“Vertical integration” can be problematic for any non-connectivity asset held inside a telco entity. Ask AT&T or Singtel.
AT&T’s purchase of Time Warner was an effort to vertically integrate into content. The goal, says AT&T CEO John Stankey, was to “help our domestic connectivity business.” As AT&T now sees matters, the streaming content business must be built globally, and not restricted to a single country, which is primarily AT&T’s connectivity business base.
That--at least as AT&T now positions the matter--requires a globally-focused business unencumbered by considerations of the domestic market. So AT&T wants to combine its Warner Media assets with Discovery, creating a larger new entity in which it owns 70 percent of the equity.
That will remove Warner from AT&T’s consolidated results. Needless to say, valuation of such a standalone business should exceed the valuation if the asset were embedded within a telco organization.
Among the other possible ways to view such assets is the ability to produce free cash flow, revenue growth and profit margins for the mother company, even if not fully consolidated within the telco itself.
In fact, valuation might be higher precisely because a “pure play” content or streaming asset is valued as other similar assets are.
Singtel, Southeast Asia's largest telecoms operator, reported that annual net profit halved to S$554 million ($418 million), the lowest net profit in at least two decades. That performance by a leader in exploring additional lines of business illustrates three related issues.
The first issue is the exhaustion of legacy connectivity services markets. The second issue is the traditional difficulty or entering new markets, either in other parts of the ecosystem or in content or applications.
The third issue is the valuation penalty any successful “up the stack” asset (content, platform, application) has when buried within the telco organization.
Singtel has been trying to diversify for years, and has been a leader in exploring growth “up the stack” in the application layer, and beyond connectivity. So the inability to reap profit rewards is troubling.
But some investments such as those in digital marketer Amobee and cyber-security firm Trustwave yielded weaker-than-expected returns, observers note. That is a recurring story for telcos who have tried for many decades to broaden their revenue bases in adjacent areas such as software or computing services.
The next moves might pair infrastructure asset sales to fund investments in other growth areas such as financial services or gaming.
At least part of the problem is valuation of telco infrastructure assets. Singtel notes that its infrastructure assets do not provide a valuation boost, compared to other suppliers that own fewer network assets.
The other issue is that Singtel executives believe ownership of towers, satellites, subsea cables and data centers has not boosted Singtel’s valuation, compared to peers who own less of such assets. The expectation is that selling some of those infrastructure elements will free up capital to deploy in other growth areas.
Weakness in mobile services revenue and market share is among the current issues. Mobile service revenue dropped 19 percent; blended average revenue per user fell 18.5 percent and subscriptions fell 3.6 percent over the last year, for example.
That is not a unique problem. Globally, other service providers face low growth rates and falling ARPU. Saturation of mobile services--the industry growth driver for decades--is part of the problem.
Beyond that, the typical telco must replace half of existing revenue every decade or so. We have seen that in fixed network voice services, mobile voice, long distance revenue and fixed network services generally. We have seen it in text messaging as well.
That might seem hyperbole, but is a demonstrable fact. Globally, that means telcos have to generate about $400 billion in new revenue just to replace what they will lose over the next decade.
Singtel’s issues really are the same issues every connectivity service provider eventually will face. The issue is how to create huge new revenue streams, outside the connectivity core. Those who argue that amount of growth can happen within the connectivity core, it seems to me, have the burden of proof.
Vertical integration might not be the only way--perhaps not the best way--to do so. Any sufficiently large asset outside the connectivity core will get a higher valuation if outside the telco, operating as a "pure play."
That might not help connectivity business revenue and profit matgin directly, but it arguably is a better way to grow the overall business.
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