Valuation Explains Proposed AT&T Acquisition of Time Warner

If you had a choice, would you rather “be Facebook” or “be AT&T?” In terms of revenue growth, equity value or physical asset intensity, many would choose to be Facebook. In other words, many would rather operate an over-the-top application business than an Internet access business.

Globally, a “telco” might be valued at 4.4 times enterprise value divided by earnings (EBITDA). Content companies might be valued at 11 to 12 times EV/EBITDA. Facebook might be valued at 16 times EV/EBITDA.

In other words, a rational person would rather own an asset worth four times that of a telco, when there is a choice.

Telco executives have limited options, unless they want to sell their assets and go out of business as independent entities. But there is one obvious strategy if they wish to stay in current lines of business, and yet reach for higher-valuation revenue streams: they can own more assets of the higher valuation type.

In other words, they can augment lower-multiple access businesses with higher-multiple content or application businesses. That “move up the stack” or “move up the value chain” strategy is simple enough, if execution risk exists.

And that explains why AT&T would want to own Time Warner.

EV/EBITDA multiples of larger emerging operators by geographical exposure

source: EY

Source: Sentieo.com

source: Queens Business Review

AT&T and Time Warner: "Own Some of the Content You are Delivering"

AT&T’s bid to buy content powerhouse Time Warner has some observers speculating that the deal has little “synergy,” even if it would bring ownership of leading and big brands such as HBO, TNT, CNN and the Warner Bros. studio.

The deal represents about an $80 billion to $90 billion move into the content business by AT&T, on the heels of its big move into the linear video business, when it purchased DirecTV for $57 billion, transforming AT&T into the largest linear video provider in the U.S. market.

source: Bloomberg

Others just think the additional AT&T debt load is unwise, in large part because of the new debt AT&T will have to take on. But that was precisely what was said about the DirecTV deal as well, and at least so far, that is proving to be a positive development.

During the recent Spectrum Futures conference, mention was made of the fundamental strategy U.S. cable operators will take to “move up the stack (value chain).” Simply, the idea is that “you have to own at least some of the content that flows over your pipe.”

The Time Warner deal appears to be a perfect example of that same strategy, employed by a telco instead of a cable company.

The issue is that all triple-play providers sell a mix of services, ranging from “dumb pipe” Internet access (“tickets to Disneyland”) to applications such as voice, messaging, video entertainment or home security.

But to avoid being reduced simply to a “dumb pipe,” an access provider has to own at least some of the content, some of the apps, some of the services its customers want to use.

In other words, in addition to selling “dumb pipe” Internet access service, which under competitive conditions is subject to price per unit reductions and price competition generally, service providers must become owners of at least some of the new apps and services that its customers want to use.

It is not complicated: that is the strategy for “adding value” and “moving up the stack.” To be sure, there are some tangible benefits. As a major buyer of content from Time Warner, AT&T now at least is able to “pay itself.”

AT&T also now earns more from video than voice services.  

How AT&T benefits from owning Time Warner is a complicated question. Some might think AT&T could win by changing Time Warner content distribution, and making that content exclusive to AT&T.

AT&T will not be able to do so, at least for those networks routinely sold on linear video services.

U.S. rules force content networks that sell content to linear video distributors to sell to all such providers. There is no exclusivity. On the other hand, there are some content services--largely selling only online, that are not covered by the rules.

The interesting example is DirecTV’s NFL Sunday Ticket service, broadcasting football games. NFL Sunday Ticket is not covered by the rules pertaining to programming networks, presumably in large part because the NFL is not directly a programming network, and simply licenses the rights to show games.

Likewise, some new mobile streaming services do not seem to fall under the rules covering linear video programming networks.

At least in principle, some content (programming, rather than networks) could be developed for “direct-to-consumer” delivery, not using the linear video distribution system, and therefore be free of mandatory wholesale rules that pertain to linear video distribution.

But AT&T does not seem to prefer the “unique content” strategy in any case, at least for the moment. That strategy is very expensive, and AT&T seems to prefer the sale of “widely-viewed content” on networks that are themselves widely viewed.

There is some benefit in the area of content acquisition costs, but not direct impact. As programming fees rise, AT&T has to pay more for such content. Owning Time Warner will not change that. But AT&T will gain--as a content owner--from the fees it earns from all other distributors.

But AT&T does seem determined to acquire additional content assets as well, just as it intends to create connected car or eventually other Internet of Things applications and services that also use its network.

What is important, though, is to note that the objective is to “own at least some of the content and applications that flow over the access pipe,” not the desire to create unique walled garden assets available only to AT&T customers. That is a crucial distinction.

The same strategy would seem to apply to other services, in other industries. Connected car services, for example, where AT&T supplies the actual end user service or platform to a car manufacturer, provide one example.

Instead of supplying simple mobile network access, AT&T will seek to become the owner and supplier of connected car services (content, security, vehicle monitoring).

There is a clear strategy here, pioneered by cable TV companies. In a business increasingly anchored by “dumb pipe Internet access,” where there is much competition for any app--voice, messaging, video, utilities, content, transactions--an access provider has to own at least some of the useful apps people want to use.

Exclusivity is not required. Branding is not constrained to the “service provider” brand, in all cases. If people want to use a particular app or service, and that is widely used, it makes sense to retain the retail brands, and not force the use of the access brand.

This is a shift in model. In the past, all services were branded under the parent’s name--AT&T X, Y and Z. In the future, what will matter is the revenue, cash flow and profits generated directly by the end user services and apps, even when--or especially because--those apps and services are in high demand by end users.

In essence, AT&T and Comcast become multi-industry conglomerates, to an extent, making money in several different industries whose common focus is that they require Internet or mobile access.

Moving up the value chain does not always require full branding under the legacy access provider name. It does require ownership of some of the assets.

What Does it Take for Telcos to Innovate?

Whether larger service providers can successfully innovate, or  not, remains a key question as service providers look for additional ways to “move up the value chain.”

On one hand, Bell Labs has won many Nobel prizes. On the other hand, many efforts by tier-one service providers have not worked out, said Rajan Mathews, Cellular Operators Association of India director general.

That might be one good reason why most tier-one service providers have grown by acquisition. The trick is to avoid destroying the value of the asset once that happens. How larger companies can cultivate innovation by startups is another story.

“Alignment of the whole ecosystem” is the only way we will connect everyone to the Internet, and also is the only way mobile service providers can prosper, according to Mohammed Shafi, CEO of Multinet Pakistan.

“From the private sector side it is a business; while the government sees communications as a service,” said Shafi at the Spectrum Futures conference. And there are many ways the ecosystem can be improperly aligned.

There is a mismatch between demand and supply, but that mismatch is not inevitable. “Competition would help,” said Shafi. “But costs are high because the government taxes every step of the way.”

Alignment also can be an issue when application providers try to work with telcos and Internet service providers or mobile operators, suggested Dennis Wong, a venture capital analyst with Golden Equator Capital. “Do ISPs really have the interests of start-ups at heart?” he rhetorically asked.

Even communication is an issue. “Large companies always speak a different language” from entrepreneurs and startup leaders, argued Shrinith V., a venture capitalist who advises startups.

For those reasons, perhaps the best way larger telcos and ISPs can participate in the startup business is as limited partners who supply money, but do not exercise management control, suggested Kenrick Drijkoningen, Golden Gate Ventures expert in residence. “It’s hard to bridge the cultural gap,” he said.

5G Networks are "Completely Different"

Fifth-generation mobile networks are coming, but even the nomenclature underplays the magnitude of the shift. The shift from first generation to second generation was the shift from analog to digital.

The change from second generation to third generation was about data capacity and potential new apps. The move to fourth generation was about speed.

 

“5G is completely different,” said Australian consultant and former regulator Bob Horton. “5G is a convergence of mobile, Internet and Internet of Things,” Horton said at the Spectrum Futures conference.

In fact, the notion that 5G primarily is about “speed, throughput and mobile broadband” is a bit of a myth, said Reza Arefi, In tel director of spectrum strategy. In fact, 5G also is about applications and especially low-latency applications.

“An autonomous vehicle can generate a gigabyte of data each second,” said Arefi. Some of that processing is required because a vehicle has to detect and respond quickly to obstacles, traffic lights and the presence of pedestrians.

5G also is proving to be the impetus for an unprecedented expansion of bandwidth available for communications purposes. In addition to use of spectrum below 6 GHz, 5G is going to use spectrum at 28 GHz, 34 GHz, 37 GHz, 38 GHz and 60 GHz, said Arefi.

One way of comparing the amount of bandwidth is to note that today’s 4G Long Term Evolution services use 20-MHz channels (sometimes less). At 28 GHz, channels will be 100 MHz wide, and it will be possible to aggregate as many as eight such channels, implying the possibility of 800-MHz channels.

What that means is much higher bandwidth, as bandwidth efficiency varies directly with the amount of spectrum available and the amount of contiguous spectrum. As much as 90 percent of all potentially usable communications spectrum lies in the millimeter wave regions between 3 GHz and 300 GHz.

In fact, the U.S. Federal Communications Commission already has said it will authorize new communications spectrum representing 29 GHz of additional capacity. Keep in mind that all presently-available mobile and Wi-Fi spectrum totals less than 1 GHz of capacity.

AT&T Shows Ir Understands How to "Move Up the Value Chain"

AT&T’s purchase of Time Warner might not make sense to some, but it illustrates a very simple strategy for “moving up the value chain.” In fact, the move matches the general way cable TV companies approach strategy related to its “dumb pipe” Internet access operations.

Simply, the strategy is that “you have to own at least some of the content delivered over your pipes and used by your customers.” That was the thinking when Comcast purchased NBC-Universal, for example.

That strategy obviously now is at least partly embraced by AT&T, which now is the largest supplier of linear video TV service in the U.S. market. Like Comcast and other cable TV operators, AT&T faces slow attrition in the core linear TV business. So linear video suppliers are transitioning to a different market, where over the top video is dominant.

For obvious reasons, mobile service providers are more optimistic about the role of mobile-consumed video than cable operators are willing to admit in public.

In any case, OTT means pressure in the “dumb pipe” Internet access business (prices per unit are falling) can be partially offset if pipe operators also own and benefit from revenue generated by ownership of content.

That also suggests an approach to other applications and services as well, outside the content area. Large Internet service providers will want to explore how they can become owners of at least of the popular apps used by people.

An analogy:Today, ISPs sell tickets to enter a theme park. What consumers want is the theme park attractions (all the things one can do on the internet). By owning at least some of the content or applications people want to experience inside the theme park, ISPs can avoid become sellers of tickets to enter the park, when competing with others who also sell admission tickets.

That is not to downplay the need to operate and upgrade the core “dumb pipe” access business. Indeed, high speed access will eventually become the foundation service for any service provider, even if “applications” also are key products (voice, messaging, content).

Historically, the ability to use such apps “untethered” also has been a value and revenue driver. Mobile voice has value beyond that of fixed voice, and will continue to hold that value over time. But there are now other ways to gain untethered access, including Wi-Fi, that diminish the formerly-exclusive value of mobile access.

So ISPs now operate in a context where they are multi-product suppliers. There is a distinct “Internet access” or dumb pipe business (tickets to the theme park) as well as the separate application and content businesses (voice, messaging, video, content, banking or payments).

AT&T’s Time Warner purchase is an example of it following the principle that “you have to own at least some of the content delivered over your pipes and used by your customers.”

How Much Could Yahoo Boost Verizon Revenues?

Scale matters for consumer social apps as much as it does for mobile service providers, cable TV companies or fixed network telcos. Among other reasons, scale means more customers, more accounts and therefore more gross revenue.

Facebook’s average revenue per user rose 33 percent year over year to $3.32 in the first quarter of 2016. That implies annual revenue per user of perhaps $13.28.

Scale therefore means that every million users Facebook gets should contribute $13,3 million in revenues. Facebook added about six million users in the first quarter of 2016, for example. So Facebook likely grew revenues $79.8 million for the quarter, and therefore as much as

$319 million over a year from that user cohort.

Worldwide, there are over 1.71 billion monthly active users, a 15 percent increase year over year.

The value Verizon can produce from adding Yahoo to its AOL unit likewise hinges on the value of scale.

If one assumes Yahoo can earn $6 per user per year from 800 million users, that implies about $4.8 billion in annual revenue. If Verizon annual revenue is at least $124 billion a year, then mobile advertising lift from Yahoo could be nearly four percent of revenue.

Assuming Verizon can continue to do at least that well, you get some idea of the  lift Verizon might expect, near term, as Verizon tries to position its AOL unit as an alternative to Google and Facebook for mobile advertising.

With the caveat that Verizon had a worker strike that affected second quarter results, it might be worth noting that the second quarter revenue decline was about $1.6 billion, with Yahoo in principle representing about $1.2 billion in quarterly revenue.

Whether Verizon can grow Yahoo users and maintain or raise revenue per user is the test of value, going forward. Scale, in other words, is the upside.

source: .benphoster.com

Some might argue the Yahoo acquisition will not help Verizon that much, especially if the core asset depreciates, instead of appreciating. But if it works, the mobile advertising push conceivably could generate eight percent of total Verizon revenues. That is material.

Hard Work, Moore's Law, Human Cleverness for Breathing New Life into Many Legacy Platforms

At one point a couple of decades ago, even sophisticated access technologists might privately have thought standard twisted-pair cables used by telcos would not work reliably enough to deliver 10 Mbps to scores of megabits per second.

By the same token, many would not then have believed cable TV hybrid fiber coax networks capable of reaching hundreds of megabits per second, much less gigabit speeds. But credit hard work, technical cleverness and Moore’s Law for breaking all those limits.

Swisscom is deploying G.fast, which allows Swisscom to reach transmission speeds of up to 500 Mbps on networks with relatively short copper drop cables and optical fiber distribution networks.

That deployment is part of a process whereby legacy networks are upgraded to deliver bandwidth that once was thought “impossible” on telco legacy copper drops, cable TV hybrid fiber coax, fixed wireless or mobile networks

Better radios, signal processing and advanced modulation techniques, plus new architectures, are also are contributing to the way mobile and fixed wireless networks is improving

In the medium to long term, Swisscom intends to supply 85 percent of all Swiss households and businesses with bandwidth of at least 100 Mbps by the end of 2020.