Practical Implications of Pareto, Rule of Three, Winner Take All

Any market researcher, studying any particular market, will tend to find something like a Pareto distribution often applies: up to 80 percent of results are produced by 20 percent of actors. Some might call that the rule of three. 

Market share structures in computing, connectivity and software 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. 

Others might call this winner take all economics.  

Consider market shares and installed base in the U.S. home broadband market (including small business accounts). Of a possible total installed base of 122 million locations, 90 percent of the installed base is held by 15 companies. 

Just two firms have 52 percent of the installed base of accounts. 

Broadband Providers	Subscribers at end of 2022	Net Adds in 2022
Cable Companies
Comcast	32,151,000	250,000
Charter	30,433,000	344,000
Cox*	5,560,000	30,000
Altice	4,282,900	-103,300
Mediacom*	1,468,000	5,000
Cable One**	1,060,400	14,400
Breezeline**	693,781	-22,997
Total Top Cable	75,649,081	517,103
Wireline Phone Companies
AT&T	15,386,000	-118,000
Verizon	7,484,000	119,000
Lumen^	3,037,000	-253,000
Frontier	2,839,000	40,000
Windstream*	1,175,000	10,300
TDS	510,000	19,700
Consolidated	367,458	724
Total Top Wireline Phone	30,798,458	-181,276
Fixed Wireless Services
T-Mobile	2,646,000	2,000,000
Verizon	1,452,000	1,171,000
Total Top Fixed Wireless	4,098,000	3,171,000
Total Top Broadband	110,545,539	3,506,827
source: Leichtman Research Group

The point is that when tracking market developments, the big broad trends are discernible from understanding the actions, strategies and results of a mere handful of firms. And while the full range of “big company” strategies, opportunities and actions can vary substantially from those of perhaps hundreds to thousands of small firms, the trends that move the needle financially typically can be gleaned from following just a relative handful of firms. 

In other words, the business “laws of motion” are dictated by a relative handful of actors, even in markets with thousands of contestants. 

That might seem unimportant. For market analysts, it is a foundational assumption.

Data Centers as Connectivity Providers

It overstates the matter to argue that “interconnection” is the core business of a data center, compared to rack space, power, air conditioning and security at better financial terms than operating one’s own internal data center. 

But it would not be overstating the matter to argue that interconnection is an absolutely vital function of a data center. 

According to Cisco data, most global data traffic actually moves within data centers. In past years, “inside the building data traffic has represented as much as 75 percent of all data traffic.  Another seven to nine percent of global data traffic moved between data centers, according to Cisco. 

source: Cisco 

Nor would it be incorrect to argue that a data center’s core revenues come only partly from real estate value. As it turns out, a growing part of the business is interconnection value.

By some measures, interconnection represents roughly 18.5 percent of Equinix recurring revenues. 

source: Nortia Research, Paolo Gorgo 

source: Nortia Research, Paolo Gorgo 

Other leading data centers also report significant recurring revenues from interconnection services. 

source: Nortia Research

We normally think of connectivity providers as the lead suppliers of “interconnection” or “networking” or “bandwidth,” but data centers also directly earn revenue from supplying interconnection services, access to networks and bandwidth. 

source: Equinix, dgtlinfra  

On its fourth quarter 2022 earnings call, Equinix noted that interconnection business saw revenues for the quarter growing 13 percent,  year-over-year, “outpacing the broader business.”

“Equinix Fabric saw continued growth and is now operating at a $200 million revenue run rate, one of our fastest-growing products,” said Charles Meyers, Equinix CEO.

In Home Broadband, Physical Media Matters, But Perhaps Not as Much as You Might Think

There always is a gap between deployed fiber-to-premises passings and customer uptake. As a practical matter, there is a lag between full marketing results and network construction. Secondly, it does not appear that “fiber access,” in and of itself, necessarily is the preferred consumer choice in competitive markets. 

source: BT, LightReading 

In markets with strong cable operator competition, for example, FTTH tends to get between 40 percent penetration and 45 percent adoption after about three years of marketing. Some FTTH ISPs hope to reach a terminal adoption rate of 50 percent, but that is about the extent of expectations. 

source: IDATE, TelecomTV

Data from other European markets shows similar gaps between facilities deployment and take rates, where take rates hover between 45 percent and 47 percent. And that is a view of physical media choices, not necessarily speed tiers chosen by customers. 

We often assume the key point is service delivery by optical fiber at the premises. The better metric is consumer choice of service plans ranked either by speed or price. 

source: Omdia, Medux 

Customers often choose not to buy the fastest tiers of service on any home broadband network, even if the percentage taking higher-speed tiers continues to grow. That is what one would expect, of course, as “typical” or “average” speeds continue to grow. Still, many consumers choose not to buy the “fastest” tiers, but rather tiers someplace in the middle between fastest and slowest. 

source: OpenVault

The point is that assessing physical media availability does not directly correlate with any particular consumer choices related to speed tiers. Speeds will keep growing on all access platforms over time. So physical media alone does not directly correlate to specific choices consumers make.   

source: RVA, Broadband Communities 

We often equate “fiber access” with “speed.” That requires some qualification. Gigabit or multi-gigabit speeds are possible. That does not mean they are always offered, or that, when offered, that consumers buy the services. 

What matters is both availability and take rates of gigabit and multi-gigabit services. Physical media really is not the issue.

"Sum of the Parts" is Getting More Important

Asset valuation in the digital infrastructure space gets more complicated as firms start to embrace functions across two or more ecosystem roles.

Even within a single category, valuation often requires understanding which "type" of asset is involved.

Infrastructure investors sometimes debate whether “core plus” is a “real” category, but there is no doubt new asset classes that might once have been considered “core plus” now are either “core” assets or, in some cases, “supercore.” The original categories come from the real estate business, and now also are the framework for infrastructure investing generally. 

Those who use the “supercore” appellation essentially move “core” assets to the “supercore” category, while the former “core plus” becomes core. The value-add category then becomes “core plus.” Some add an additional “opportunistic” category including assets in emerging markets and assets whose primary value is asset appreciation rather than operating income. 

source: Mercer 

“Supercore” has in the past referred to assets with regulated prices and rates of return, such as electrical utilities. “Core” assets might be considered those with business moats, pricing power and predictable demand. Toll roads, railroads, energy distribution companies. airports or mobile network towers provide examples. 

Generally speaking, supercore assets are perceived as having the lowest risk, core-plus as having higher risk, greater variability but also higher growth rates or profit margins. 

Key valuation metrics arguably also vary between the asset classes. 

Supercore assets--the most predictable assets, with the highest business moats--often rely on earnings (EBITDA) and pierce-earnings multiples.

Core-plus assets often require injections of new capital, so often rely on internal rate of return metrics. Optical fiber networks often are in this category. 

Core assets might more often be evaluated using net operating income or discounted cash flow analyses. These are considered mature and stable categories. Mobile towers and data centers often are in this category. 

------------------

Virtually all observers would agree that valuation multiples for assets such as data centers are different from valuations of connectivity providers, and that valuations for other assets also will differ from either of those types of assets. 

sources: Oliver Wyman, Bank of America 

Industrial technology, which includes industrial process control, industrial software, vision technology, robots and motion sensing, can feature EV/EBITDA multiples somewhere between “connectivity providers” and data centers. 

source: Capitalmind 

source: Adventis Advisors

To be sure, valuation multiples change over time, and already seems to be true in 2023 for public software companies. 

source: Microcap.co  

Multiple compression from the robust financial markets of 2020 is obvious in every vertical category. 

GICS Sector	12/31/2022	6/30/2022	12/31/2021	6/30/2021	12/31/2020
Communications	8.57	9.27	12.96	14.78	14.14
Consumer Discretionary	14.44	14.98	21.88	23.02	26.09
Consumer Staples	16.42	14.92	17.53	16.53	16.92
Energy	5.37	6.98	8.97	22.52	-
Health Care	16.24	14.93	18.18	19.73	17.36
Industrials	15.06	13.89	17.62	25.12	20.61
Information Technology	15.96	15.91	23.45	22.87	22.65
Materials	9.14	9.05	11.91	15.25	18.18
Real Estate	16.61	17.83	24.48	25.27	21.30
Utilities	13.75	14.35	14.23	13.59	13.63

source: Siblis Research 

The whole point is that industries have different sorts of multiples. And valuation becomes much more complicated when firms start embracing multiple roles within the ecosystem. “Sum of the parts” evaluations then must be conducted to figure out what an asset ought to be worth.