in practice very few companies actually pay these rates as it is much cheaper to establish a direct connection with these third parties. This is exactly what T-Mobile wanted to do with Truphone, but Truphone refused saying the work would take too long and delay their launch (which has been in beta for goodness knows how long)

According to the T-Mobile legal skeleton, Truphone instead wanted a connection through BT Wholesale and a rebate scheme organised specifically for T-Mobile. It is almost certain the Voda, Orange and Hutch 3G will have been following the court proceedings and will call Truphone asking for a similar rebate on their interconnect rates. O2 is much more complicated because of course they actually own Manx Telecom and presumably has been making money all along from their relationship with Truphone and has not providing them with "test" numbers and interconnect for charity.

Truphone is also silent on the bundle issue. I cannot see how ANY court will force T-Mobile to give away free calls to Truphone customers. Almost certainly Truphone is facing its number range being outside the T-Mobile bundle. In other words, if a T-Mobile customer calls a Truphone customer they will be charged at a new rate yet to be determined by T-Mobile. Again, Vodafone and Orange will be awoken to the fact that billing for these types of calls are permissible and they were including them free.

This is a real downside for any Truphone customer – will they give out their Truphone number when they know their friends and business associates will be charged extra for the privilege of calling them? Or will the Truphone customers just give out their standard mobile number? Remember, in the Truphone setup, customers actually have two mobile numbers for each device. Again, this really damages the Truphone business model – reduced inbound termination volumes along with reduced rates will blow a big hole in the business model.

So Truphone will get its connection, but the big question is at what cost to its business model? and was this the T-Mobile strategy all along?

Private Equity Takeover of Telecoms

There is a very interesting case study of the Private Equity takeover of TDC – the state PTT in Denmark. The Abstract more or less sums the situation up:

The debate over the implications of private equity leveraged buyouts revolves primarily around one central issue, the extent to which private equity ownership promotes efficient long-term investment and operational management in the target firms, or the maximisation of short-term returns to private equity investors to the detriment of the target firm’s long-term development. Supporters of private equity buyouts claim they introduce a longer term planning horizon for firms with public shareholders who have demanded that management be preoccupied with quarterly earnings improvements and short-term movements of the stock price. Critics claim private equity groups maximize the short-term cash value of the assets for payouts to investors and impose unsustainable debt structures that preclude investment in long-term growth opportunities. It would appear from the evidence to date that the objective of the leveraged buyout of TDC is not to invest in TDC’s growth and development, but rather to withdraw as much cash as possible from TDC through the combination of special dividend payments, management and financing fees, and finally the sale of a much smaller residual company.

The full paper can be found at Regulate Online.
Hat Tip: The High Priest of EuroFibre, Dirk van der Woude.

Truphone & T-Mobile: Interconnect Battle

Basically, T-Mobile will not allow its customers to call Truphone customers because T-Mobile believes that Truphone is asking far too much money to connect the calls. Truphone and T-Mobile can’t seem to reach an agreement and therefore Truphone is seeking an court injunction. The decision should be delivered on Monday.

Truphone is asking the court to:

• force T-Mobile to connect the calls;
• do so via BT’s network; and
• include the calls within T-Mobile’s bundle.

T-Mobile is forced by OFCOM to allow every 3rd party to connect to its network and make calls to its customers if the 3rd party so desires. This is because T-Mobile is deemed to have SMP (Significant Market Power) on termination of calls to its network and furthermore OFCOM regulates the blended day, evening and weekend rate.

It is important to differentiate between termination and origination calls: in the case of origination, T-Mobile is not deemed to have SMP. Therefore, Truphone customers can make calls to T-Mobile customers and they do so via the BT Wholesale network at the rates below:

• T-Mobile to BT Wholesale – 8.146p/min
• BT Wholesale to Truphone - 8.7138p/min (category fm3)
• Truphone to Customer – 15p/min (ex-VAT)

For simplicity I am just quoting the daytime rate. It is worth noting that Truphone charges 15p/minute for weekend calls while T-Mobile wholesales the calls at 4p/minute. If T-Mobile is forced by the court to connect calls to the Truphone network using the method proposed by Truphone then T-Mobile will be forced to pay BT Wholesale 9.6282p/min for daytime calls.

In my opinion, the Truphone court request for T-Mobile to include the calls within the T-Mobile bundle is patent nonsense. T-Mobile, or any operator, must be permitted to include whatever it wants within its own bundle and charge whatever it likes for services. Truphone is not forced by anyone to charge a fee for its on-net calls and is free to determine its own pricing model.

BT itself includes all these new WiFi based companies in a new category of tariff (Fixed to WiFi) and the Truphone number range is in the "fw3" category. BT Retail charges ex-VAT 11.84p for calls to Truphone numbers and 13.06p to T-Mobile numbers despite BT Wholesale rates for T-Mobile being cheaper and much, much larger volumes than calls to Truphone numbers. Also, BT Retail offers for bundles of Mobile minutes do not include Truphone calls specifically and fixed to wifi calls in general. This is not just BT, TalkTalk have a seperate tariff for "fw3" calls.

I also think the argument that T-Mobile must connect via BT’s network is weak. T-Mobile would never interconnect with, for instance, Vodafone via BT Wholesale – they would interconnect directly and save the BT Wholesale margin. In certain circumstances T-Mobile would connect to companies via BT Wholesale, but only because the cost of negotiating and providing a physical link does not make a direct link economic. It is basically T-Mobile’s decision.

The real question is whether T-Mobile should be forced to connect calls to the Truphone network. I actually think that they should be forced to do so, but I don’t think that Telecommunications law currently states that they must and I certainly don’t think that T-Mobile should be forced to accept any price determined by Truphone and BT Wholesale.

I’m unsure how the current deadlock situation could be resolved, but it would probably involve some sort of arbitration proceedings. From the skeleton legal arguments put forward by both parties, there appears to a wide difference of opinion as to who did what when and what the current state of negotiation is.

I’m also unsure of why Truphone did not go down the OFCOM route. In fact the T-Mobile skeleton states:

…T-Mobile notes whilst OFCOM has the power to grant interim relief (and Truphone’s legal advisers are specialists in telecommunications, well aware of the powers of OFCOM). Truphone is silent on whether it has approached OFCOM for relief…

This hints that either Truphone have approached OFCOM already and been rejected or is reluctant to do so, because OFCOM will reject them.

Truphone states in its skeleton that the real reason T-Mobile is refusing to interconnect is that:

Truphone offers a new and innovative VoIP product which would provide fresh competition in the retail mobile market and benefit customers through its low cost services. Truphone seeks to compete with T-Mobile, amongst others, on the retail market.

Personally, I’m all in favour of new services and price arbitration; however I can’t see Truphone gaining an injunction in this round of arguments in court. I can see T-Mobile offering interconnect agreement but at rates that will do serious damage to the Truphone business model, which I guess has been the T-Mobile’s strategy all along. Ultimately, I would guess that T-Mobile would prefer a scenario where Truphone’s customers are charging a monthly fee to make up for the loss in interconnect “profits”

Truphone have a lot further hurdles to overcome once the interconnect argument is solved. The first of which is the recent OMTP ruling, which ironically Truphone will require OFCOMs assistance to solve.

T-Mobiles legal skeleton is here and the Truphone legal skeleton is here. Hat Tip: The Register.

Tiscali and Pipex: A Bleak Future

I am not surprised that Tiscali has bought the broadband and voice division of Pipex, but I am extremely surprised at the price - £210m. Tiscali annonced the acquisition yesterday, (3 page pdf) along with a new debt facility of €650m. I consider this a huge premium basically for a business which has at best stalled and needs a lot of work to integrate into Tiscali existing business.

In 2005, the Pipex division had a turnover of £76.5m, in 2006 this had grew to £231.8m and Tiscali forecast that the standalone business would have a £300m turnover in 2007 with £20m EBITDA. This looks quite healthy apart from the fact that nearly all of the growth comes from the big three acquisitions in 2006 of Homecall (Mar), Bulldog (Sept) and Toucan (Oct). It has not been divulged how much of the growth in 2007 is from the effect of full year contribution from these businesses.

In its 2006 Annual Reports, Pipex reported 570k broadband customers; in the Tiscali press release they revealed they had acquired 570k broadband customers. In other words, there has been no net growth in the first six months of 2007 in a market that is still exhibiting good growth rates – Pipex has been losing market share. We could do a similar calculation on the voice base, but the figures are even more opaque.

Even worse is the effort required to integrate the Pipex base onto the Tiscali network and back office systems. Mary Turner, the Tiscali Uk head honcho claims:

Over a four-year period, we estimate cumulated synergies in the region of £150 million at EBITDA level ca £50 million to secure the synergies and efficiencies.

Personally, I think £50m is slightly optimistic and also certainly doesn’t include the porting cost of moving the customers onto Tiscali’s ULL network. There is a huge integration risk and churn point for the Pipex base. Even the normally indefatigable Charles Dunstone of Carphone Warehouse described the potential acquisition of Pipex as a step too far in terms of integration effort.

Tiscali itself seems to be slowing down in its organic growth. Tiscali reported its customer numbers of 1.54m at the end of Q2 compared to 1.48m at the end of Q1 and 1.42m at the end of 2006. This is despite offering some of the most aggressive prices on the market for double play unbundled customers. Either nobody is taking up the offer or Tiscali is experiencing a lot of churn on its legacy base, neither of which is a good sign for Tiscali. In terms of the unbundled base, Tiscali is reporting 500k compared to 437k a quarter ago or about 10% of the net adds and only 32% of the total base. Tiscali currently has 800 exchanges unbundled and is targeting 1,000 in total.

In the 1H07 Tiscali UK revenues stood at EUR 253 million, + 23% YoY. EBITDA stood at
EUR 36 million (14% of revenues), +21% YoY. The equivalent revenue growth rate in 2006 was 39%. In 1H2006 Tiscali added 266k ADSL customers wheras in 1H2007 the growth rate is around 120k.

I think this slowdown in the Tiscali growth rate is the real rationale for the deal. I cannot see in the short term the competitive threat lessening and I can’t figure any “unique selling point” for the Tiscali services compared to the competition. BT and Sky are going to prove formidable competitors with strong brands and a decent reputation. I suspect that Carphone/TalkTalk will never be beaten on price. All this is before the scale and cost advantages of Virgin Media.

The future looks bleak for Tiscali UK. The only real hope for Tiscali investors is that LLU Company valuations will increase in the future as they become scarcer.

Carphone Swap.It deal

Carphone Warehouse has just announced a new type of deal whereby you get two handsets during an 18-month contract. Basically, you get an handset upfront and a new one after 9-months of the contract.

The example here is for a £35/month contract with o2 and a D600 handset from Samsung. I’m assuming that the swapper handset is an equivalent handset. A brand new U600 retail costs £210 from Expansys. So actually the offer is effectively in the eyes of the consumer a £210 discount.

However, if they take the same bundle from the OneStopPhoneShop which is a Carphone online brand, there is a £340 cashback offer with the first 10-months of the contract being at £1/month. Therefore the discount is better for the end user in a cashback deal rather than a swap.it deal if they can be bothered with all the bureaucracy that a cashback deal entails.

Given that Carphone works on a wholesale price for the handsets and not the retail price quoted by Expansys, it illustrates that the whole concept of cashback is that not everyone reclaims the money. There must be a lot of dissatisfied customers who took cashback deals out there.

BSkyB Trading Update: Mild Disappointment

The Broadband adds were boringly in line: Sky unbundled 205k which was 40% of total uk unbundled lines of 514k for the quarter. Personally, I was hoping for an improvement on last quarters effort of 207k and taking the total over 50% of uk unbundling. The fact that the numbers are extremely similar implies to me that Sky is up against some sort of unbundling processing limit of around 3k/working day. Having said that, Sky now accounts for 24% of total uk unbundled lines, 580k out of 2,424k, which is a pretty impressive achievement in a year.

The Sky offnet base is standing at 136k or 19% of the total broadband base and demand is also pretty consistent with 54k added in the quarter. I’m not sure whether this reflects the power of the bundle or the power of the Sky brand, because Sky is actually relatively expensive for offnet broadband.

In terms of voice, it looks as if Sky has performed well in a declining market. The recent OTA2 figures showed a decline to 6.13m from 6.21m CPS customers a quarter before, whereas Sky added 171k to go 526k. Sky has plenty of options with this product to cut costs further, especially as scale is realised and network effects start to kick-in.

The scary factoid for the competition was that it was made crystal clear that churning people off the other broadband networks was the target. There was no talk of growing the market as with payTV, the raw message was basically:

“We have built it, we are better than the rest and they will come”

The 90k expansion in payTV was made up of 77k in the UK and 13k in Ireland which is more than I expected. The interesting fact was that it was mentioned that 33% of broadband customers were new to Sky – in other words 86k. On face value, it looks as if the See, Surf and Speak triple play campaign is starting to pay dividends in customer acquisition.

Also it is heartening to see the annualised churn reducing to 12.1% from 13.7% the quarter previously. In the short term, I think a reduction in churn is the justification for the investment in broadband. In fact most of the presentation was spent highlighting how big a competitive advantage Sky believe their customer service is. Only time will prove this advantage, but Sky makes a pretty compelling case.

The most disappointing part of the presentation was the lack of new product announcements – no news on MPF, no news on linking the Sky+ box with the broadband modem and no new internet content or application deals. As an aside, it was mentioned that a WLR product was to be launched, but given that it will be basically zero margin and just serves to cut the umbilical chord to BT, it is hardly groundbreaking. I think the marketing guy slipped up when he said he had the product at home and it worked. WLR is just a billing product and doesn’t affect the physical line. I suspect he must have been speaking about a MPF product and been a little dazed and confused.

The lack of launching a MPF product could be because:

• the Sky back-office systems and voice platform isn’t ready for the mainstream;
• Sky can just think the Openreach process is too error prone; or more likely
  
• Sky could be keeping its powder dry for later when more value is needed to be introduced on the entry level triple play product if and when the SMPF demand dries up.

What is certain is that with only 8.3% of the Sky base signed up for Broadband and 6.1% signed up for Telephony, there is a lot of upselling opportunities remaining even before the general increase in penetration of payTV. Sky has a really bright future and from the share price movement today more and more people are starting to buy into the story.

UK LLU Economics

Over the past month I have been a busy bee developing a generic model for LLU economics and trying to work out if there is a sting or honey for shareholders. I have based my work on detailed models developed by Jonathan Lishawa who to be perfectly fair has provided most of the brainpower. Jonathan has in the past held senior positions in the LLU industry and consults on broadband strategy for merchant banks and investment funds so knows what he is on about.

Here is the ten thousand mile view for three "example" services:

A key assumption in the example above is that it is based upon 2.5m customers spread across 1,500 exchanges. It also assumes that none of the capex is acquired via M&A and therefore is apportioned to each customer. It is also assumed that churn will be lower for the triple play than MPF or SMPF double plays. Also included in the SAC costs for the triple play bundle is a set top box, wireless modem and site visit.

By playing with the variables, it is also noticeable that the recent TalkTalk £16 package will be cutting the margin extremely close to bone, especially given that an assumption in the model is that the backhaul circuits are provided using the new Openreach BNS1000 product which is extremely cheap and really only of use to companies with a reasonable sized backbone. ie not TalkTalk.

Similarly, the Sky broadband products are also hard to justify on a standalone basis and I can only get them to work by significant reductions in churn on the core payTV product for existing customers. However, a Triple play customer is quite attractive if they are new to payTV.

Sky and TalkTalk both have 18-month contracts and therefore the capital is paid back over the length of the contract. However, in the case of Tiscali which is a 12-month contract and a SMPF/CPS service there is a much bigger risk. The promotional pricing of £9.99 for 3 months and £12.99 for twelve months does not appear to cover the capital costs within a twelve month contract even with a £7.50 gross additional voice revenue.

BT Retail does not provide a LLU service, but instead uses ipstream and cps. Having said that with a £13.99 price for 6 months and £22.99 for the next 12 months, BT would be much more profitable than the rest – even with a much more expensive CPE – the Home Hub is much higher spec than the traditional bundled modem offered by the rest.

One of the key variables which is in the model is the support costs which are estimated at £1.57/month/customer. This could be said to be slightly optimistic and only be valid if the customer very infrequently calls the help line. In order words, the service itself would have be of an extremely high quality with low network failures and more importantly very accurate billing.

The Bill&Collect processes in general and the systems to support billing (OSS) are normally where Communication Providers struggle to keep costs under control. Nearly everyone who moves from a fixed tariff environment (ie monthly rentals) to variable tariff environment (ie rating individual calls) are always surprised by how expensive it is to produce bills and collect the money. Most of the OSS costs are in capex rather than opex and therefore the costs are hidden when looking just at EBITDA figures.

Vodacom Back to Work Tactics

Vodacom in south Africa are experimenting with novel strike breaking tactics . This is the first time I have heard of this tactic being used in the world.

The service provider blocked the strikers' cellphones, citing a "no work, no pay, and no benefits" policy.

CWU spokesperson Mfanafuthi Sithebe said: "Vodacom confirms our long held view that the company has employed reactionary expatriates with no knowledge of the labour laws and the supreme law of the country."

Reactionary Expatriates? Last time, I heard all of Vodacom senior executives were South African.

Hat Tip: DizzyThinks

BT hoovers up Brightview

BT have announced this morning the purchase of Brightview. I'm sure that Brightview with its plethora of Customer Service awards will be a welcome addition to BT’s growing portfolio of internet brands. As well as Plus.net, Metronet, Force9 and Free Online from the Plusnet acquisition, it can now add Madasafish and Global Internet. In addition BT will now be in the virtual ISP market serving JohnLewis with its Waitrose and GreenBee products.

Brightview comes along with around 62k customers, which whilst not sounding much actually takes a lot of pressure of Q3 net additions for a net price of £15.8m. With an EBITDA of £3m, BT is only paying just over 5x Earnings. In addition, I’m sure a huge chunk of the costs was already being paid to BT wholesale not only in BT Central costs and other ISP costs, but also BT Wholesale was Brightview’s telephony provider.

BT has allowed Plusnet to continue as a standalone ISP, I wonder with the smaller size of Brightview whether this strategy is feasible. BT has two options it can either roll Brightview into the main BT Retail operation or it can roll it into Plusnet.

The ISP Market, especially the consumer end, is becoming harder and harder for smaller ISPs to continue to earn a decent living and I expect the next couple of years to feature either bankruptcy or sale of most of the remaining small consumer ISPs.

The big question is now whether BT will change the direction of its hovering operation to focus upon the SME market. I think there are two tasty morsels in Zen Internet and Demon Internet (owned by Thus) which would be for sale at the right price.

Of course, the biggest old school consumer ISP still up for grabs is Pipex, but I think BT has decided to bow out of the bidding for this and itself will leave it to Tiscali.

Surprise Sky Broadband Presentation Scheduled

BSkyB have surprisingly today announced a presentation about broadband for next week. This is just two weeks before full year results are planned.

The presentation will focus on a general update, including broadband and telephony after 10-months of operation, and priorities for the next 12 months.

Normally, Sky doesn’t do Trading Updates, so I can only suspect that Sky have some new products and/or services to announce. The original broadband launch was announced at this time last year (16th July)

Personally, I’m expecting Sky to announce:

• a move into Full Unbundling for people on-net and Wholesale Line Rental for people off-net, thereby cutting the umbilical chord to BT;
• connecting the Sky+ and the Wireless Router/Modem to allow long tail on-demand downloaded video viewed through the TV; and
• more Sky branded online services with perhaps a link with the News Corp owned MySpace.

I’ve also been keeping an eye on the exchange coverage and Sky has been particularly busy over the last month. According to the invaluable Samknows, Sky unbundled 128 exchanges in June to take them currently to 1127 unbundled exchanges. It will be extremely close with Carphone Warehouse as to who has unbundled the most at the current moment. It wouldn’t surprise me in the least if Sky also plan to announce a slight expansion to the exchange coverage.

Also, if as I suspect, Sky have had a stellar quarter in terms of broadband net additions and account for over 50% of the total industry unbundled net adds, it will put the rest of the key unbundlers (Carphone, Tiscali, Orange and O2) under tremendous strain. I also expect an element of gloating with forecasts of having a larger broadband base than AOL with the 2007/8 year without having paid the £370m pricetag.

Bad Quarter for Unbundling Volumes

The OpenReach statistics for 2007Q2 have been prepared and 2,423,567 lines in the UK are now unbundled.

This represents 678k orders processed for the quarter and a net increase in lines of 514k. This implies an annualised churn of 30.3% using an average base for the quarter of 2,167k.

The Q1 comparatives were 762k orders processed and 615k lines added with an annualised churn of 36.9%.

Obviously volumes have dropped and either one or all of the main unbundlers are suffering.

The quality indicators still seem to be wildly erratic with shared LLU (SMPF) still vastly outperforming fully unbundled (MPF) lines. For instance the key error rate (28-day ELF) indicator is 0.79% for SMPF and 6.64% for MPF. Order performance has vastly improved with 99.8% of SMPF and 98.1% of MPF orders delivered on time.

Apple Plays the EuroOperators for Fools

Rumours in the press are rife this morning that Apple is going to pick as its initial launch partners: O2 in the UK, T-Mobile in Germany and Orange in France. Personally, I think the whole saga runs the risks of undermining the three most vital mobile strategies which have underpinned their "return to growth" story since most European mobile markets have become saturated:

1. Pan European Efficiencies

Most mobile operators have spent many billions claiming that economics of scale and European reach is vital – the Apple deal makes this argument look ridiculous.

Furthermore what o2 will gain in the UK will be offset by losses in Germany; what T-Mobile gains in Germany will be offset by losses in the UK; and what Orange gains in France will be offset by losses in the UK.

Of course, it is not a zero sum game and the biggest "loser" will be Vodafone, so the rest will be happy.

2. Shift in Value Chain

Most operators have been fighting for an ever big share of the mobile value chain: for instance keeping third party retailer commissions under control and keeping handset manufacturers out of the mobile services market.

The Apple deal fundamentally undermines this model with distribution only available via Operator and Apple stores; Apple taking a share of ongoing revenues; and probably leading to overall higher industry network churn.

Of course, it is not a zero sum game and the biggest "loser" will be the independent retailers, so there is a crumb of comfort to the operators.

3. Undermines Advanced Wireless Network Services

Worst of all for the Mobile Operators is that the iPhone uses the slow as a snail EDGE network, prefers WiFi connections for internet access and prefers, pardon the swearing, physical cables for side loading of content.

What was the rationale for pumping many billions into 3G networks again?

Conclusion

I think it ridiculous that a whole industry would undermine its fundamental strategies with a short term panic reaction to a trendy handset.

But there you go…

uSwitch and Comparator Websites

I’m getting more and more fed up by the mass media reporting of uSwitch and other comparator site surveys. I think all these surveys should carry a huge health warning:

“The only purpose of this survey and the company who financed it is to get you to change suppliers and earn a profit for the financiers of the survey”.

These surveys are so biased as to be unbelievable and do not deserve any free publicity. If uSwitch want to advertise they should do like the rest of the internet sites.

If the surveys were run by YouGov and financed by Tory party and ran questions such as “How many people are dissatisfied with the current government?” They would be laughed at by the media and given zero exposure.

I’m not even going to give the company any more oxygen by mentioning the results of its latest survey, but suffice to say one of one companies who regularly come bottom for customer service in broadband, also is one of the heaviest advertisers when it comes to mobile phone contracts.

In fact, it is ridiculous that uSwitch on page after page of offers in the mobile area show e2save, OneStopPhoneShop, ThePhoneSpot and Carphone Warehouse offers – the customer presumably thinks they are being given choice of suppliers, when in fact they are one and the same company.

As uSwitch themselves explain:

uSwitch.com has agreed deals with some suppliers across all our services to receive a small commission payment when a customer chooses to switch or apply for a product through us.

The business model is one of harvesting of lead generation for companies which is incredibly profitable not only because of the inherent low costs of the internet, but also but the fact that the site awareness is generated by negative publicity on industries spread in the mass media for free.

Virgin Mobile Minorities right to take the Cash

When Virgin Mobile was bought by the company formally known as NTL and now known as Virgin Media back in July 2006, the options were as follows:

• Cash Only - 372p
• Shares Only - 0.23245 shares in NTL (valued roughly at 351p)
• Cash & Shares - 67p Cash and 0.18596 Shares in NTL (valued roughly at 281p)

The Cash & Shares option was really the “Branson option” as it was pitched well below the Cash only or Shares only options which were aimed at the minority 28.8% shareholders. Richard Branson through Morstan Nominees owned 71.2% or 184,238,328 shares in Virgin Mobile.

In fact this was a great return for the minority shareholders: compared to the cash offer the share price had risen 86% in the two years since ipo in July 2004 and an increase of 48% from the average share price in the twelve months preceding the offer.

Press are speculating that the offer from Carlyle is pitched at around US$32.50 which equates to 377p/share in the equivalent Virgin Mobile share price. An increase of 5p is hardly a decent return taking into account the cost of money and presumed increased transaction costs with a NASDAQ stock denominated in US$. The Virgin Mobile Minorities with the benefit of hindsight appear to have better served by taking the cash.

In fact most of the minorities appeared to take the cash and run. NTL issued stock worth £518.8m in the transaction or approx. 34.4m shares of which the Richard Branson allotment was 34.2m shares. These shares were valued at £15.07 or US$26.59. The Cash Cost to NTL was £418.2m.

For Richard Branson himself, he took the cash and shares offer which resulted in £123.4m cash payment in July 2006 and 34,260,959 shares. Branson current position with the NTL/Virgin Media shares is complicated by the cap ‘n’ collar transaction he has recently taken out for 12,847,860 shares or 37.5% of his shareholding. The collar element is $31.98/share and resulted with a prepayment of US$224.9m. Assuming that any buy-out price would be greater than US$31.98, this would leave Branson with an additional payment being due of US$192.7m minus some cost-of-money adjustment.

Outside of this derivatives transaction, Branson has 21,413,099 shares remaining in NTL/Virgin Media with a value of around US$696m at a buyout price of US$32.50. I’m guessing that he will want to roll-over all or part of this shareholding into the new (and presumably even more highly leveraged) Virgin Media. Once the effect of the increase in debt is taken into account, he might even be able to maintain his approx. 10% shareholding in the new company and thus protect his brand, oops sorry annual royalty payment of 0.25% of Virgin Media consumer revenues.

The big question is what is Branson going to do with all this cash – it certainly gives him more flexibility with regard to Virgin Mobile USA and the proposed IPO.

IPOs of MVNOs in the USA will be tough at the moment after the failure of amp’d. Overnight it appears as Helio has secured another US$200m in financing from the deep pocketed parents, SK Telecom and Earthlink.

I’m wondering if there is an opportunity for Branson to do a Virgin Mobile UK on Virgin Mobile USA. The original terms of the Virgin Mobile UK network deal between one2one and Richard Branson in retrospect turned out to be heavily skewed in favour of Virgin Mobile. Once, one2one was sold to T-Mobile, the new management were not too happy about the situation and renegotiated the contract with Richard Branson taking 100% ownership of Virgin Mobile, a new wholesale deal between Virgin Mobile and T-Mobile and some return due to T-Mobile if Virgin Mobile was subsequently IPOed.

Now that Sprint is struggling and probably reluctant to put more equity into Virgin Mobile USA, I’m wondering if Branson can put some more cash in with the hope of a better wholesale agreement and increased shareholding. Thereby, Branson would avoid the need for an immediate need for an IPO of an unprofitable company at a difficult time.

Mind you, Branson could also just as easily have seen the bubble on the MVNO game is fast deflating and it is best not to put any more cash in. He also has embryonic and cash hungry MVNOs in France, South Africa and India to worry about.

TalkTalk Double Play Entry Price Reduced

The TalkTalk entry price is now down to £16.39/month. The big difference between this and the previous £20.49/month is that Unlimited Daytime Calls to UK Geographical number are included on the £20.49/month package.

Amazingly, this is not the cheapest entry price on the market which goes to Tiscali with its £14.99/month offer which to be fair is for only a 2-meg connection and includes weekend geographic calls. Tiscali also has a smaller LLU footprint claiming to cover only 52% of the country compared to TalkTalk claims of 70% coverage.

I’m not sure whether the reduction in prices reflect a smaller amount of net adds for both companies in Q2. From the Openreach KPIs released so far, it appears that there has been a slowdown in both gross and net adds from Q1.