Is FTTH Some Form of "Greater Fool" Theory?

One has to ask whether some version of the “greater fool” investing approach applies to private equity and institutional investor positions in copper access networks that can be repositioned as optical access assets. 

That theory suggests an investor can make money buying overpriced assets so long as there are investors willing to pay an even-higher price. It works until there are no more “fools” left. 

The issue might be that payback models for today’s investors do not clearly seem to make sense on an operating basis. And fiber-to-the-home always has had marginal payback, even if strategically important. 

The most-shocking changes are the revenue assumptions for consumer locations. These days, the expected revenue contribution from a home broadband account hovers around $50 per month to $70 per month. Some providers might add linear video, voice or text messaging components to a lesser degree. 

But that is a huge change from revenue expectations in the 1990 to 2015 period, when $150 per customer was the possible revenue target. In some cases, revenue up to $200 per home location was considered feasible. 

To be sure, capital costs arguably have fallen to some extent. But most ISPs also operate in competitive markets, which increases the danger of stranded assets. 

And though ISPs might once have built their payback models on three potential revenue sources--voice, video entertainment and internet access--they now tend to base returns on one single service: consumer home broadband. 

To be sure, some ISPs also point to value for supporting small cell networks and upside from business customers. But one never sees detailed financial contributions from these areas in quarterly earnings reports. 

That suggests the contributions are indirect and hard to measure. 

“Our fiber ARPU was $61.65, up 5.3 percent year over year, with gross addition intake ARPU in the $65 to $70 range,” said John Stankey, AT&T CEO, of second quarter 2022 results. “We expect overall fiber ARPU to continue to improve as more customers roll off promotional pricing and on to simplified pricing constructs.”

Lumen reports its fiber-to-home average revenue per user at about $58 per month.

Recent presentations also have shown fiber-to-home home broadband average revenue per user of about $63. 

But assume for the moment that such additional value can be reaped. Why have potential investors other than connectivity service providers seemingly changed, bringing in financial investors from “outside” the ranks of service providers?

The clear argument is that digital instructure now is viewed as within the class of infrastructure investments that long have been favored by institutional investors. Digital infrastructure also is viewed as interesting by private equity firms that long have invested in underperforming or appreciating assets. 

Real estate and infrastructure investors are said to have different motivations for investing in each asset class. Real estate investment trusts, for example, traditionally are valued for their ability to produce income. 

Infrastructure offers predictable cash flow and business moats. But both assets also are supposed to offer diversification from asset risk related to concentration in stocks and bonds. 

On the other hand, both asset classes tend to be viewed similarly these days. Firms that invest in real estate also invest in infrastructure, including digital infrastructure such as cell towers, data centers and optical fiber networks. 

Private equity firms, which tend to invest in assets believed to be underperforming, tend to see similar opportunities in both real estate and infrastructure. Both asset classes are viewed as offering high financial returns. Both offer diversification for investment portfolios. 

Both are hedged against inflation and offer capital appreciation. Both are seen as supply-limited assets. And in recent days, some forms of digital infrastructure also benefit from government subsidy programs that reduce capital investment hurdles. 

And both types of assets are long-lived, capital intensive assets where leverage normally is required. 

We ultimately will see whether digital infrastructure winds up with some form of “greater fool” dynamic, in at least some parts of the sector. 

At the moment, payback from FTTH producing $50 to $70 monthly revenue from perhaps 40 percent to 45 percent of locations does not immediately suggest the FTTH capex produces a clear and interesting financial return. 

That might well be the case in areas where the first firm to deploy FTTH can reap take rates far higher than 45 percent. The payback might also be notable if wholesale access means the facility operator can count on both retail and wholesale market share. 

Such conditions arguably exist most often in rural markets, and less often in urban and suburban areas. Networks in rural areas are more expensive than networks built in urban and suburban areas, so payback seems to remain an issue in virtually all markets, even with government subsidies. 

The point is that some of us have yet to see payback analyses that are completely convincing where it comes to copper access networks intended for FTTH upgrades. Eventually we will find out. Let’s just hope some version of the greater fool theory is not operating. 

“Buy high, sell higher” works until there are no more buyers willing to “buy higher.”

When Do "Non-Core" Revenues Reach a Level Suggesting a Firm has "Transformed" Itself?

AT&T once earned as much as 14 percent of its total revenue from “non-communication” services, mostly related to its linear TV subscription business, which the firm now has spun off to shareholders. 

Many “mobile operators” and “telcos” are looking to expand revenues from sources beyond the traditional connectivity services, according to GSMA. Some telcos in the Asia-Pacific region have gotten as much as 15 percent up to 50 percent of total revenues from non-communications products, according to Twimbit. 

 source: Twimbit

Before it spun off its linear video business, AT&T had booked as much as 40 percent of total revenue outside of core communications services and products. On average, larger telcos book as much as 22 percent of total revenue from sources outside their communications core. 

source: GSMA Intelligence 

source: GSMA   

Indices such as revenue from “non-core” sources is important for a number of reasons. It can show that “new product” progress beyond basic connectivity is possible. Growing revenue beyond the core also opens up the possibility that transformation also is possible. 

To the extent that connectivity providers want to grow beyond “access and transport” to provide all sorts of value that create new revenue upside, the percentage of “non-core” revenue matters.

For a few firms that might attempt a substantial “digital transformation,” the revenue contributors matter even more. If any connectivity provider can reach the point that more than half its revenues come from non-connectivity sources, we might argue that firm has transformed its business model.

Telcos are Good at Buzzwords, Pretty Lousy at Transformation

When connectivity providers serving retail customers are urged to become digital service providers or techcos, they are being urged to move into new areas of the ecosystem (applications, use cases, roles, value, products. 

Such calls, make no mistake, are for “telcos” to become something else. What precisely such terms mean is a matter of interpretation. For some, it means “revamping operations to reduce costs; digitally transforming the customer experience and service development processes; and developing a differentiated value proposition that leverages 5G, IoT, and edge investments and capabilities.” 

source: STL Partners

Organization culture designed to encourage experimentation, “digital” solutions, partnerships and virtualized and open infra approaches are a good thing. 

Those all are laudable goals, to be sure. Lower costs, better customer experience and faster product development times are good things. “Differentiated value propositions” building on the core network and core revenue model likewise are good things. 

Skeptics might ask why any of those objectives are not simply sound management. What business leader does not want higher value, lower costs, better customer experience and faster product development times?

In other words, all the talk about becoming techcos might be essentially using today’s tools to manage and execute any business better. So being a “techco” means using modern software, information technology and computing as do all other well-managed companies.

Not to be critical, but if “becoming a techco” means “running one’s business well,” I’m not sure the term means very much, in terms of strategy, though it is quite important operationally. 

Likewise, some might argue that being a digital service provider entails a way of doing things that emphasizes personalization or mass customization. Again, not bad things.  

There are other interpretations, though. A “digital service provider” might imply selling higher-value, higher-order applications and solutions beyond mere connectivity. That also generally implies operating in different parts of the computing, software, solutions or application value chains. 

source: Researchgate 

If one maps value chain roles and operations roles, it is possible to claim multiple roles for any retail connectivity provider. In fact, it is possible to argue that retail connectivity providers have many roles, at least where it comes to delivering a connectivity service. 

source: Semantic Scholar 

Likewise, it might be argued that a connectivity service involves multiple roles for the service provider. But those make most sense for creation and delivery of a connectivity service. 

source: The New Stack 

The value chain looks very different when “connectivity,” an essential part of the internet-based applications, computing or experience value chain, is viewed in context of the full value chain to deliver an experience to an end users. 

In that case, the internet access function is more highly compartmentalized. So, in a context of “digital service provider,” the connectivity provider role must expand. We can argue about the logical areas for expansion, but the basic argument is that connectivity providers seeking to become digital service providers have to add roles elsewhere in the value chain. 

source: On5G 

So access providers might move into being operators of data centers, content delivery networks, online marketplaces, advertising venue providers, payment or transaction providers, content owners and bundlers or app providers. 

That implies moving outside the area of core competence and into other realms and functions. 

In essence, the call to become a “digital service provider” might also entail becoming an asset owner and supplier of all sorts of other values beyond connectivity. Financial analysts rarely praise such moves, as the track record for service providers trying to do so is spotty at best. 

“Concentrate on your core business” almost always winds up being the advice. But it is nearly impossible to “become a digital service provider” without taking such risks. Rephrase slightly to “become a digital solution provider,” or “become an app provider,” or “become a platform.”

All those ideas imply becoming the owner and supplier of assets providing value in the internet-delivered application, experience or capability spaces beyond “mere” connectivity.

It implies ownership of branded apps, content, business solutions, software or computing services beyond “connectivity.”

Not to be critical, but much of the language around “becoming a techco” or “digital service provider” is more marketing hype than business strategy. Sure, managing a business well is praiseworthy. Creating personalized experiences and customized features is helpful. 

But those are not the same outcomes as assuming new and broader roles in the value chain; ownership of different types of assets providing different value propositions. In the past, that has meant efforts to create branded and owned mobile app stores; data centers; cloud computing services; content networks and sites; occasionally devices. 

But such efforts go far beyond internal operational measures to run the business better, improve customer experience or personalization. Basically, what connectivity providers are after is new roles in the broader value chain. Spinning new buzz words is not that.

Home Broadband Speeds Reaching Multi-Gigabit Levels

Home broadband speeds have climbed for more than two decades and virtually nobody expects that trend to stop. Consider the growing number of internet service providers offering gigabit and multi-gigabit home broadband services.  

A 2022 Omdia survey of 760 home broadband service providers across 178 geographies found that 60 percent of service providers offered service plans operating at 1 Gbps or higher. In North America, 13 percent of service providers already had begun offering multi-gigabit speeds, Omdia says. 

Region	# of service providers surveyed	% SPs offering 1Gbps or faster
Asia & Oceania	144	51%
EMEA	392	57%
Latin America & Caribbean	71	20%
North America	160	88%

source: Omdia 

The other observation is that some form of “digital divide” seems likely to persist, as rural networks tend not to match the performance of urban networks. Networks in developed countries tend to outpace networks in developing regions. 

And beyond availability (potential customers can buy), consumers make their own decisions about what to buy, and why. As a rule, customers tend not to buy the most-pricey, highest-performance tiers of service. Instead, they tend to buy service somewhere in the middle. 

In 2022, for example, North American home broadband customers mostly were buying services operating between 100 Mbps and 500 Mbps, according to Omdia. That was neither the slowest nor the fastest tiers of service available.

source: Omdia 

Over time, that “typical” service level will shift upwards and to the right. But most customers will still be buying service somewhere in the middle.

If You Have a Choice, Expand into a Faster-Growing, Higher-Valuation Part of the Internet Ecosystem

A management professor once told us that when choosing to enter a line of business or career, one generally does better picking an industry or segment that is growing fast, compared to an industry or segment growing slowly. 

The same general observation arguably also holds for lines of business a connectivity provider might consider when looking for revenue growth or repositioning into additional segments of the internet ecosystem. 

As connectivity providers look for new ways to grow revenue, there are only a few basic strategies they can adopt. They can add scale. They can add new connectivity products. They can try to increase the value of their connectivity products. Or they can move into new areas of the internet value chain and add new roles within the ecosystem.

Adding scale is the simplest strategy: sell more of what you already do sell. Creating more “added value” arguably is the next step up in complexity, as it requires creation of new features, bundles, channels or support. 

The strategy of selling new connectivity products is more complex, as the additional product lines might not have the market potential to be large revenue contributors. Those products might require new skills or be sold to different customers. 

Most complicated of all is taking on new roles within the ecosystem. That carries both the most risk but sometimes also the most reward. 

New products and greater scale generally add revenue bulk. That matters because valuation is higher for firms with higher growth rates and business moats. Growth prospects alone tend to move firms towards the upper range of EV/EBITDA rankings from perhaps 12 times (or lower ratios) towards the high end around 15 times. 

The value of moving into additional parts of the ecosystem is that sometimes those other roles carry higher EV/EBITDA valuations. Telcos generally have EV/EBITDA rations in the 10 times to 12 times range. 

Content or media firms, for example, also have ratios in the 10 to 15 times range. So taking on content ownership roles adds gross revenue and might provide additional profit margin advantages and diversification. 

Likewise, consumer electronics firms often carry EV/EBITDA ratios in the 10 times to 15 times range. 

Movement into internet content roles could provide a boost in EV/EBITDA ratios to a range from 15 to 20 times. Likewise, semiconductor firms often have rations in the 15 to 20 area. 

Moving into other roles could carry EV/EBITDA valuations in a similar or higher range, in other words.  

E-commerce apps and sites, for example, might carry ratios in the 20 times to 30 times range. Software firms might carry ratios in the 20 to 21 range. 

Looking at EBITDA and net income margins, larger telcos and connectivity firms might have EBITDA margins in the 20 percent range, with net income margins lower than EBITDA margins. Smaller providers might have EBITDA in the 10 percent range, with net income margins lower than that. 

EBITDA margins for linear video can range from 15 percent to 20 percent. Net margins (after taxes) might range from 10 percent to 15 percent. 

EBITDA margins for content companies such as Disney, Warner Brothers Discovery or Paramount can range from 20 percent to 25 percent. Net margins (after taxes) might range from 10 percent to 15 percent. 

EBITDA margins for internet content companies such as Google, Meta or Twitter can range from 30 percent to 40 percent. Net margins (after taxes) might range from 20 percent to 30 percent. 

EBITDA margins for e-commerce apps and sites such as Amazon or eBay can vary based on translation volume. Smaller sites might have EBITDA in the 10 percent to 15 percent range, while Amazon has in the past had margins closer to 20 percent. Net income margins might range from five percent to 10 percent. 

EBITDA margin for smaller software firms might range from 20 percent to 25 percent. Net income margin might range from 15 percent to 20 percent. Larger firms tend to have higher margins. Microsoft or Oracle could have EBITDA margins as high as 30 percent. 

The bottom line is that a successful move by a telco or connectivity provider into almost any other part of the internet ecosystem can trigger a higher valuation of earned revenue.

Are Home Broadband Prices Going Up or Down?

Are home broadband prices going up or down? It might seem an easy question to answer. "Up," of course, many will say. But ask a different question: what are the price trends compared to other essential products. One might get a different answer. 

Home broadband pricing comparisons are more tricky than you might suppose. One has to choose which sorts of plans to compare. Is the comparison to be made of the most-affordable plans, those in the middle or the highest-priced plans? 

And what if half or more of all customers buy service bundles, not stand-alone internet access plans? Does one exclude buying behavior from half or more of the audience? And what if a significant percentage of customers are on promotional plans? Does one compare those, or only the “standard” plan pricing when promotional periods end?

In other words, it does not make sense to compare price plans most consumers do not buy. Though judgment and choices must be made, what are the plans “most” consumers actually buy? As a rule, that will mean comparing not the value plans or the highest-cost plans, but plans someplace “in the middle of the range,” as that is what most consumers actually buy. 

All that and we have to include the impact of inflation, which distorts longer-term “real” price trends. Finally, there are changes in product quality over time. Does one compare 10 Mbps plans to 100 Mbps or 1,000 Mbps over time? And if so, how does one adjust for quality improvements? Such hedonic adjustment applies whenever legacy products have changed in some key way that makes them new products.

The classic example has been personal computer technology. But internet access also has changed in similar ways over time. 

source" USTelecom

It is hard to answer the question “have home broadband prices risen since 2009?” without using hedonic adjustment and also adjusting for inflation. The Bureau of Labor Statistics uses hedonic adjustment to track producer prices for home broadband, for example, since speed and other attributes change over time. 

The rationale is that a dial-up internet connection is not a  comparable service to home broadband at various speeds (10 Mbps, 100 Mbps, 1 Gbps, for example). Since prices tend to stay about the same over time while speeds have increased for the “most bought” tiers of service, BLS adjusts prices to account for quality improvements. 

source: Bureau of Labor Statistics 

In other words, home broadband prices might not be “too high.” Where many other essential products have seen price increases--even before the recent bout of high inflation--home broadband prices arguably have decreased. 

Ignoring hedonic changes, Compared to 2008, fixed network broadband costs have fallen, globally, though there is a slight rise in developed nations, driven by consumer preferences for higher-priced and higher-speed services, according to International Telecommunications Union data. 

source: ITU 

Consumers do not like price increases, it goes without saying. But nominal price increases, when inflation is at any rate above zero, are going to happen. Real price increases must adjust for currency differences, inflation rates and hedonic quality changes, not to mention actual consumer behavior.

Some Parts of Amazon's E-Tailer Operations are Not Valued Appropriately

An interesting valuation issue exists at Amazon, partly based on revenue growth expectations, profit margin potential, but also business model. Amazon’s two major lines of business are Amazon Web Services, at about 16 percent of sales, and the e-commerce and advertising operations, representing the bulk of Amazon sales volume. 

Simply, AWS supplies all of Amazon’s net income. 

source: Amazon 

AWS also arguably represents all of Amazon’s profit.

source: FourweekMBA 

Amazon’s e-commerce operations clearly use a platform business model, while Amazon Web Services only uses that model for a portion of AWS operations, notably the marketplace for third-party app and software suppliers. 

The valuation of these operations suggests that a platform business model does not, in and of itself, have a consistent value across all industries. Valuations can be higher or lower depending on the context. 

AWS--which mostly is not a platform business model, might be valued at a software stock's valuation of 10 times sales. The e-commerce operations might be valued similarly to other retailers. Walmart and Target, for example, might be valued between 0.66 times sales up to 0.74 times sales. 

Of course, buried within the e-commerce operations are other lines of business that should carry a different valuation. Amazon’s growing advertising operations, subscription services and third-party logistics and sales platforms, for example, should not be valued on a simple retailer basis. 

Advertising-driven firms might be valued from three times revenue up to eight times revenue or higher, in some cases. So that portion of Amazon e-commerce that generates advertising revenue represents a different valuation than the simple e-tailing. 

All that suggests that a platform business model does not carry with it an automatic higher or lower valuation than that same business operated in a traditional “pipeline” manner. Growth potential obviously has a greater impact.