Valuation Differences Between Hyperscalers and Telcos Lead to False Analogies

We have all repeatedly seen comparisons of equity value of hyperscale app providers compared to the value of connectivity providers, which show the valuation differential between them. 

The comparison often is used to show a huge gap between the equity performance of telcos compared to hyperscale app providers, usually within the context of an argument that connectivity providers create value for others that should be shared with the access providers. 

source: Statista 

That is arguably not valid. Different industries often have different valuations. And those expectations are based on revenue growth. Hyperscalers grow fast, telcos do not. That is why the valuation differential exists.

Without internet access, hyperscalers would not exist. But that also is true of electricity, computer chips, computing devices and software.

source: Seeking Alpha 

And hyperscale app providers most certainly are valued more highly than most other firms in most other industries.

Consider the industry price-to-earnings ratio. Software might have a trailing P/E ratio of 111, meaning the stock price is 111 times earnings. An energy company might be valued at nine to 10 times. The disparity also exists for the expected earnings (forward P/E). 

source: Broker Chooser 

The point is that some industries are valued more highly than others by investors, even when many of those industries use products supplied by other industries. Health care relies on telecommunications, real estate, energy and information technology, but all those industries are valued at higher average P/E ratios than “telecommunications.”

source 

Telco executives argue that hyperscaler value is “based on” the use of access networks. But most products use railroads, water, electricity, airports and airplanes, trucks, wastewater systems, natural gas and other “utilities” including internet access. 

Equity valuation has nothing to do with “who uses what and when” but only expected earnings growth. 

source: STL Partners 

Hypescaler revenue is expected to grow much faster than access provider revenue. But the internet economy includes some parts of most industries, all all use internet access to some extent. 

The analogy might be to all industries and their use of electricity. Yes, electricity has high value. Yes, almost everybody and every organization uses electricity. But it is nonsensical to argue that therefore electrical energy providers “create economic value” that should be shared with the energy producers.

Rule of Three Seems to Hold, Whether Facilities-Based or Wholesale is the Access Mechanism

Communications policy makers long have believed that where facilities-based competition is not possible, a robust wholesale framework is the best alternative. And at least where North America or Europe are concerned, that belief seems justified. 

Whether reliance on wholesale or facilities competition is authorized, market share structures tend to be fairly similar: leadership by three firms, corresponding to the rule of three. 

“A stable competitive market never has more than three significant competitors, the largest of which has no more than four times the market share of the smallest,” BCG founder Bruce Henderson said in 1976.  

Codified as the rule of three, the observations explains the stable competitive market structure that develops over time, in many industries. 

That 4:2:1 pattern suggests that the market leader has twice the share of provider number two; which in turn has double the share of provider number three.   

In the fixed networks, though we might argue the market share pattern is not yet stable, that suggests a mobile or fixed network market should be led by three firms. 

source: ACCC

In the French fixed network internet access business, which is largely based on use of wholesale access, share structure is not too dissimilar to that seen in Australia, which uses a wholesale approach. 

source: Point Topic

In the United Kingdom, which has a wholesale regime for fixed network internet access providers, but also has facilities competition from O2 Virgin, market share structure also is not dissimilar from markets where competition is largely wholesale based. 

source: Statista 

In the U.S,. fixed networks market, which relies on facilities-based competition, we also see the “market leadership by three firms” pattern. The qualification is that no fixed network  firm is actually allowed to cover the entire market, which adds a bit more fragmentation, in terms of firms with four percent to five percent market share. 

Source: Leichtman Research Group data, IP Carrier analysis

The Downsides of Cryptocurrency

As with money itself, it often is hard to determine whether cryptocurrency is inherently good or bad; it depends on how it is used. 

Cryptocurrency often is said to offer the values of lower transaction costs; greater security; lower fraud exposure and possibly even categories of money that cannot be used for certain purposes, or by certain persons.

That might be either a tool for political suppression or liberty; safety or danger. Money that cannot be used in certain ways which might protect children. It could prevent some forms of money laundering and crime. 

It could just as easily be used by governments or groups to suppress political freedom and civil rights, as if a government-sanctioned or controlled crypto could be programmed to prevent certain types of spending by some individuals or groups. 

If we already see efforts to destroy the businesses or careers of people whose views are considered noxious (even if simply views one does not support) you can see where the temptation to do so using crypto features does exist. 

But crypto also raises other issues, including among them the most basic question of “what is money?” Can it function as a medium of exchange that--like all money--reduces transaction costs? There is the related issue of whether crypto also can function as a store of value like gold.  

Some believe cryptocurrencies could enhance financial system resiliency as well, in part by separating the lending function from other financial services including payments.  

And since micropayments are viewed as a feature of Web 3.0, there is a relationship between cryptocurrency and different Web monetization methods, including the ability to pay content creators. 

Eventually, thoughtful protections will be necessary to prevent the darker side of crypto from emerging in ways that attack civil liberties and human freedom.

Less than 25% of U.S. Commercial Buildings Have Fiber Connections

Roughly 1.3 million--24.7 percent of the five million commercial buildings in the United States are lit with optical fiber, according to Vertical Systems Group. That is an improvement from the 11 percent of fiber-connected buildings in 2004, for example.  

That suggests the large number of smaller locations where demand is not believed to support immediate fiber-to-location deployments. 

As you would expect, the larger buildings have been wired. Buildings with 20 or more employees had fiber access at nearly 75 percent.

Buildings with fewer than 20 employees had a fiber access rate of about 16 percent. 

Cable operators saw an opportunity there and have made a business out of supplying higher bandwidth to such locations using hybrid fiber coax access. Small business connections, in particular, were an early focus for cable operators, as some have estimated that 80 percent of small businesses did not require gigabit connections.

BT Business Push Reflects Market Structure

BT's new push to support business customers makes sense for a couple of reasons, but primarily because much of the revenue earned by a telco or mobile operator comes from business customers. 

source" Grand View Research 

Also, much of the new revenue from 5G is expected to come from business use cases. 

The other obvious angle is that there is only so much revenue connectivity providers can coax out of consumers, who tend to spend less than three percent of their income on all communication services and devices. 

Even when business customer spending is not materially higher, percentage-wise, the gross revenue and profit margins tend to be much higher than for consumer services. 

source 

And that matters, as telco return on invested capital has been falling since 2010. Industry supporters cite government regulation as a possible way of boosting returns. The call for payments by a handful of giant app providers to fund telco infrastructure is an example of that. 

source: McKinsey

Major Channel Conflicf in Internet Ecosystem

Channel conflict always exists, to some extent, in any value chain, since one participant’s revenue model is another participant’s cost of doing business.

That has been an issue in the internet ecosystem for some time, as app creation and ownership has been separated from network facilities ownership. In other words, the very organization of the internet and computing separates functions into layers that operate independently of each other.




source: GSMA

Participants in the ecosystem act in a “permissionless” manner. And that always has irked connectivity providers, as any person with access rights or any lawful app can use the network without a formal business relationship with the underlying network.

So the connectivity industry now is making a push to alter revenue models. Consider a couple of analogies. What if refrigerator manufacturers and air conditioning suppliers had to pay electrical utilities additional fees because they drive electrical use on the grid?

Connectivity providers argue about revenue or valuation shares to make the argument that they are due more value from the ecosystem. But that is like arguing all appliances and apps using electricity collectively represent the vast proportion of value in the “anything using electricity” ecosystem.

That is the case in virtually every ecosystem: the things humans do that use electricity are vastly more “valuable” in economic terms than the value of electricity that gets sold. In other words, things people buy and businesses sell is the bulk of value in any area.



source: GSMA

It is not a stretch to argue that increasing costs for some participants to shift revenue to some other part of the ecosystem is simply part of the normal desire of any participant to “make more money.”

In a sense, that is “calling party pays” in the communications business. That also is the principle behind “access fees” paid by one carrier to another when customers place calls between networks. If one network terminates a call placed by a customer on another network, the receiving network is paid for the use of its network to do so.

The model actually works in the reverse in the water supply business in the United States. The heaviest users--farmers--pay far less for water than do the lighter household users. You can think of all sorts of public policy reasons why that should be the case, but the point is that subsidies and prices in an ecosystem can vary, and will be the source of channel conflict within an ecosystem.

In the end, the retail buyer pays for all the other profits of all the other participants in any ecosystem. A sustainable infrastructure matters as much as sustainability for all the other essential parts of any ecosystem.

But make no mistake: what connectivity providers propose is similar to charging third party appliance, app, content or other suppliers in the ecosystem to use a network that--like any other utility--ultimately makes its money charging its own customers for usage.

There is nothing magical about business models. Markets can be created and sustained with revenue created both by buyers and sellers; users and customers; suppliers and consumers. To the extent that government can change the rules shaping any industry’s business model, there is nothing “unlawful” about some entities proposing that the government change rules about how internet access services are provided.

The proposal by connectivity providers that both customers (end users of connectivity services) and partners supplying appliances, apps, services and content also pay for access is, however, a change of business model for any utility-type business (natural gas, drinking water, sanitation; waste management; electricity and telecommunications).

Some might point to airports as an example of such “both sides pay” models. Airlines pay landing fees to airports. Passengers pay airlines for travel. But airlines also recoup the cost of landing fees from passengers. So, ultimately, passengers pay for the landing fees of the airlines.

Connectivity providers propose something along those same lines. It is not unusual nor unlawful for them to try. It would not be unlawful if implemented. But customers (or end users) would still wind up paying, as all the other participants who are assessed new costs would find ways to recover those costs from their own customers.

Those “customers” would be advertisers in some cases, who would then recoup their own higher costs by passing them on to retail buyers in some fashion. In principle, the costs could be partly passed onto their own suppliers or investors.

Sustainable infrastructure is a good thing. Sustainability for the rest of the ecosystem is a good thing as well. But this a prime example of channel conflict.

The Internet Already is "Balkanized"

International communications have always been borderless in a controlled way. Both governments and service providers have guidelines about how and when communications can cross borders. 

Oddly enough, there are more barriers in the internet era, in large part because governments always have controlled the movement of content across borders.

So  regulation might be a bit different in the internet era, but it has not gone away, by any means. In fact, more barriers exist, compared to the days when only voice crossed borders. 

Governments routinely block some content, a process that has been obvious for some time.

source: Freedom House 

The internet is not borderless.