Windstream Takes Another Big Gamble

Windstream already has taken a couple big gambles, betting on becoming a business services provider and spinning off its network assets into a real estate investment trust. It now has taken another big gamble, eliminating its dividend.

It likely is never a good sign when a former dividend-paying company eliminates its dividend, as Windstream now has done. There are two ways to look at the move, and both suggest high degrees of risk.

Nearly two decades ago, a few dividend-paying telcos or platform suppliers had to consider eliminating their historic dividends, so severely had the business model become. The potential upside was that such moves would allow the firms to invest scarce capital in plant and other potential growth initiatives, such as making acquisitions.

The big potential downside was that such moves were a gamble; an effort to replace one whole class of investors (dividend seekers) with a new class of investors (seekers of growth). The big gamble, in that regard, was the ability to make the transition from a utility-like business model to a true “growth” profile.

A few firms in such predicaments did cut dividends. Perhaps more firms decided to sell themselves.

It is not yet clear whether Windstream’s move, which will conserve capital, will succeed, long term. The firm already had spun off its network assets into a separate telecom real estate investment trust. The result is that the Windstream operating business actually does not own the networks it uses to provide its retail services.

Windstream, in essence, is a fixed network version of a mobile virtual network operator. It also is a big competitive local exchange carrier with a big incumbent network, sort of on the CenturyLink model.

And that is the gamble Windstream now appears to have taken: move further in the direction of being a business services specialist.

"Overinvestment" is as Bad as "Underinvestment"

“Overinvestment” arguably is as big a problem as “underinvestment” where it comes to access facilities. Consider the matter of internet access capabilities. As a marketing platform, “gigabit internet access” now increasingly matters, as it is becoming the U.S. market norm.

But the cost to gain that capability matters, as numerous internet service providers have found that take rates for that package are less robust than might have been expected. CenturyLink, for example, acknowledges it is losing customer accounts in the “under 20 meg” service areas. That mostly is because cable alternatives in such areas are in the hundreds of megabits per second range already, and are heading for a gigabit.

“But when you get to 20, 40 and above, we're seeing growth year-over-year in subscribers,” said said Maxine Moreau, CenturyLink president of consumer markets. “And what we say is as the customers move in higher-speed tiers, we see a corresponding reduction in churn.”

“Even in the markets where we have gig, customers they're not buying gig,” said Moreau. “They might buy 40 meg, 100 meg even though we have one gig available.”

Avoiding “overinvestment” is precisely why Google Fiber, Verizon and AT&T will be looking at 5G-based fixed wireless alternatives to more fiber to the home deployments.

Harvesting of Legacy Revenues Still Matters

Relying on “legacy” services is not a strategy for revenue growth at most tier-one telcos, nor is it a “safe” strategy for the longer term.

On the other hand, incremental gains in the legacy business can be a huge contributor to maintaining revenue and profit margins as growth initiatives are launched.  In other words, in the near term, it still matters to harvest as much legacy revenue as possible.

And that is what Frontier Communications hopes to achieve over the next quarter and year as it looks to grow business revenues in the Texas, California and Florida assets Frontier purchased from Verizon.

One strategy is to leverage the installed distribution and access fiber to boost business revenues in those areas.

And getting more leverage out of legacy assets is a big concern at CenturyLink as well. Note the language in CenturyLink’s second quarter earnings call.

“Second quarter operating revenue on a consolidated basis was approximately $4.1 billion, a seven-percent decrease from second quarter 2016 operating revenues.”

“Core revenue, defined as strategic revenue plus legacy revenue, was $3.66 billion for the second quarter, a decrease of 7.9 percent from the year ago period.”

“Enterprise segment generated $2.22 billion in operating revenues, which decreased nine percent from the same period a year ago. Second quarter Enterprise strategic revenues were $985 million, a decrease of 8.9% compared to the second quarter 2016.”

“Legacy revenues for the segment declined 10.1 percent for second quarter 2016.”

The consumer segment decreased 6.2 percent, year over year. Consumer strategic revenues declined four percent year-over-year.  

“We do anticipate coming in slightly below our full-year 2017 revenue and adjusted diluted EPS guidance, primarily driven by higher legacy revenue decline and lower consumer broadband revenue growth than anticipated,” CenturyLink said.

Many would doubt it is possible for CenturyLink or Frontier Communications to reverse those trends in the legacy business.

Slow, steady decline is how Moody’s recently described the outlook for U.S. telcos Windstream, CenturyLink and Frontier Communications. But Moody’s also said that higher capital investment could help those firms avoid that fate. CenturyLink has boosted its capex to raise internet access speeds.

One might suggest another possibility: in addition to higher capex, it might be possible to boost internet access speeds at lower cost than previously was thinkable, using newer access technologies, ranging from G.fast for augmenting digital subscriber line to fiber to the home to fixed wireless.

Harvesting matters, in part, because it buys time for a transition to new revenue sources and business models.

80/20 Rule for Fixed Network Assets in the 5G Era

The function of the fixed network has been changing for decades, and should change still more in the 5G era. Originally, the fixed network was the mechanism for supplying retail services to consumer and business customers.

In the 5G era, more of the value of the fixed network will come from its trunking capabilities, to support fixed wireless, small cell, macrocell and business customers, and less from retail fixed network services for consumers.

That seems to provide yet one more example of the 80/20 rule, or Pareto distribution, in business and life. Even if 80 percent of the value of the fixed network eventually comes from 20 percent of the use cases, an access provider likely must continue to operate the full network for all potential use caes.

Several years ago it was possible to argue that three major “rural telecom services providers” had made a clear strategy switch to focus on business customer segments. CenturyLink provides the foremost example. After the acquisition of Level 3 closes, CenturyLink will earn a massive 88 percent of total revenue from business customers.

Windstream and Frontier Communications also had made moves in the direction of business segment revenue. As recently as 2015, all three former rural carriers earned a majority of revenue from business customers. Windstream earned 78 percent of its revenue from business customers, for example.

Then Frontier Communications made a major shift by acquiring Verizon accounts in California, Texas and Florida, representing about 3.7 million voice accounts, mostly of the consumer variety. That backed business revenue down from a high of about 46 percent to 40 percent.

source: Frontier Communications

For Windstream and CenturyLink, then, a big issue is that their legacy mass market networks are generating a relatively small portion of total revenue, but likely driving a disproportionate share of costs.

In its second quarter of 2017, CenturyLink earned about $2.2 billion from its enterprise segment and about $1.4 billion from its consumer segment.

But traditional rules of thumb suggest that about 80 percent of total costs come from the access network, and that relatively little of the access network cost actually supports business customers. The other problem is stranded assets.

CenturyLink like has less than half its access lines serving the consumer segment earning revenue, as cable TV competitors tend to have more than 50-percent share in the consumer market. So the cost of the asset base is supported by an account base that is about half what it once was.

That is why CenturyLink  says its operating expense per access line increased by more than 50 percent from 2007 to 2015, from approximately $650 to nearly $1,000.

Enterprise costs per data circuit also increased from $18,831 to $20,832, from 2011 to 2015. But the rate of increase was less than in the consumer services segment, and revenue from enterprise services also is much higher.

It never has been clear that any tier one service provider’s mass market access network could be “spun off,” retaining only the core assets required to support its enterprise customers.

The big challenge is that the mass market network contributes some revenue, but not the growth, for a tier one fixed network such as CenturyLink operates. Verizon’s customer base is different, so consumer arguably makes a bigger growth contribution.

This might be one of those instances where the 80/20 rule operates. At a high level, 80 percent of the growth comes from 20 percent of the network, but no operator can afford to dispense with those assets.

It remains striking that the rather-extensive access networks operated by the former rural carriers generate so much of their total revenue from a relatively small portion of the asset base. That is less true for the cable networks, which were legacy consumer market suppliers, but the portion of cable operator business revenue will continue to grow.

Artificial intelligence Can Improve Telco Revenue, Capex, Opex, Profit Margin

Artificial intelligence (machine learning) can make a key difference in forecasting telecom industry market share trends and performance, says James Sullivan, J.P. Morgan head of Asia equity research (except for Japan).

Consider the key matter of market share. “When overall industry revenue growth is stagnant, as it is with most telco markets, market share movements become the determining factor of an operator’s top-line performance,” says James Sullivan, J.P. Morgan head of Asia equity research (except for Japan).

The implication: if your forecasting models are better at detecting changes in market share, your forecasts for revenue also will be more accurate.

That is important as forecasting changes in market share trends and anticipating trend breakage has historically been challenging for the Street,” says Sullivan.

He points to the case of forecasts for AIS from 2010 to 2016. AIS posted strong market share

improvements from 2010 to 2012, which resulted in revenue significantly beating analysts’ forecasts. As analysts extrapolate from past performance to model future performance, they missed a trend change.

The same thing happened with trends changed again between 2014 and 2016, when competitor True deployed its 3G/4G networks, resulting in less AIS revenue than history suggested would be the case, from 2014 to 2016.

“For now at least, the uses of advanced analytical techniques, such as machine

learning, are mainly applicable to the gathering and processing of alternative data

sets,” says Sullivan.

“In our view, we can take a significant step towards solving long run market share and capex forecasts for telcos if we can understand and obtain the following data sets:

1) What is relative network quality by region, in terms of download / upload speeds but also network availability by technology?

2) What is current data pricing for each operator in each country analyzed, updated constantly?

“These statistics, taken together, define relative value and assist in forecasting pricing power by operator, market share shifts, incremental capex, and therefore incremental opex and margins,” argues Sullivan.

“In our view, capex is dependent on demand for data and data usage and current utilization/coverage of an operator’s network,” says Sullivan. “Changes in data

pricing can signal how demand for data will evolve, while relative network quality

can be a signal for utilization rates.”

The point is that data pricing and network quality are the key data sets required to forecast capex.

Networks “are not commoditized and therefore value is a function of price and quality.” So it is “value” that ultimately drives usage, capex and opex.

Sullivan will be speaking at the Spectrum Futures conference.

source: PTC

China Unicom, China Telecom Find Virtualization Reduces Power, Costs; Boosts Server Performance

Network functions virtualization, which will be a foundation for coming 5G networks, also has direct implications for cloud data center costs, Intel and China Unicom and China Telecom, have found.

Virtualization has many facets, but always builds on a separation of control plane and data plane functions. In simple terms, that allows use of hardware from multiple suppliers (“commodity hardware”) to implement the control operations, a capability that should allow lower server costs.

The intermediate objective then is “virtualized software running on a standard server,” leading to lower capital and operating expense.

However, argues Intel, “many current virtualized network functions  implementations are not well optimized for the new virtual environment and offer far less performance than their traditional proprietary counterparts.”

“While NFV, SDN, and orchestration can greatly reduce the operational complexity of deploying a telecommunications cloud, the infrastructure required to overcome the performance shortfall can be costly,” says Intel.

Control and User Plane Separation (CUPS), as defined by the 3rd Generation Partnership Project (3GPP), enables independent scaling of the control and data planes and is the next logical step for VNF design, Intel says.

While the control plane is easier to scale using standard off-the-shelf compute and memory resources, scaling the data planes to support complex packet processing at high rates can be challenging, says Intel.

The opportunity is to design a system where the data plane can support reconfigurable packet pipelines and complex packet processing at very high throughputs.

For example, in recent deployments, the Intel SmartNIC solution, deployed with HP Enterprise gear, achieved a total power reduction of about 50 percent compared to a standard NIC server.

Together, the Intel Arria 10 FPGA-based SmartNICs and commercial server central processing units optimize the data plane performance to achieve lower costs while maintaining a high degree of flexibility, as well, Intel says.

The SmartNIC provides a performance improvement per server greater than three times the base case.

source: Intel

Using SmartNICs improves performance and supports higher throughputs at a marginal power and cost increase, as well, Intel says.

HPE calls this their system for virtualizing data plane resources “vBRAS”  (virtual broadband remote access server) technology. VBRAS  scales the control and data planes independently on physically separate, standard off-the-shelf server platforms.

The data plane is optimized for packet processing and also accelerates computationally-intensive traffic shaping and quality of service functions, which is more efficient, and allows operation at lower costs.

In a second case, Intel is enabling mobile edge computing for China Unicom. Nokia designed and developed it to run on the Intel Xeon processor.

The design allows extending data center solutions to the very edge of the network. That, in turn,

Improves mobile user experience by providing high availability of content with reduced latency.

Value, Not FTTH Is the Issue,

At some point, even the biggest new developments in internet access simply become routine. So it is with the full deployment of commercial gigabit internet access capabilities by Mediacom.

Mediacom Communications says its entire  network now is able to supply gigabit per second internet access speeds to every location on its network. That represents 2.8 million homes and businesses passed, scattered across 1,000 U.S. communities.

Mediacom has argued it would become the first major U.S. cable company to fully transition to the DOCSIS 3.1“Gigasphere” platform, and appears to have done so.

What might be less "routine" is mass deployment of gigabit access by telcos in the U.S. market, in areas where they have not already deployed fiber to home networks.

Unlike cable TV companies, telcos have to make big changes in their access platforms to reach ubiquitous gigabit speeds.

Between 2004 and 2013, large telcos (mostly Verizon, but including AT&T, CenturyLink and Frontier) accounted for about 83 percent of the FTTH build, while other providers added just 17 percent of the annual additions, according to Fiber to the Home Council.  

Since 2013, the large telcos only accounted for about 52 percent of the build while the “other 1000” FTTH providers added 48 percent of the new connections.

Homes connected to FTTH networks in the United States have grown to about 30 million, while subscribers are about 13.7 million. That means take rates, where FTTH is available, are about 46 percent.

That is just a bit higher than the market adoption one would expect to see in most U.S. markets where cable TV companies and telcos compete head to head. Typically, telco take rates are in the 40-percent range, with cable operators tending to get as much as 60 percent share.

source: Verizon

So the issues is not access media, but value. Cable operators, even without fiber to the home, have been able to gain leadership of the fixed network internet access market, and now are moving towards gigabit speeds on a mass market basis.

In fact, even when they compete with FTTH, cable companies seem to be able to routinely garner most of the net new additions. In the first quarter of 2017, cable companies got more than 100 percent of net new additions, in fact.

All together, the U.S. housing market includes about 126 to 130 million dwellings. So FTTH penetration (actual customers, not passings) is about 11 percent.