Windstream Acquisition of EarthLink Fits

Windstream’s proposed acquisition of EarthLink is supposed to unlock about $125 million in annual synergies, including an additional $990 million of revenue. The deal also illustrates the importance of enterprise and mid-market customers in the core telecom market for service providers unable to grasp other opportunities.

Smaller service providers often do not have the options tier-one providers have available to them to diversify into new lines of business as older revenue sources decay.

CenturyLink, for example, does not own mobile assets. Neither do Windstream, Frontier Communications. None of those firms have the scale to move into content creation or mobile advertising, Internet of Things apps and connected cars.  

Still, there are some options. Not all segments of the core telecom market have the same revenue per account or margin per account profiles. Rural accounts generally come with lower average revenue per account than urban accounts; consumer accounts produce less revenue than business accounts.

So CenturyLink and Windstream and Frontier Communications have followed similar strategies. All originally were rural service providers and all three have pushed to become providers of services sold to business customers.

The former rural carriers have taken a path that is open to them, namely shifting the center of gravity of their operations from lower-revenue-per-account consumers to more-lucrative business customers.

If the CenturyLink purchase of Level 3 Communications clears, CenturyLink will earn 88 percent of revenues from business customer services.

Since about 2010, both Windstream and Frontier have earned most of their money in the business segment, despite the continuing preponderance of consumer accounts.

In its second quarter of 2015, Windstream had revenues of $1.4 billion. Consumer revenues  represented just $314 million--about 22 percent--of total revenues.

Frontier Communications total revenue of about $1.4 billion as well, with consumer revenue of about Total residential revenue was stable at $615 million for the second quarter of 2015, while total business revenue was $621 million. So a bit more than half of revenue was generated by business customers.

source: Windstream

Without Zero Rating, Video Service Models Will Not Work

Though zero rating has been viewed through a “network neutrality” lens, it also, and equally, is a matter of content business models. To outlaw zero rating is to outlaw many content businesses as well.

For that reason, and ultimately, zero rating will have to be deemed lawful for content businesses that use the internet. That is why all four U.S. mobile service providers are moving to some form of zero rating for video consumption.

Historically, most media and content businesses have relied on zero rating. Cable TV subscribers buy content, and use the access network--without extra charge--simply as the delivery mechanism. Over the air TV and radio use the same model, as do satellite content providers. Streaming video services operate the same way.

Even print content subscriptions do not charge separately for “delivery” of magazines, newspapers or other content.

As the internet now has become the delivery mechanism for video and other content, business models and regulatory frameworks for managed content services will have to be allowed, or the media business model will not work.

The reasons for the change are simple enough. The consumer content business actually does not work if a content subscription also includes charges for use of the network.

Video is the most bandwidth-intensive application typically used by consumers, by an order of magnitude or more. In other words, consumption of one minute of video consumes more bandwidth than one minute of web browsing, and up to a few orders of magnitude more data than one minute of texting, voice or messaging.

Revenue per bit metrics likewise are skewed. By some estimates, where voice might earn 35 cents per megabyte , revenue per Internet app might generate a few cents per megabyte. It gets worse. Mobile operators earn nothing when customers watch over the top services such as Netflix, beyond the typical bigger data buckets such behavior will drive.

Forecasts that the typical smartphone user will require 4.4 GB per month of data completely fall apart if significant video consumption is factored into the model. Between 2016 and 2019 alone, video data consumption could increase by an order of magnitude.

A single viewed two-hour movie might consume 480 MB, a high-definition movie consumes perhaps 850 MB. As mobile video consumption becomes a major activity, it is not hard to predict the impact on networks and data consumption if a typical viewer watches only eight items a month of movie content, consuming between 4 GB and 7 GB per month.

And that might well prove to be an understated amount of consumption. Mobile video consumption might already have surpassed desktop video by the end of 2016.

source: IAB, GfK

source: Cisco

source: Cisco  

Why SingTel, Axiata, AT&T, NTT and Verizon are Making Investments Outside Their Core

There is an exceedingly good reason why firms such SingTel, Axiata, AT&T, NTT and Verizon are undertaking growth initiatives many consider risky, such as moving into digital content and advertising.

With the voice model maturing, some markets still are pinning hopes for growth on data revenues. But what is to be done in markets where data adoption already is nearing saturation? That is the reason tier-one service providers are investing in lines of business "outside" their traditional "access revenues" core.

Communications service revenue is a mix of price per unit and volume, which is to say, a function of supply and demand. Up to a point, suppliers can compensate for increased supply, which lowers prices, by increasing sales volume.

If supply continues to increase,  that strategy fails, though. And some might argue that the drivers of supply increase are numerous. New competitors, new spectrum and new technology are expanding supply.

Demand is increasing, as well. But that demand also comes with price sensitivity. Consumers cannot pay “any amount” for communications services. So even if demand growth is exponential, revenue growth tends to be linear.

Source: JP Morgan

Source: JP Morgan

source: Cisco

In 2011, researchers at Analysys Mason provided this estimate of future mobile revenue per gigabyte, a basic trend hard to refute.

source: Analysys Mason

A separate 2011 forecast by Strategy Analytics suggested the same trend would develop. Analysts at McKinsey likewise have pointed out that service providers need to radically reduce costs for data access.

All those trends make clear why mobile and fixed service providers are vigorously looking for big new revenue sources. Volume increases are not going to compensate for price per unit drops, forever.

The telecommunications business is harder than it used to be, but not only because competition now is the rule. The emergence of the Internet means the access and transport functions are only a part of a bigger ecosystem.

As consultants at PwC point out, telcos and access providers operate in the “network” part of the full value chain. But most of the value will come elsewhere, from services and apps able to provide the intelligence and control for processes that modify real-world activities.

That is why moving up the value chain is so important, and why many access providers are investing in Internet of Things, machine-to-machine communications and industrial Internet, if rather cautiously.

Is CenturyLink Acquisition of Level 3 a Mistake, or Sound Strategy?

There is no shortage of critics of AT&T’s bid to buy Time Warner, no shortage of those who also think CenturyLink’s effort to buy Level 3 Communications is a mistake. Many in the policy community likewise considered the Comcast acquisition of Time Warner, the AT&T acquisition of T-Mobile US and the merger of Sprint with T-Mobile US profound mistakes.

One might even find a few who think, well after the Comcast acquisition of NBCUniversal, that deal was a mistake.

Perhaps even some who doubt Windstream’s acquisition of EarthLink will make much sense. Windstream reportedly is in talks to buy EarthLInk. Windstream, based in Little Rock, Arkansas, had a market capitalization of about $653 million, while Atlanta-based EarthLink was valued at about $572 million.

To be sure, there are antitrust concerns at the heart of many of the proposed acquisitions. But even when antitrust is not a key issue, many believe some of the proposed deals are unwise.

Lack of synergy, lack of value creation or execution risk are common complaints. CenturyLink plus Level 3 Communications only makes a bigger company losing money, some argue. AT&T does not need to own Time Warner to reap the benefits of content acquisition, others argue.

Execution risk is an issue; always is. But an argument can be made that accepting even moderately-high levels of risk is a necessity for all tier-one service providers, for structural reasons.

In monopoly days, service providers owned 100 percent of the applications they sold. In the internet era, service providers own some of the apps customers use. Strategy in the internet era is to capture at least some of the value of the applications business, as total ecosystem revenue is moving to apps, and away from access.

And that is the key to understanding some of the mega-mergers. Smaller service providers often do not have the options tier-one providers have available to them. CenturyLink, for example, does not own mobile assets. Neither does Windstream.

Also, both CenturyLink and Windstream, plus Frontier Communications have followed similar strategies. All originally were rural service providers and all three have pushed to become providers of services sold to business customers. None arguably have the scale to become major players in digital advertising, mobile advertising or mobile content.

With that option off the table, the former rural carriers have taken a path that is open to them, namely shifting the center of gravity of their operations from lower-revenue-per-account consumers to more-lucrative business customers.

If the transaction clears, CenturyLink will earn 88 percent of revenues from business customer services.

Since about 2010, both Windstream and Frontier have earned most of their money in the business segment, despite the continuing preponderance of consumer accounts.

In its second quarter of 2015, Windstream had revenues of $1.4 billion. Consumer revenues  represented just $314 million--about 22 percent--of total revenues.

Frontier Communications total revenue of about $1.4 billion as well, with consumer revenue of about Total residential revenue was stable at $615 million for the second quarter of 2015, while total business revenue was $621 million. So a bit more than half of revenue was generated by business customers.

You might argue that moving into brand new lines of business is better, if it can be done. But where it cannot be done, then shifting operations to higher-revenue customers makes sense, where it can be done.

The telecommunications business is harder than it used to be, but not only because competition now is the rule. The emergence of the Internet means the access and transport functions are only a part of a bigger ecosystem.

As consultants at PwC point out, telcos and access providers operate in the “network” part of the full value chain. But most of the value will come elsewhere, from services and apps able to provide the intelligence and control for processes that modify real-world activities.

That is why moving up the value chain is so important, and why many access providers are investing in Internet of Things, machine-to-machine communications and industrial Internet, if rather cautiously.

Charter Confirms it Will Get into Mobile Business

In case you had any remaining, doubts, both Comcast and Charter Communications--firms that control 75 percent of all U.S. internet access subscriptions faster than 25 Mbps and 82.5 percent of all U.S. cable customers--are going to be in the U.S. mobile services business.

“Charter intends to leverage and expand its existing Wi-Fi service, work with MVNO partners, and, at the appropriate time, invest in its own licensed spectrum based wireless network,” the company says in a filing with the Federal Communications Commission.

You can draw your own conclusions about what that ultimately will mean for the structure of the U.S. market.

But it is at least plausible that Sprint and T-Mobile US cease to exist as independent entities, and that all four of the largest U.S. mobile providers are parts of “fixed plus mobile” firms that sell the full range of video, voice and data services to consumers and businesses.

That could develop if--and some would say “when”--Comcast and then Charter move to acquire one of the two “mobile only” providers at the top of the U.S. mobile market. As has been the case in other parts of the communications market, the leading cable companies will challenge the legacy telcos--AT&T and Verizon--for market share.

Should that happen, there will no longer be any question about whether “mobile only” works as a fundamental strategy for the tier-one providers. At the point where all four tier-one providers operate both mobile and fixed networks, the “mobile-only” strategy will be reserved for smaller specialists.

As has become the case for telcos that have non-overlapping fixed network footprints, Comcast and Charter also will, for the first time, compete against each other in the mobile realm.

Mobile will foundational for cable operators looking for revenue growth. For starters, it is a big business where they can take market share, as they have done in voice, internet access and business services.

With respect to enterprise services, one only has to note the shift of enterprise traffic from fixed to wireless networks (mobile, Wi-Fi and probably fixed wireless), to understand the attraction of owning mobile assets.

Traditional “fixed network” traffic might represent as little as three percent of volume by 2025, Bell Labs believes. For nearly any major service provider serving enterprises, inability to sell mobile services at retail misses much of the market opportunity.

source: Future X Network

In Data Era, Will Revenue Match Costs?

Though--as always--different nations, regions and providers will face different business model changes in the next era of communications, a potentially disastrous possibility exists.

In the voice era, lower unit prices stimulated usage. That did not prevent voice prices--especially international and national long distance--from dropping by a couple orders of magnitude. But vastly-higher volumes sold partly made up for the retail unit price changes.

Some believe tougher problems await in the data era.

Even after accounting for Wi-Fi and new technologies and alternate business models, there will be still significant global wireless data demand that is not economically possible to serve,” says James Sullivan, J.P. Morgan head of Asia equity research.

In other words, demand will not match supply, in part because data revenue will not scale with capital investment, even if that was roughly the case with voice services. As voice prices dropped, usage exploded, so lower unit prices were somewhat balanced by more volume.

Declining value capture is paired with a significant, and ongoing, increase in capital intensity. In at least some cases, that will mean possible nationalizing of networks. In other cases, competitors might be forced to consider sharing network facilities, to stave off such intervention.

That would overturn nearly a half century of moves to privatize assets and introduce competition.

“Emerging market telcos have no choice but to fundamentally change the structure of industry assets through the unification of networks via nationalization, centralization under a regulated return utility, or more aggressive commercial network sharing,” argues James Sullivan, J.P. Morgan Chase Head of Asia Equity Research.

Simply, between now and 2024, telco capital investment and operating expense will climb, while revenue growth lags. But there also is regulatory risk. India, the Philippines, Thailand, Malaysia, Indonesia and Turkey are countries where capex pressures are the big problem.

Regulatory risks exist in Indonesia, Brazil, South Africa and Malaysia, he argues.

Markets with the potential for the most extreme margin compression include the Philippines, India and South Africa; while more defensive margin markets are Nigeria and China, says Sullivan.

Differential margin always has been a characteristic of the business. Universal service funds exist because it often is not possible to support universal communications in rural areas, for example.

Gross revenue and profit margin always has been higher in the business customer segments than in the consumer segments; higher in some geographies than others; higher in denser areas than in lower-density areas.

Gross revenues and profit margin also have varied by product line.

Sullivan’s argument is that there is something profoundly different about supply costs and revenue in the data era. Consider what mobile operators are doing in the U.S. market to accommodate burgeoning video content demand: they are zero rating content.

In other words, customer data plans are not charged when consumers view entertainment video. That is not an unusual practice, historically. It is the way linear video subscriptions, broadcast TV, broadcast radio and most other content businesses have operated.

But consider the capex implications: huge investments in capacity have to be made under conditions where the key drivers of demand (video) do not produce direct incremental revenue.

It is a huge challenge.

Is "Mobile Only" a Viable Long-Term Strategy at the Top of the U.S. Mobile Market?

One of the bigger strategic issues in the traditional telecom business is whether a “mobile only” strategy is sustainable, or whether ownership of both fixed and mobile assets, in the same market, is a better approach, if it can be achieved.

With some exceptions, only the legacy, monopoly-era service providers have an easy choice. Since they already own the fixed network, and want the growth mobile provides, it is an easy choice to embrace both.

Attacking carriers tend, in most markets, to be mobile-only providers, in part because additional spectrum and government policy allows them to enter markets as attackers, and because the cost of building a fixed network is prohibitive.

The exceptions are North America and Western Europe, where attacking carriers sometimes are able to acquire both mobile and fixed assets, allowing them to operate as “full service” providers out of market.

In the U.S. market, for example, half of the top mobile operators are “mobile only,” while two (the legacy providers) own both fixed and mobile assets.

At least some observers might argue that a viable “mobile only” role can be sustained, long term, in the U.S. market. Some of us doubt that.

The reason is that neither of the two mobile-only businesses appears to have the scale to survive as independent entities, for the long term.

While a merger of the number-three and number-four service providers is theoretically possible, U.S. regulators have vetoed two separate efforts to merge assets--AT&T and T-Mobile US; and Sprint-T-Mobile US--within recent years.

Beyond that, other providers have the means and motivation to acquire the mobile-only companies. As both Comcast and Charter Communications, the two behemoths of the U.S. cable TV industry, will be getting into the mobile business, and since the business now is a scale game at the top, both T-Mobile US and Sprint offer ways for those two firms to enter the mobile business in a major way, with national footprints.

Other potential suitors also might exist. Dish Network has to create facilities or sell its licenses. And any number of other firms in the internet ecosystem might have reasons to consider such acquisitions, though such moves do not make as much sense as acquisitions by Comcast and Charter.

So, at least in the U.S. market, the answer to the strategy question might be that a “own both” strategy will apply.

That does not rule out some specialized “mobile-only” business models based on use of unlicensed or affordable shared spectrum. But such approaches are not likely to seek leadership of the traditional mobile market. It will simply be too competitive a market for any such undertakings.

In the near term, the U.S. mobile service provider market is grinding ahead, with subscriber growth extremely difficult in the saturated market.

T-Mobile US added the most gross connections in the third quarter of 2016, adding two million gross accounts. AT&T added about 1.5 million gross new accounts.

The U.S. mobile market ended the quarter with about 5.2 million gross new connections gained by the top-four carriers, but a net connection gain of about 482,000 connections.

And many of those connections were lesser-revenue tablet or Internet of Things adds. A total of 1.3 million tablets were activated in the third quarter of 2016, for example.

AT&T and T-Mobile US both increased their overall service revenue, quarter over quarter. Sprint and Verizon experienced service revenue decline, quarter over quarter.

The bigger picture is that the question about grand strategy (mobile-only or mobile-plus-fixed) is likely to be settled in favor of “mobile-plus-fixed,” ultimately, at the top of the traditional mobile business.

What might happen with other specialized “untethered or mobile” business models remains unclear. Those approaches are almost certain to be employed by contestants in the internet ecosystem who have other roles, and see value in adding the access function.

 

source: Compass Intelligence