Hyperscale App Providers Drive Global Undersea Demand

Some themes never change, in the undersea or long haul transport business: new cables are lightly loaded, but eventually reach capacity, requiring upgrades; prices per unit keep falling and demand is driven by over the top application providers.

But one important change has happened. “Content providers are removing a large portion of the customer base,” says Brianna Boudreau, TeleGeography senior analyst. That “makes the rest of the market extremely competitive.”

In other words, despite huge increases in capacity requirements every year, most of that growth is “private capacity,” used directly by the likes of Google and Facebook, and not part of the “public networks” market (that capacity is not purchased from a public networks supplier).

“Now networks are being built by hyperscalers,” says Tim Stronge, TeleGeography VP. That is a historic change.

On Latin American routes, about 70 percent of total traffic now moves over private networks. In other words, only about 30 percent of undersea, long haul traffic actually is sold to customers who use “public” networks,  according to Erick Contag, Globenet CEO.

On trans-Pacific routes, OTT app providers also are driving demand, accounting for about 33 percent of lit demand on the “public” networks, says Jonathan Kriegel, CEO Docomo Pacific.

In effect, there now are three major business models in the subsea business: resale, presale or organic use, according to Michael Rieger, TE Sub Com VP. Resale is what we used to call the public networks model of selling capacity and services to business or consumer end users, either wholesale or retail.

Presale is another model in the subsea business, where anchor tenants agree to buy capacity in advance, before the network is built. That is a form of long-term wholesale or investment sharing. “Everyone becomes a partner,” says Nigel Bayliff, Acqua Comms CEO.

The newest model is private networks, where an entity (typically an application provider) builds a network entirely for its own organic use.

Most undersea cable systems serving Latin America, for example, presently are running at no more than 20 percent utilization, according to Erick Contag, Globenet CEO, but will run out of capacity by 2023.

Demand for capacity is growing about 40 percent per year, driven largely by capacity demand from  OTT app providers.

Why Subsea Networks Measure Cash Flow, Not Profit

Marginal cost pricing is now, and has been, a huge business model problem for capital-intensive communications infrastructure providers. Marginal cost pricing involves selling incremental units at incremental cost to produce those units, not including the amortization of the actual network build.

The hope is that the seller eventually can recoup sunk costs eventually. Whether that actually works is increasingly the issue for communications infrastructure.

Indeed, some already argue that tier-one telcos do not recover their cost of capital, perhaps an indication that marginal cost pricing is dangerous to the long term health of the industry.

That is an issue, according to Eric Handa APT Telecom CEO.  As a rule, suppliers hope to recover their capital investments in three years. That hardly ever happens, says Handa. In other words, cash flow is the key business requirement, as most subsea--and possibly many other access networks--will never recover capital investment amounts.

Suppliers “need to recognize that loss and sell to cover future opex,” says Handa. That is why, these days, one sees the use of “earnings before interest, taxes, depreciation and amortization,” a measure of cash flow, and not a measure of “profit” in a “generally accepted accounting practices” sense.

That should provide a warning for regulators: modern communications networks are expensive and might no longer be “profitable.” Policies that make harder the task of sustaining cash flow (not even profits) will burden suppliers that already are not “profitable” in the old sense.

Applying HHI in a Triple-Play Merger Context Will be Complicated

The next antitrust review involving any of the larger fixed network providers will provide a challenge, as the evolution of the business into a triple-play business means internet accounts, video accounts and, to some extent, voice accounts. Under such conditions, figuring out the actual market share, or household reach, will involve a bit of work, across the three key service silos.

In the fixed networks business, antitrust reviews have included a number of tools, such as the Heffindahl-Hirshman Index (HHI). But, up to this point, regulators and antitrust officials might not have had to deal with the complexities of an industry that sells multiple products (internet access, entertainment video, voice), with different households buying different mixes of those products.

Also, the video entertainment share analysis is complicated by the significant presence of one independent satellite provider, though the biggest satellite provider now is owned by AT&T.

As a rough rule of thumb, past proposed horizontal cable TV mergers have used a 30-percent test: no single proposed entity could have market share of more than about 30 percent of U.S. accounts, or have networks passing more than about 30 percent of U.S. homes.

Those rules are applied differently in the mobile business, as national reach of the population is not the issue, but rather actual account share.

Some day, it might be even harder, as the difference between the mobile and fixed industry segments might blur quite a lot.

For the moment, the HHI remains a huge barrier for many of the trial balloon mega-mergers being floated.

Can Verizon Justify Much More Investment in Fixed Networks Segment?

Verizon earned $32.3 billion in its fourth quarter of 2016, including about $3.2 billion from its fixed line mass market customers, while earning $23.4  billion from its mobile segment. In other words, all mass market (consumer and small business) revenues represented just under 10 percent of total revenues, while mobile represented about 72 percent of total revenues.

It is quite easy to argue that fixed network operations actually make less sense for Verizon than for most other telcos. Some might even argue whether it would make sense to get out of the fixed network business, if a buyer could be found.

The corollary is that regulatory burdens in the fixed networks area probably do not help Verizon make the case for robust fixed network investment. And that case would be difficult in any case.

Consider that Verizon, in its Fios areas, has 40 percent penetration of internet access services and about 34 percent adoption of its video entertainment services. Given that cable companies have nearly all the rest of the internet access share, while cable and satellite split the video share, it is hard to see how Verizon does much better in its Fios areas, no matter what  it does.

Wireline operating income was $414 million in fourth-quarter 2016, Compare that to mobile segment operating income of $6.3 billion.

Fixed networks are a small part of Verizon’s revenue, cash flow and profit (if any), while Verizon arguably does as well as it possibly could in that area. It is not a recipe for robust additional investment.

source: Verizon

Enterprises Boosting Cloud Spending

Enterprises are increasing their spending on cloud services, analysts at Forrester say. As you would guess, that is going to decrease the amount of spending by enterprises on their own hardware and software.

Since 2013, the percentage of enterprises that have deployed cloud has risen from 10 percent to 33 percent, and 49 percent of enterprises with more than 100 employees now use public cloud, according to Forrester Research.

Analysts at 451 Research predict enterprise information technology staffs will spend an average of 34 percent of their overall budgets on hosting and cloud services in 2017, up from 28 percent last year, with increased reliance on infrastructure, applications management and security.

IDC, meanwhile, predicts that 23 percent of IT infrastructure and application workloads will reside in the public cloud in two years, up from today's 14 percent.

Hybrid cloud management, application development, the internet of things, and a myriad of software innovations are ways existing suppliers will have to work to remain relevant, Forrester says.

source: Forrester

Streaming is the Biggest Change in U.S. Video Entertainment Market, Says FCC

The most significant change in the status of competition in the market for the delivery of video services has been the introduction of Sling TV by Dish Network and DIrecTV Now by AT&T, the U.S. Federal Communications Commission says.

Others might also note the importance of the AT&T acquisition of DirecTV, which vastly expanded the addressable universe of homes AT&T could reach from less than 21 percent to virtually 100 percent of U.S. homes.

One sign of the robustness of competition is that profit margins, which once were as high as 40 percent, had fallen to about 10 percent in 2015, and likely are a bit lower in early 2017.

The FCC says profit margins were 15 percent in 2014 and 20 percent in 2013. That might be unappetizing in one sense, but arguably is meaningful in a context where other legacy services, whatever their profit margins, do not contribute much revenue. Video services represent a huge percentage of potential access provider revenue, if margins are not so high.

By some estimates, internet access gross margins (at least for cable operators) might be as high as 60 percent, while voice services might have profit margins near 20 percent. Telco margins likely are not that robust.

If cash flow matters--and it does--then the revenue video entertainment represents is hard to match, averaging between $80 and $110 a month, per account.

According to SNL Kagan, there were 134.2 million housing units in 2014 and 135 million housing units in 2015. The FCC therefore assumes that cable and satellite companies cover nearly every household in the country.

At the end of 2015, cable suppliers accounted for 53 percent of all subscribers, down from 53.4 percent at the end of 2014. Direct broadcast satellite (DBS) providers accounted for 33.2 percent of subscribers at the end of 2015, down slightly from 33.3 percent at the end of 2014.

Telephone companies accounted for 13.4 percent of MVPD subscribers at the end of 2015, up from 12.9 percent at the end of 2014.

Total subscribers declined in 2013, 2014 and 2015, with the suppliers losing about 1.1 million video subscribers in 2015.

But total video revenue increased from $112.7 billion in 2014 to $115.6 billion in 2015, partly because of rate increases and partly because of subscribers upgrading to higher levels of service.

What Happens at FCC in 2017?

Though it is likely network neutrality rules will be changed under a new Federal Communications Commission, we are likely mostly to see a return to “internet freedoms” rules that emphasize access to all lawful apps, a position we might call “weak” network neutrality, compared to the strong form of net neutrality (best effort only access, no quality of service mechanisms) that has been the recent policy.

At the same time, much of the change will come in the area of “why and how” network neutrality rules are justified, with a likely move away from Title II common carrier regulation and FCC action justified by the Communications Act Section 706 rules.

Separate from the specific network neutrality provisions themselves, there has been debate over the imposition of such rules using either common carrier or “report-making” authority that becomes “regulating” authority.

The other change is institutional. Unlike the recent FCC, the new FCC likely will prefer that consumer protection and potential antitrust issues be overseen by the Federal

Trade Commission, not the FCC.

Expect the FCC to undo both claims of legal authority underlying the FCC’s net neutrality regulations: Title II and Section 706. What has fueled the fight over the last decade is the FCC’s authority, not the core of “net neutrality” itself, says Berin Szóka, TechFreedom president.

We might also see more spending on universal access and support for broadband deployment, with new incentives for deployment in urban areas.