Competitive Pressure Remained the Story in 4Q 2009, Says Fitch Ratings

Competitive pressures remained strong throughout the industry in the fourth quarter of 2009, say analysts at Fitch Ratings, especially among local exchange carriers and cable companies, as those firms increasingly compete in identical spaces, with similar products.

The fourth quarter revealed especially aggressive marketing and competitive pricing and discounting strategies, Fitch says. This trend is expected to affect the competitive landscape going forward, especially putting pressure on average revenue per user and profit margins on discrete products.

The big problem for telco contestants is fixed voice line losses. Although high unemployment continues to affect sales of business lines, and the effect of wireless substitution continues, affecting residential lines, total access-line losses began to decelerate toward the end of 2009 as service bundling, including network-based video services offered by operators such as AT&T and Verizon continued to gain scale.

Cable operators had an arguably easier time, gaining high-speed data subscriber market share growth during the fourth quarter of 2009 despite a decrease in overall broadband additions caused by the persistently weak economy and maturation of the broadband market.

The wireless segment of the business arguably faced the fewest problems. Total wireless net additions were strong, says Fitch.

The industry’s capital spending grew by approximately 20 percent from the third to the fourth quarter of 2009 but remained below fourth-quarter 2008 levels. It is Fitch’s opinion that all communication service providers must invest in their respective networks in 2010 in order to maintain or improve their competitive positions.

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2009 Was Tough for Cable and Telcos, 2010 Will Be a Bit Better

Fitch Ratings analysts say 2010 will be a better year for telcos and cable providers. There are challenges, to be sure. But the biggest question is whether cable and telco companies will be able to keep finding new revenue sources to replace those being lost.

European telcos face further stagnation of top-line revenues and likely have further to go in the process of cutting operating expenses, say analysts at Fitch Ratings.

The weak economic recovery, continued regulatory pressures, maturing service penetration and strong competition, are some of the key forces putting pressure on cash flow and profit margins.

At the same time, service providers are forced to continually invest in mobile and fixed network upgrades  to keep abreast of burgeoning data traffic demands, Fitch says.

To be sure, operators are introducing new services to replace declining revenue sources. But it "looks unlikely that the network operators will benefit from new service revenues in the way they did from SMS data," Fitch says.

Incumbent cable and telco providers in the United States will face many of the same pressures, including increased amounts of competition, wireless substitution and a sluggish economy.
Traditionally, U.S. telecommunications and cable service demand has lagged economic recoveries, and high unemployment, despite the recovery, as well as pressure in the housing sector will put pressure on 2010 financial results.

Fitch expects this lagging trend to continue and any U.S. economic improvement in 2010 will likely not be reflected in telecommunications and cable results until 2011.

"Although the telecom and cable industry has maintained strong liquidity and free cash flow, macroeconomic woes including unemployment rates and a struggling housing market will continue to limit financial growth for the sector," says Michael Weaver, Managing Director at Fitch.

Fitch estimates that aggregate access line losses for 2009 will be approximately 10.5 percent for retail local telecommunications providers. There was a bit of a change in 2009 as slower losses to cable voice providers was offset by higher business access line losses.
Business and residential access line losses should stabilize in 2010 and continue in the range of 3 million to 3.2 million each quarter, which would represent a yearly loss of approximately 12 percent, says Fitch. There is a statistical artifact here.

As the base of voice lines declines, a fixed number of lost lines represents a larger percentage change than it used to. So although it appears at first glance that line loss is accelerating, that is not the case. The decline is steady, but larger in percentage terms.

The loss of legacy revenue of course heightens the importance of new revenue sources for fixed network operators. Broadband access had been such a driver in the 1990s and early 2000s, but is less significant now that the market is saturated or nearly saturated. Fitch estimates that high-speed access subscriber growth slowed in 2009 to 1.7 million net subscriber additions.

In 2010, net new additions should slow further to 1.4 million accounts. But make note: Fitch believes wireless broadband substitution now is poised to become a material factor in line growth.
Multi-channel video likewise has been a growth driver for Verizon and AT&T, but also is slowing. Fitch estimates that net new video customers will grow by two million subscribers in 2009, slowing in 2010 to approximately 1.5 million.
Commercial service revenue will face a roughly flat situation in 2010 after 2009 declines over six percent for wireline companies. In 2010, commercial revenue will grow about one percent.

In total, Fitch estimates that aggregate wireline revenues will decline in 2010 near the mid-single-digit range, a modest improvement over 2009. EBITDA will similarly fall in aggregate by a low- to mid-single-digit range for the industry as benefits from headcount reductions offset losses of high-margin legacy services.

Cable operators also saw accelerating video subscriber losses in 2009 with a reduction of approximately 2.75 percent. Subscriber losses are the result of weak new home growth, but more important, they are the result of competitive erosion from direct broadcast satellite and telco video offerings.

The cable basic subscriber erosion rate will accelerate in 2010 as competitive pressure remains fairly constant, but there will not be the lift from digital television conversion that boosted cable performance in the first and second quarter of 2009.

Fitch estimates that basic subscriber erosion will increase to approximately 3.5 percent in 2010. High=speed access additions also slowed materially for cable  operators in 2009, and Fitch expects subscriber growth of approximately 1.7 million in 2010.
New DOCSIS 3.0 services should help cable operators in the commercial space, though.

Cable telephony subscriber growth rates fell rapidly in 2009 with a reduction of over 40 percent, but with operators still adding two million net subscribers. Fitch estimates that cable telephony net additions will fall to 1.4 million in 2010 as wireless substitution and weak housing-starts affect results.

Cable operators successfully increased their share of the small business and home office market in 2009. Fitch estimates that commercial service revenue increased by approximately 25 percent for cable companies in 2009.

In 2010, operators will start to move up to the mid-size business customer segment in 2010. Fitch estimates that cable revenues will increase in the three percent to five percent range in 2010 and that firm margins will lead to a similar level of EBITDA growth.

Fitch estimates that the total wireless subscriber base grew by about five percent in 2009 andwill slow to four percent in 2010.

Post-paid net additions declining by 42 percent for 2009 compared to a 36 percent decline in 2008. However, data services and advanced devices such as smartphones, netbooks and aircards kept post-paid gross additions relatively flat in 2009. That might not be too comforting, as it shows churn rates are greater than new customer acquisition.
Fitch estimates that prepaid net additions will increase by nearly nine million in 2009 compared to approximately five million for post-paid. Fitch expects that pre-paid additions will again achieve in 2010 a level similar to 2009.

Voice average revenue per user (ARPU) continues to erode at a growing pace approaching double digits in 2009 in part due to lower roaming revenue. This trend will continue in 2010 and at a level equal to or even higher than 2009.

Data ARPU growth has limited the impact of voice ARPU erosion on total ARPU, which has remained relatively steady. Fitch continues to believe that strong data growth will again be achieved in 2010.

In aggregate, Fitch forecasts that wireless revenue will increase in the mid- to high-single-digit range in 2010 and that margins may erode slightly because of higher marketing and retention costs and the success of unlimited prepaid plans.

Fitch expects that capital expenditure will be flat in 2010. Free cash flow increased by 20 percent in 2009 as companies materially reduced capital expenditures.

Fitch believes that FCF will again increase in 2010 by approximately 10 percent due to modestly higher aggregate EBITDA and continued low levels of capital expenditure.


Fitch Ratings

Competitive Cable Developing Too Slowly?

One year after the passage of a law designed to ease the entry into the cable market of competitive providers in Michigan, only 110 of 2,000 communities in the state have a choice of cable providers, according to Multichannel News.

That is to be expected. Cable choice requires construction of brand new networks, not just the granting of a franchise. That takes immense amounts of capital and time, as well. A single new network in a single community can take three years or more to build, if there are no competing demands on construction and installation resources.

And there is history to consider. New video service providers have been attempting to so just this sort of thing for several decades, using a variety of methods, of which the most successful so far has been the use of direct broadcast satellite. There have been scattered regional efforts to duplicate cable networks, but overbuilders have not been notably successful, in large part because it is difficult to justify building a network that gets less than 30 percent penetration, which is what overbuilders largely have been able to attain.

Voice and cable modem services have helped the business case, but overbuilding remains a challenging financial proposition, and few expect widespread new competition in the terrestrial space from any other than incumbent local telephone companies.

The point is that nobody should be surprised nothing much has happened in just a year. New ubiquitous broadband networks take time to build, as well as lots of capital. If it were easy, lots of people would be doing it.

CLECs Must Race Tide

Even though consumers now account for only about 22 percent of total incumbent telco revenue, and even though dominant telcos are losing share in that market, competitors in the business segment essentially are racing an incoming tide.

That tide is lost incumbent market share. At some point, regulators will decide the market leaders have lost enough share, and give incumbents more freedom to price and package their services, which inevitably will lead to higher wholesale rates for competitors that now rely on incumbent facilities--and wholesale discounts based on their market power--to build their businesses.

So the essential strategic task is to take share now, while it can be more easily gotten, knowing that competitive conditions will sharpen once the incumbents are more free to package and price. And that tide is coming in.

U.S. telcos continue to lose residential phone subscribers to both cable VoIP and wireless subscriptions at a steady seven to eight percent a year, according to Citigroup analyst Michael Rollins. Wireless is a lesser issue, as incumbents own a majority of that business, and simply must cope with product substitution. Wireless penetration should rise from an estimated 83 percent this year to 87 percent by the end of 2008.

Indeed, by 2010, wireless-only households should rise to 27 percent, from 13 percent last year and an estimated 17 percent this year, Rollins argues.

Cable VoIP penetration should jump from 10 percent last year and an estimated 14 percent this year to 25 percent by 2010. If the Federal Communications Commission sticks with precedent, that is going to be enough lost share to trigger an end to wholesale access policies favorable to CLECs.

If Rollins is right, those deregulation rules will start to trigger in just a couple of years. Of course, one can argue that market share losses in residential are not the same thing as losses in the business markets. But that hasn't stopped the FCC from deregulating in the past.

Ironically, incumbent market share loss is the very thing that will unleash them as more formidable competitors.