Will CenturyLink Spin Off Consumer Business? Can it?

It should not be surprising that CenturyLink, which now generates perhaps 75 percent of its revenue from enterprise services, is exploring possible divestment of its consumer network operations.

The company now is a mashup of Level 3 enterprise services and the legacy consumer telecom services business. In essence, CenturyLink is too separate assets: the Level 3 global enterprise business and the sprawling U.S. local telecom business built on former Qwest and CenturyLink assets.

The problem is that many of the CenturyLink networks are rural-weighted, though the company serves a number of smaller “tier-one” cities such as Denver, Salt Lake City, Seattle, Las Vegas, Portland, Des Moines, Orlando, Phoenix and Minneapolis, for example).

“As I briefly mentioned on our fourth quarter call, we've been open to looking at assets like our consumer business,” said CEO Jeff Storey. “We have now engaged advisors to assist us in that review.”

source: S&P Global Intelligence

The issue for CenturyLink is what to do with the legacy telco assets, which are not driving company growth, and are slowly shrinking.

Over time, more of the value of fixed networks becomes its role as a backhaul mechanism for small cells, especially as cable TV operator emerge as the leaders in serving consumer customers.

But the value of fixed networks to support dense mobile networks is mostly an opportunity in the larger cities with lots of business activity and higher populations, or in the downtown cores, not so true for less-dense parts of the service territory.

In fact, it seems ever more true that the business value of a telco fixed network is mobile backhaul (part of the enterprise opportunity for any fixed network operator). If more of the revenue appears likely to be generated by enterprise services, that might call into question the value of fixed network assets serving lower-density consumer locations.

With telco market share in internet access relatively low, the amount of stranded assets has gotten to be a significant problem. The issue for CenturyLink is identifying both potential buyers with lots of capital, and a business model that calls for harvesting revenue from a declining consumer business.

Global Telecom Revenue Will Grow 0.5% Through 2023

Global spending on telecom services (including subscription TV) totaled $1.6 trillion in 2018, an increase of 0.8 percent year over year, according to IDC.

IDC expects global revenue to reach $1.66 trillion in 2023.

The mobile segment, which represented 53 percent of the total market in 2018, is set to post a compound annual growth rate (CAGR) of 1.4 percent over the 2019-2023 period.

Fixed network data service spending represented 20.5 percent of the total market in 2018, with an expected CAGR of 2.6 percent through 2023.

Video services revenue increased by seven percent in 2018 and is expected to post a CAGR of 3.7 percent by the end of 2023.

Global Regional Services 2018 Revenue, Growth
Global Region	2018 Revenue ($B)	CAGR 2018-2023 (%)
Americas	616	0.0
Asia/Pacific	512	0.8
EMEA	487	0.9
Grand Total	1,615	0.5

source: IDC

Upside from "Digital Transformation" Will be Hard to Find

One key problem when assessing the success of “digital transformation,” broadband or “economic development” programs is that there are so many simultaneous potential drivers that we cannot ever be sure what contribution any single factor has provided.

For example, one might note that European telecom companies (and their equity values) have not done as well as “technology” or “media” firms since 2007. But that also is likely true in many other regions. We cannot separate regulatory frameworks, firm decisions and strategies, underlying economic growth levels or differences in any region’s density of firms in any technology, media or telecom segment that is showing higher growth rates.

source: Bloomberg

Beyond that, even examining results at firms such as Telefonica, which most observers would agree has had an aggressive posture on “digitalization,” there is a known productivity paradox, where investments in technology do not produce measurable productivity gains, even after a decade of widespread deployment.

In fact, a recent study has shown no correlation between broadband and economic growth.

One can argue that such gains will eventually show up (though it could take a decade or more). One can argue the gains will, in fact, not show up. One might even argue we cannot measure the gains. The point is that “automating existing processes,” always the first step in applying any information technology, might not produce measurable gains.

After time, when entire business processes are retooled, it might be possible to show gains. But that takes time. We sometimes forget that Amazon, for example, was founded in 1994. But not until 2015 did Amazon pass Walmart (once the largest U.S. retailer) in terms of market value.

Some 12 years later, Amazon’s total sales were less than $11 billion, at a time when U.S. retailers had sales of $252 billion, but almost no net income. That is by choice, of course. The point is that a long passed before Amazon became a fearsome and feared competitor, using a “digital” business model.

source: peridotcapitalist.com

source: Statista

source: Amazon, Vox

Measurable gains (revenue, profit, sales) might be hard to quantify, in the retail parts of the connectivity business.

Netflix was Right: Original Content is the Future of Streaming

If “content” is the reason consumers choose to buy a particular streaming video service, then it stands to reason that as content availability changes, so might the fortunes of various suppliers.

Up to this point, the dominant streaming services were built on a wide breadth of popular licensed content from networks and studios. But original content now has become a key feature, and as licensed content is pulled back by copyright owners to fuel their own rival services, content fragmentation is going to increase.

That is likely to increase consumer unhappiness and lead to new forms of bundling. Ironically, that bundling was for decades the key value of linear services, which aggregated a huge amount of content, most of which was not watched by any single consumer.

One way or the other, original content now will move to the forefront of buying decisions. If popular TV series now are “licensed” to third parties, but is restricted in the future to the copyright owner’s own services, it immediately becomes “original” content. In other words, if Disney content can only be viewed on a Disney streaming service, or Warner Media content can only be viewed on a Warner Media service, that content becomes “original,” not “licensed.”

Netflix has been preparing for such a future for some time, in part because it is following the HBO playbook, which is to build the franchise precisely on original content.

source: emarketer

Not everybody agrees on the value of licensed content, though. It is conceivable that some services might continue to rely on bundles of licensed content, either because they cannot afford to create much original content, or because their own niche original content is not broadly appealing enough to generate scale.

Can Service Providers Boost Consumer Share of Wallet?

Household spending (all other things being equal) is a zero-sum game: when spending in one category rises, spending in others must drop. Spending on communications varies by country.

For connectivity service providers, there are clear implications. To earn more money per account, service providers likely must add new types of products, creating enough value that consumers are willing to buy less of other goods. Shifting demand curves in that manner is quite difficult. It is not impossible, just difficult.

There is, for example, some evidence that households are spending more on communications products(devices plus connectivity and apps) than they used to spend on communications in the past.

In Myanmar, a new mobile market, spending per household might be as high as eight percent of total spending. In Australia, communications spending (devices and services) might be just 1.5 percent of household spending.  

In South Africa, households spend 3.4 percent of income is spent on communications (devices, software and connectivity). In Vietnam, communications spending is about 1.5 percent of total consumer spending.

In the United States, all communications spending (fixed and mobile, devices, software and connectivity, for all household residents) is perhaps 2.7 percent of total household spending.

source: Nielsen

Of course, it is entirely possible that “all things are not equal.” Incomes are rising in many parts of the world, creating more discretionary income. Prices for communications products (hardware and software) are changing: rising for top-end devices; dropping for the growing base of affordable devices.

Since subscription TV now is often considered part of the “communications” industry, both connectivity and entertainment revenues have to be considered.

Also, prices for connectivity services are dropping. From 2000 to 2018, mobile and fixed line charges in Europe and other developed markets have dropped.

source: Frontier Economics

Consumer demand also is shifting. There is less demand for voice and texting services, much more demand for data services. Basically, that has shifted communications spending away from voice and messaging and towards internet access.

Up to a point, we see the same trend in mobile and data access that we earlier saw in long distance services: lower cost per unit but sales of many more units. Still, consumers only have so much money to spend on communications overall.

source: U.K. Department for Digital, Culture, Media & Sport

That does not mean the demand cannot be shifted. That is possible, but not easy. One reason service providers look to “move up the stack,” adding more value by occupying new parts of the value chain (applications and services, for example) is that doing so adds new potential revenue sources.

That is one way to shift revenue per account: create conditions where consumers spend more money, on new products, beyond the existing suite of products.

Does a Big Expansion of FTTH Make Sense for AT&T?

By some estimates, AT&T passes 55 percent of U.S. homes. Assume total U.S. housing units number 139 million.

Assume a rental vacancy rate of seven percent and a homeowner vacancy rate of 1.4 percent. Assume the percentage of owned housing is 64.2 percent, implying there are 89.2 million owned homes.

In that case, there also are some 35.8 million rental units. That further implies 33.3 million occupied rental units, and some 88 million occupied owned housing units.

Altogether, that implies a total universe of about 121.3 million occupied U.S. housing units. In principle, that means 121.3 milion potential locations a communications service provider might sell services to.

Assume AT&T, passing 55 percent of those locations, therefore could sell fixed service to about 66.7 million locations. That would still be on the high side, as there are some locations--boats, trailers, rented rooms, very-rural locations--that probably are not “sellable” locations. Assume such locations represent one percent of locations, or about 670,000 locations.

So round the addressable base of locations to 66 million.

In its first quarter of 2019, AT&T reported $2.8 billion of internet access revenue, representing about 25 percent of entertainment group revenue of $11.3 billion. AT&T reported 13.8 million broadband accounts in total.

That implies a penetration rate of about 21 percent (so call that the installed base).

AT&T claims 3.1 million “fiber” customers (fiber to the home), with 12.4 million locations passed by FTTH. That implies a take rate of 25 percent, where FTTH is available. Granted, sales should increase over time.

AT&T believes it can boost that take rate to 50 percent over time. Verizon has been able to get a bit more than 40 percent take rates over time, so a 40-percent share target seems reasonable enough.

The issue is what percentage of total passed homes could profitably be upgraded to FTTH.  If AT&T by the end of 2019 has 14 million FTTH homes, that leaves 52 million homes remaining for potential FTTH upgrades.

It is difficult to determine what percentage of those 52 million homes might be amenable for FTTH upgrades. For the sake of argument, assume half those homes actually are in areas dense enough that FTTH is feasible at a cost of about $1,000 per location.

So assume a potential universe of 26 million potential FTTH homes. Assume an actual customer then requires $600 additional cost to activate.

That implies capex of about $26 billion to build the network. Assume AT&T could get 25 percent take rates for the new FTTH services. Here is where it gets tricky. We must assume AT&T already has about 21 percent take rates for internet access already. So what percentage of the new FTTH accounts are incremental, and what percentage are simply upgrades by current customers?

It seems unlikely that AT&T loses many customers by upgrading to FTTH. But that also means a new FTTH network with 25 percent adoption actually represents a net gain of perhaps four percent new accounts.

Even if all the gains at 40-percent adoption are new accounts, AT&T stands to gain about 19 percent new accounts by making the FTTH upgrades. That might represent 4.9 million new accounts.

That implies an investment of nearly $5 billion for customer premises capex. Ignoring time value of money and interest expense, assume capex is at least $31 billion.

Assume “average” internet access revenue of about $130 per quarter, per account, or $43 a month. Assume FTTH boosts average revenue per customer to about $53 a month.

That implies recurring revenue, at 40 percent take rates of about $636 per year, per account. Annual incremental revenue then is about $3.2 billion.

Assume gross margin is about 40 percent. That implies incremental free cash flow of about $1.3 billion annually. So the big question is whether it makes sense to invest $31 billion to earn an additional $1.3 billion in free cash flow.

Smartphone-Only Internet Access Among Low-Income Households Reaches 26%

Some things do not seem to change: in developing or developed nations, lower-income consumers use phones for internet access. Roughly 26 percent of households with income less than $30,000 annually rely on smartphones for internet access, Pew Research Center reports.

source: Pew Research

Low-income U.S. households are steadily increasing their internet use, but the usage gap between higher-income households and lower-income households remains.

source: NTIA

Subsidized service for lower-income households helps. But there still is a correlation between internet use and education, age and geography, not just income.  

source: Pew Research Center