Can Telecom Industry Afford its Coming Consolidation?

While there always are lots of reasons why a particular merger idea does not get traction, one is worrisome for any weaker firm: potential acquirers believe the asset is going to depreciate further.

That, in fact, is one strategy some have floated for “when” to make a bid to acquire Sprint, or any other major set of telecom access assets.

“Not now” is the rationale some would put forward, even if a later bid makes sense. Some would argue Sprint has not stabilized its business. Others might argue the asset will be available for less money, later, because they sense Sprint cannot fix its problems.

That is likely to be a growing issue over the next decade as a huge wave of consolidation starts to sweep over the telecom industry. At a high level, here is the problem. It will take huge amounts of capital if 85 percent of today’s telecom assets are acquired over a 10-year period.

One can question whether enough borrowing power exists to get that done, if at the same time capital is plowed into building new 5G networks and, at the same time, tier-one providers make investments in new businesses “up the stack” that are meaningful contributors to present or future revenue streams.

Assume, as a figure of merit, that a telecom company can be purchased for about twice its annual revenue. Assume annual telecom industry capex is about $355 billion, but that these amounts are going to be needed to build the coming 5G networks, as well as maintain existing networks.

Assume annual industry revenues are in the range of $2.4 trillion. Assume 85 percent of total assets are acquired over a decade. That suggests $2 trillion of revenue. At a multiple of “two times revenue,” that implies an investment of about $4 trillion over a decade, to consolidate 85 percent of today’s assets.

Assume global telecom debt stands at a bit less than $1.5 trillion. Assume half of the consolidation is comprised of no-cash mergers of equals. That leaves about $2 trillion of new debt to be funded. In other words, global service provider debt would more than double over a decade.

You can make your own decisions about whether that is possible, much less a workable scenario.

Some of us might argue that new debt load does not account for any investments in new lines of business at the application or platform layers (content, apps, middleware, operating systems).

Assume such investments eventually have to be made at a significant level to have any hope of affecting telecom service provider earnings. Assume that means a level of investment at least as large as the investments in horizontal scale.

That implies an additional debt load of perhaps $2 trillion, for a total new debt load of about $4 trillion.

For an industry that arguably will have issues covering $1.5 trillion in debt, you might wonder whether it is even conceivable that lenders will approve debt levels of as much as $5.5 trillion.

But there is one way to reduce some of the debt burden: a collapse of equity values, which makes the acquired assets much less expensive. That will be the case, earlier, in markets where assets become “distressed” sooner rather than later.

Verizon Touts Shift to Fiber Products, Net Growth is Nil

“Organically, fiber-based products grew more than three percent” (in the second quarter of 2017) said Matthew Ellis, Verizon CFO. Many will interpret that as a sign of clear progress for the FiOS network, and it is, in many respects.

One always has to evaluate “new” revenue from next generation platforms on a “net” basis, as is the case for other statistics such as mobile account gains. The simple reason is that a legacy or incumbent provider mostly finds that the next-generation platform cannibalizes some existing revenue, while hopefully creating incrementally-new revenue streams.

So it is with Verizon’s fixed network operations. “On an organic basis, wireline segment revenue decreased 2.8 percent compared to a decline of 3.2 percent last quarter,” said Ellis. “This shift in the wireline revenue trend towards fiber is growing.”

So FiOS and fiber-based revenue was up three percent, while segment revenue was down 2.8 percent.

source: Verizon  

In the fixed networks business, a good example of the former is consumer shifts from digital subscriber line to optical fiber or fixed wireless services. When a current customer takes the newer service, but drops the older service, there is zero net account change.

That is going to happen for most human 4G accounts, which eventually will be dropped for 5G accounts, again with zero net change, even if headline numbers will trumpet the growth of 5G subscribers and accounts.

On the other hand, next generation platforms sometimes clearly create new incremental revenue streams. Video entertainment services--not possible on a narrowband network--is the best example in the fixed network realm.

Video also is arguably the best example of a new capability for 4G, compared to 3G, although others might point to tethering or general web access as other areas where there are indirect but key differences from 3G capabilities.

The key challenge for 5G is the magnitude of new revenue that can be created from new services beyond replacement of existing 4G use cases.

Value is What the Customer Says it Is

In the end, “value” is always what the customer says it is, even if suppliers spend lots of time trying to shape those perceptions. Consider “gigabit per second internet access.” That’s better than 40 Mbps or 100 Mbps, right?

As with all “you would rather?” or “which is better?” exercises, nothing much matters until price is part of the decision matrix. I would tell you a Tesla is better than a Hyundai, but that is an abstraction. The chances I’d actually buy a Tesla, compared to a Hyundai, are very low, because value is the issue, not only “quality.”

So it is that most Comcast customers, able to buy gigabit internet access service or lower speeds for less money, likely choose to buy the midrange speeds at the midrange price.

“Nearly 55 percent of our residential customers take speeds of 100 megabits per second or higher,” said Michael Cavanagh, Comcast CFO. All that one statistic tells you is that 45 percent of consumers buy speeds less than 100 Mbps.

It does not yet tell you what percentage of customers will shift to gigabit services, from all other speed tiers. One would predict that relatively few will do so.

Consider the behavior of Comcast’s initial Xfinity Mobile customer base. You would say these are the early adopters, and that might lead you to believe these early customers are the “high performance” segment of the audience. That does not seem to be the case.

“Most of our (mobile) customers are taking ‘by the gig’ (plans) versus unlimited,” said Dave Watson, Comcast Cable CEO. In other words, the lead adopters seem to be “value” segments, not “bleeding edge” segments of Comcast’s customer base.

Rarely, in consumer telecom markets, do most customers buy the “best” or “basic” packages of any product. Most buy the “better” or midrange packages, instead. The likely explanation is that customers see the best balance of features and price (“value”) in such packages. And suppliers likely anticipate that reaction and build their retail packages accordingly.

The point is that gigabit internet access is going to be a key marketing position, even if it does not represent the bulk of sales for firms about to offer basic-better-best packages. What gigabit does is shift the dynamic range of the potential offers, creating new “super-premium” tiers and also redefining “basic” and “better” tiers.

But consumers will still buy based on value, and for most, the midrange will still fit best.

Innovation can be Democratized in Era of Artificial Intelligence and Big Data

AI will be good for smaller firms trying to innovate. 

https://www.inc.com/greg-satell/heres-how-big-data-and-machine-learning-will-help-.html

5G Will be About Enterprise Use Cases

source: Bell Labs

By 2025, the percent of enterprise traffic, now at perhaps 28 percent of total, could reach 96 percent of total, according to Bell Labs.

If you want to know why some of us believe the future for 5G is enterprise use cases, that is part of the reason.

On a separate level, Bell Labs also predicts that as much as 61 percent of all enterprise traffic will be terminated or originated using some wireless mechanism.

If 5G and some variation of Wi-Fi account for 61 percent of traffic, that leaves about 35 percent of total enterprise traffic that is neither 5G nor some form of Wi-Fi, but still wireless.

You might therefore guess that some of that traffic will be fixed wireless local access or some other form of wireless access, including specialized low-power, wide area networks of sensors.

By 2025, 69% of Enterprise Employees Might Use a Software-Defined VPN

Software-defined wide area networks (SD-WAN) are the current rage in enterprise networking circles, and probably for good reasons. According to Bell Labs, by about 2025, perhaps 69 percent of enterprise employees will be connecting by a software-defined virtual private network, which is what an SD-WAN provides.

source: Bell Labs

Third Telecom Era Approaches

As revolutionary as was the change from telecom monopoly to competition, we appear to be on the cusp of a third era.

For a number of fundamental reasons, “telecommunications” roles are becoming more porous, diffuse and shared. The notion that “anybody can be an internet service provider,” in contrast to “there is only one lawful provider of service,” illustrates the point.

Depending on the use case, an enterprise (public hotspot) or even consumer (cable homespot, mobile tethering) can act as the ISP. For purposes of delivering e-books, Amazon acts as a special purpose ISP. Google and Facebook act as ISPs in a variety of settings and roles. Google Fiber competes directly with telcos and cable companies as a general purpose fixed internet services supplier.

In India, Google and Facebook partner to operate Wi-Fi hotspots in public locations and villages. There may be other roles and platforms in the future.  

Beyond that, as we move towards an era of pervasive computing. Value moves inexorably “up the stack,” to applications and use cases, and away from the simple value of internet access.

And that same process also means that traditional telecom apps (voice, messaging, content delivery) can be supplied by third parties, over the top of any specific internet connection. That further increases the potential amount of competition, and therefore will affect potential profit margins.

All that illustrates the point that industry revenue streams and business models are non-exclusive and open to challenge. Declining average revenue per account is one example of the trend. Declining profit margins are another direct result.

That, in turn, drives firm strategy. More scale helps with gross revenue and profit margins. That is why a major global wave of consolidation is likely--or virtually certain--over the next decade.

The U.S. market, for example, has not yet started to consolidate in the same way that India’s market already has started. In fact, it is likely the Indian mobile market will shrink in half, in terms of facilities-based suppliers, within a year, from eight to four.

It is only a straw man, but assume something similar happens in the U.S. market. That would potentially reduce the number of leading suppliers in half (across the fixed and mobile domains). Where there are perhaps nine leaders (across the fixed and mobile segments, including two cable operators, four mobile suppliers and three big fixed network suppliers), there could, over perhaps a decade, be just four left, with varying global roles, as well.

Any way you look at it Sprint, T-Mobile US, Dish Network are virtually certain to be involved in the next big merger wave in the U.S. telecommunications market. Charter Communications or Comcast are possibly going to be involved, as well as a few content firms.

While it remains possible that a Sprint tie-up with T-Mobile US could be proposed, it is not the only combination that makes sense, and many of those other mergers would likely have a better chance of regulatory approval.

That consolidation would mirror similar big market structure moves in India, which long has been among the mobile markets with the most facilities-based contenders.

So far, all we’ve seen in the U.S. market are talks and rumors. But the action is coming, for obvious strategic reasons. As profit gets wrung out of the business, more scale is the short-term answer, at the very least buying additional time and resources to work on the long-term objectives of changing the value proposition.

A reasonable and workable objective is to achieve a balance of “access” and “application” revenues that might approach 50-50. To be sure, nobody has done that yet. Eventually, it is likely to be necessary for survival.