Paradoxically, Higher Capex is a Negative Unless Big New Revenue Streams are Created

Paradoxically, heavy capital investment in telecom networks often is considered to be a negative in financial markets, even if such investment results in higher consumer welfare and an arguably better long-term strategic position.

So it is mildly surprising to hear Globe Telecom touting aggressive spending to improve services in the Philippines. Some might argue that is the only way Globe, and others, can prosper, long term.

Still, it is somewhat uncharacteristic to hear Globe touting a boost in its capital-to-revenue ratio up to 28 percent in 2015, after climbing to 27 percent in 2014.

Globally, telecom capex-to-revenue ratios have been running between 15 percent and 20 percent, with a declining trend.

There is a clear logic. Global telecom revenue growth has dropped to less than GDP growth, according to PWC.

“Some segments (e.g., fixed line) are already in absolute decline, and even global mobile revenue is expected to begin declining in 2018, according to some researchers,” says PWC.

Under such circumstances, it no longer makes sense to invest as heavily as once made sense, since revenue gains will underperform the intensity of the investment. That is a strategic issue of paramount importance.

Ongoing investment might be required, but financial returns might be slim. Inevitably, that means the challenge is to uncover and discover big new revenue streams that justify higher sustainable investment.

source: Infonetics Research

Of course, much depends on what sort of infrastructure is being deployed. Capex in the mobile business is less expensive, compared to fixed network, but also includes spectrum costs.

Still, generally speaking, U.S. mobile market ratios have been falling for some time.

source: TMF Associates

Those levels lead local telecom industry averages of 23 percent in 2015 and 2014.

The capex-to-revenue ratio in China was 36 percent in 2015 and 33 percent in 2014.

In 2015 and 2014 capex-to-revenue ratios in Singapore were 26 percent and 22 percent, respectively; in Indonesia with 24 percent and 26 percent, respectively.

Thailand’s ratio was 23 percent in 2015 and 21 percent in 2014. India had a 2015 ratio of 17 percent and a 2014 ratio of 16 percent.

Taiwan’s 2015 ration was 14 percent and 16 percent in 2014.

Hong Kong had a 13 percent 2015 ratio and 14 percent 2014 ratio.

Malaysia had 13 percent ration in 2015 and a 12 percent ratio in 2014.

Fundamentally, higher capital investment, relative to revenue earned, is a difficult long term proposition. What must be discovered are ways to boost the “revenue” part of the ratio. Higher sustained investment is possible, when that happens.

What Happens When Telcos Start Going Bankrupt?

One has to wonder what happens if many fixed network telcos essentially go out of business, even if that has not yet happened on a significant scale. That might have been unthinkable decades ago.

After all, one might have argued, people and businesses still will need to communicate, even if telcos go bankrupt. And, others might argue, assets do not evaporate, even in a bankruptcy.

So reformed providers would emerge from any bankruptcies of today’s telcos. In large part, that is what already happened with the former “long distance” giants, whose assets now are part of former Regional Bell Operating Companies.

It might be worth noting how wrong prognosticators can be, in that regard. At the time of the Bell system breakup, it was widely believed that the fast-growing, interesting parts of the former Bell system would reside in the separated long distance business, not the local communications business.

In other words, AT&T, freed to grow in the unregulated long distance business, would outshine the regulated “Bably Bell” local access companies (Bell Atlantic, NYNEX, Pacific Telesis, US West, BellSouth, Ameritech and Southwestern Bell).

Most will not recall such times. It was before the Internet, the personal computer, widespread and affordable mobile services.

Notably, the prognosticators were quite wrong. AT&T was absorbed by SBC, which earlier had gobbled up Ameritech, BellSouth and Pacific Telesis; before NYNEX, Bell Atlantic and GTE were merged to create Verizon; before US West was acquired by former rural telco CenturyLink.

MCI was acquired by Verizon. Bell Laboratories and Western Electric, which had been renamed Lucent, also was acquired by Alcatel, which in turn now is owned by Nokia.

Voice no longer drives revenue or business strategy for any of the surviving players. Apps are almost completely created by independent providers and accessed using the Internet.

Worse, the fate of many fixed network telcos is dire.

“Slow yet steady decline” is the fate that awaits CenturyLink, Frontier Communications and Windstream Services, according to ratings agency Moody’s.

“Constraints such as capital allocation practices that favor shareholder returns, lagging infrastructure relative to cable companies and high cost of capital will prevent wireline telecommunications companies (telcos) from taking the necessary steps to fuel growth, resulting in their slow yet steady decline,” says Moody's Investors Service.

Essentially, the telcos are caught in a death spiral.

As they are owned by dividend-seeking investors, the firms cannot shrink or cancel their dividends without causing massive investor flight, with few “growth” investors available to replace those fleeing equity owners, since virtually nobody believes those firms can become “growth” properties.

Their ultimate fate is the issue. Some would argue those firms have high cost structures only formal bankruptcy can cure. The firms could, after radical restructuring, reemerge with cost structures suited to the market opportunities available to them.

That is the optimistic forecast. The pessimistic forecast might be that, even after bankruptcy, the fundamental business model might be unattractive, as costs might still not be low enough, nor revenue opportunity high enough, to sustain long-term operations on a profitable basis.

At the same time, cable TV companies have emerged as key, and ultimately, perhaps, the dominant providers of communications services.

At the same time, other providers are emerging. Google, for example, might be preparing to add voice service to its Google Fiber and video service. That would make it a full triple play competitor to cable TV and telco providers.

AT&T and Verizon, meanwhile, have become mobile service providers with significant fixed network assets, and might not face collapse even if the fixed network business continues to shrink.

Moore’s Law “changes everything,” one might say. More accurately, Moore’s Law means we can create new products, applications and networks using resources that previously were not commercially sustainable, from devices to apps to Internet access to whole networks.

You might argue that is a very good thing, as we might very well need new devices, apps, access and networks as major portions of the legacy communications and application ecosystem become unsustainable.

In a worst case scenario, where major former telcos literally are unable to keep their assets in operation sustainably, the successor companies might already be coming into view. Cable TV companies would be the dominant providers, but major firms such as Google, and likely others, also would have stepped in to replace former fixed network telcos.

In other words, complete business collapse of some traditional fixed network telcos would not be a complete disaster for end users. Other providers would have emerged. And technology will enable many others to contemplate providing service..

The end of an age where communications were dominated by fixed telecom networks therefore would not be a crisis. Those functions are likely to have been replaced by newer generations of competitors.

A previously-unthinkable “soft landing” would then be possible, rather than a “hard landing” where alternative suppliers had not already established themselves in the market.

TRAI Gets Ready to Outlaw Zero Rating

The Telecom Regulatory Authority of India appears ready to outlaw “zero rating” programs such as Free Basics or Airtel Zero, which allow consumers access to use of some apps without requiring either purchase of a data plan, or “usage” against a data plan.

It now appears we are headed for a lengthy period where the ramifications and extent of network neutrality rules get tested in a wider range of settings.

That seemingly always has been implicit in different understandings of what the concept entails, and might not be fully harmonized for quite some time.

For some, who favor a narrower understanding, network neutrality means that no lawful application can be blocked or slowed by the government or an Internet service provider for commercial reasons, though the difficulty has been that sometimes network management might have that effect.

Many would say it is simply prudent network management to take measures to preserve access to network resources at times of peak load, for example.

Supporters will say the move protects consumers and app providers from potential access provider exercise of market power. Under the possible new rules, no Internet access provider could favor its own apps over third party apps, some will argue.

Others will argue the potential new rules stifle innovation and investment, outlawing one way retailers can provide value to consumers and create differentiated offers in the market. In that view, zero rating is no different than any other sampling or discounting mechanism commonly used in the retailing of any product.

Ignoring legitimate disagreements over the concept and application of network neutrality rules, the move also would provide a not-uncommon instance of how difficult it is to craft regulatory policies that spur innovation and investment while also providing high consumer welfare benefits.

It also appears we are headed for an extended period where narrow technical rules to preserve app access increasingly are caught up in broader political questions of industrial policy. Laudable though many policies might be, in narrow technical terms, broader forces are at work.

Forces in government and the economy worldwide are trying to tilt the playing field in favor of domestic firms, and against firms from other countries. That often takes the form of regulatory, legal, taxation or other action that, among other things, is viewed as a means of protecting or promoting internal economic interests, and limiting the influence or success of “outside” firms.

No longer are issues about Internet or Internet app regulation simply about equal treatment of  bits or consumer access to all lawful apps. Unfortunately, those issues now are ensnared in broader policy issues related to perceived economic advantage on a wider scale.

That virtually assures a longish period of policy divergence, and wider differences, rather than harmonized understandings. Rates of innovation and volumes of investment now are perceived to be at stake. Unfortunately, consumer welfare also might be impaired.

Some mistakes are inevitable.

India 700-MHz Spectrum Auction Faces Potential Buyer Strike

Minimum prices set for an auction of 700-MHz spectrum in India are so high (two to four times higher than prior auctions)  that many of the leading mobile companies will not bid. And, according to Fitch Ratings, the eventual spectrum winners might well regret having won. That “winner’s curse” has happened before, often with 3G spectrum auctions.

India's telecom regulator recommended a reserve price of INR115bn (US$1.7 billion) per MHz for nationwide 700MHz spectrum.

Fitch Ratings “believes that efficiency gains from deploying 4G services on 700MHz will be insufficient to offset the relatively high price.”

The reserve price is about twice the price set for 800-MHz spectrum, 3.4 times the reserve price for 900-MHz spectrum and four times the minimum prices set for 1.8 GHz spectrum.

Winning therefore “could exert further pressure on participating telcos' balance sheets and cash flow, and limit their ability to invest in capex over the medium term,” say Fitch Ratings analysts.

In fact, the top four telcos, including Bharti Airtel, Vodafone, Idea Cellular and Reliance Communications may hesitate to bid, as balance sheets already are “stretched,” while available cash is expected to become an issue once Reliance Jio enters the mobile market in the spring of 2016.

Instead, the leaders might choose to rely on spectrum they already have acquired. Bharti Airtel will use 900 MHz, 1.8 GHz and 2.3 GHz.

Reliance Jio, after having invested about US$15 billion on spectrum and networks, will use 800MHz and 850MHz spectrum.

In March 2015, the leading mobile operators had to spend of US$17.7 billion to retain use of spectrum they already were using.

“We believe that there are far fewer reasons for telcos to invest as much in the 700 MHz auction,” Fitch says. As always, there are other alternatives.

Companies can, to some degree, trade and share spectrum, for example.

They also can buy other firms, acquiring spectrum in the process.

During 2015, Reliance Communications merged with Sistema JSFC's MTS India. Reliance Communications also has further plans to merge its wireless unit with that of Maxis Berhard's Indian unit, Aircel Limited.

Fitch believes that smaller and weaker telcos will further seek to be acquired  or exit the industry.

Videocon India, one of the smaller firms which is struggling, has agreed to sell its 4G spectrum assets to the third-largest telco, Idea Cellular.

Fitch expects competition to intensify upon Jio's entry in the market

Blended monthly average revenue per user could fall by five percent to six percent to around INR160 (2015: INR170.

Earnings will suffer as prices drop and marketing spend increases.

"Long, Slow Decline" for Fixed Network Telcos, Says Moody's

Not every problem has a solution, at least not a solution satisfying to the entities with the problem.

In the U.S. market, for example, an entire category of service providers--”long distance” suppliers--ceased to exist. Sure, the assets remained in service, but the firms, and the category, essentially disappeared.

Recall that AT&T and MCI were stand-alone firms engaged solely in the long distance voice (and to some small extent in the capacity market). AT&T was bought by SBC, which took the name and assets.

MCI was purchased first by Worldcom and then Worldcom by Verizon. Sprint still owns its long distance assets, but it is a smallish and declining business with little impact on overall company financial results.

The same fundamental problem is faced by the larger fixed network U.S. telcos. “Slow yet steady decline” is the fate that awaits CenturyLink, Frontier Communications and Windstream Services, according to ratings agency Moody’s.

“Constraints such as capital allocation practices that favor shareholder returns, lagging infrastructure relative to cable companies and high cost of capital will prevent wireline telecommunications companies (telcos) from taking the necessary steps to fuel growth, resulting in their slow yet steady decline,” says Moody's Investors Service.

Essentially, the telcos are caught in a death spiral (my words, not Moody’s). As they are owned by dividend-seeking investors, the firms cannot shrink or cancel their dividends without causing massive investor flight, with few “growth” investors available to replace those fleeing equity owners, since virtually nobody believes those firms can become “growth” properties.

“Telcos such as CenturyLink Inc. (Ba1 negative), Frontier Communications Corp. (Ba3 stable) and Windstream Services LLC (B1 stable) all have high dividend yields that promote a cycle that steadily erodes each company's value and scale,” says Moody’s. In other, the need to pay dividends starves the firms of the capital they might otherwise put into network infrastructure.

"These telcos have strong operating cash flows and the ability to invest more, but they are hindered by market expectations for dividends," said Mark Stodden, a Moody's Vice President and Senior Credit Officer. "Their weak market position can only be changed by increased investment, but this would threaten dividends and is unpalatable to both equity investors and management teams."

Moody's also notes that the high cost of capital has kept these companies from investing in the necessary infrastructure to provide faster-speed service to residential and small-business customers.

A widening competitive gap between these telcos and cable TV operators is the result.

Some problems just have no positive solutions. As was the case for the long distance providers, market exit will be the eventual result.

Iliad Ponders U.K. Mobile Market Entry

Iliad’s Free Mobile, eyeing asset disposals a Three UK and O2 merger would entail, is considering entering the U.K. mobile market.

European Union regulators will give the proposed merger close scrutiny, as the merger would reduce the number of facilities-based national mobile providers from four to three.

That is a key reduction, as many observers and regulators think four is the minimum number of contestants to promote robust competition. An entry by Iliad might, some could argue, immediately bring the number of leading providers back up to four.

Others might argue the U.K. market already has Virgin Mobile and other mobile virtual network operators, with future entry by Liberty Global a virtual certainty. Sky might be interested in any divested transmission and customer assets as well.

Ironically, no matter what regulators or incumbents seem to desire, new competitors seem able to enter mobile and Internet access markets rather frequently, despite the high barriers to entry that many would say exist.

In India, Reliance Jio has triggered a massive restructuring wave.

In the U.S. Internet service provider market, Google Fiber and scores of independent ISPs are building gigabit Internet access networks in markets dominated nearly completely by cable TV and telco ISP operations.

In the U.S. mobile market, where regulators nixed a merger of number three and number four mobile providers (Sprint and T-Mobile), Comcast is preparing its own entry into the market, while Dish Network has amassed serious spectrum assets (either to entry as a retailer or to sell its assets), while additional contestants such as LIghtSquared and Globalstar also want to get into the mobile business in some way.

One might well argue that no matter what service providers and regulators might prefer, reducing the number of leading providers in mobile or Internet access markets is proving to be ephemeral.

Telco Success in New Markets Can Take a While

As mobile and fixed network telcos gear up for coming Internet of Things opportunities, it will be helpful to remember that success will take time. That same admonition applies for mobile video services or any other over the top efforts telcos ultimately will undertake.

Rarely do telcos achieve success right out of the gate. In fact, it can take a decade or two before it is clear they have obtained a sustainable position in a new market.

A few will remember the skepticism many had a few decades ago about prospects for telco to succeed in entertainment video, especially in roles other than as distributors of subscriptions.

The argument had been that telco ownership of content assets would not work well, as content was not a core competence. Skepticism about telco roles in the over the top app (OTT) arena are similar, and early efforts in OTT sometimes have suggested skepticism is warranted.

But it also is fair to recall that it has taken decades for telcos to position themselves for a leading role in linear video entertainment. There was no “overnight success.” In part, the reason was the need to upgrade a substantial percentage of physical plant to support quality video.

Many do not recall that US West, Pacific Bell, Bell Atlantic and AT&T once considered owning, or actually owned, major cable TV assets.

That those assets later were divested only shows how long it can take before a sustainable business model develops in the telecom business. BellSouth filed to operate a cable TV service in 1996.

Prior to that, PacBell, Bell Atlantic and Nynex had formed TeleTV, a business unit to create programming.  

And as many would attest, replacing copper access with fiber to home is a huge financial undertaking.

That alone, given the difficulties, would have been an obstacle.

But AT&T now is the single biggest distributor of linear video in the U.S. market. Yes, it relies heavily on former DirecTV assets, but its leading position is striking, for an industry not believed to be a serious contender in video, decades ago.

There has been even more skepticism about telco ability to compete in the video programming part of the business. But that might have been said about former cable TV operators as well, and that has proven a misplaced fear.

So long as programming entities are allowed to manage themselves, there has proven to be no serious impediment to cable TV operator success as owners of programming assets. Verizon hopes to prove that also is the case for telcos.

It has been two decades since those early forays, and telcos now are established providers of linear TV in the U.S. market. They now are positioning for mobile video and related businesses.

It might take some time. But there is no reason to believe telcos are incapable of success in video services or any of the related businesses. They just have to approach it the right way.

If history is any guide, it might take some time.