5G Leaky Bucket Problems

What happens with legacy services is arguably more important, near term, than what happens with new services created by 5G networks. The reasons are obvious: the new services represent smallish revenues while the legacy services represent most of the total revenue.

Small percentage declines in core legacy services have more revenue and profit margin impact than all the new services put together. The image of a hamster running on a wheel might not be appetizing, but that is the situation connectivity providers face.

Or, if you like, a leaky water bucket where new water is poured into the bucket as water continues to leak from holes.

Most connectivity service providers serving well-served and nearly-saturated mass markets would be happy if annual revenue growth chugged along at about a two-percent rate. Service providers in some markets can expect higher growth rates, but the global average will probably be in the two-percent range. 

Given some deterioration in legacy lines of business (negative growth rates), growth rates in one or more new areas might have to happen at higher-than-two-percent rates to maintain an overall growth rate of two percent. 

And that is the problem for new 5G services in the edge computing, private networks or internet of things areas, for example. The new revenue streams will be small in magnitude, while even a modest decline in a legacy service can--because of the larger size of the existing revenue streams--can pose big problems. 

Many service providers, for example, expect big opportunities in business services, which underpins hopes for private networks, edge computing and IoT. But revenue magnitudes matter. 

Consumer revenue always drives the bulk of mobile operator service revenues. And revenue growth is the key issue.  

But it will be hard for new 5G services for enterprises and business to move the revenue needle. 

Edge computing possibly can grow to generate a minimum of $1 billion in annual new revenues for some tier-one service providers. The same might be said for service-provider-delivered and operated  private networks, internet of things services or virtual private networks. 

But none of those services seem capable of driving the next big wave of revenue growth for connectivity providers, as their total revenue contribution does not seem capable of driving 80 percent of total revenue growth or representing half of the total installed base of revenue. 

In other words, it does not appear that edge computing, IoT, private networks or network slicing can rival the revenue magnitude of voice, texting, video subscriptions, home broadband or mobile subscription revenue. 

It is not clear whether any of those new revenue streams will be as important as MPLS or SD-WAN, dedicated internet access or Ethernet transport services, for example. All of those can be created by enterprises directly, on a do-it-yourself basis, from the network edge. 

source: STL, KBV Research 

In the forecast shown above, for example, services includes system integration and consulting, certain to be a bigger revenue opportunity than new sales of connectivity services. 

And though it might seem far fetched, the lead service sold by at least some connectivity providers might not yet have been invented.  

At least so far, 5G fixed wireless is the only new 5G service that is meaningful and material as a revenue source for at least some mobile operators. Even if network slicing, edge computing, private networks and sensor network support generate some incremental revenues, the volume of incremental revenue will not be as large as many hope to gain.

It is conceivable that mobile operators globally will make more money providing home broadband using fixed wireless than they will earn from the flashier, trendy new revenue sources such as private networks, edge computing and internet of things. 

source: Ericsson 

Wells Fargo telecom and media analysts Eric Luebchow and Steven Cahall predict fixed wireless access will grow from 7.1 million total subscribers at the end of 2021 to 17.6 million in 2027, growth that largely will come at the expense of cable operators. 

source: Polaris Market Research 

If 5G fixed wireless accounts and revenue grow as fast as some envision, $14 billion to $24 billion in fixed wireless home broadband revenue would be created in 2025. 

The point is that the actual amount of new revenue mobile service providers can earn from new services sold to enterprises is more limited than many suspect.

Unknown "Homes Passed" Data Hampers Revenue Growth Estimates

Some important types of statistics and data are not collected because governments do not force firms or industries to collect it. For example, many governments think it is important to track data on where home broadband exists, where it does not, how fast it operates, who buys and who does not. 

Private firms often have important incentives to track and measure their own revenues, sales, profit margins and growth rates. Financial markets and accounting rules often require measurement of this sort. 

AT&T, for example, reports revenues for mobility, fixed network business revenues and consumer fixed network revenues from internet access, voice and other sources. But those are traditional financial metrics, not operating indices such as penetration or take rates, churn rates and new account gains. 

source: AT&T 

Nobody seemingly believes the same effort should be made to measure the number of home broadband provider locations or dwellings reached by various networks. Better mapping, yes. Metrics on locations passed? No. 

And yet “locations passed” is a basic and essential input to accurately determine take rates (percent of potential customers who actually buy). That input matters quite a lot to observers when evaluating the growth prospects of competitors, even if that figure does not matter much for policymakers, who mainly care about the total degree of home broadband take rates, on an aggregate basis. 

The U.S. Census Bureau, for example, reported some 140.5 million housing units housing units as part of the 2020 census. The estimate for 2021 units is 142.2 million units. Assume 1.5 million additional units added each year, for a 2022 total of about 143.6 million dwelling units. 

Assume vacancy rates of about six percent. That implies about 8.6 million unoccupied units that would not be assumed to be candidates for active home broadband subscriptions. The U.S. Census Bureau, though, estimates there are about 11 million unoccupied units when looking at full-time occupied status. That figure presumably includes vacation homes.

Deducting the unoccupied dwellings gives us a potential home broadband buyer base of about 132.6 million locations. 

More difficult is the degree to which access networks operated by any single contestant actually pass those locations, as firms generally do not report such numbers in quarterly financial or annual reports (they do not have to do so). 

And that is where estimations must be made. AT&T’s 2022 10-K report cites 14.2 million customer locations connected. Assume AT&T has about 20 percent take rates for its home broadband services where it operates. That implies a housing unit coverage of about 71 million dwellings. 

Assume AT&T has a higher take rate of about 39 percent where it operates fixed networks. That implies housing coverage of about 36 million dwellings. 

The estimate of 71 million home passings strikes me as too high, but the estimate of 36 million seems too low. In the past I have used the figure of 62 million homes passed for AT&T. 

Assume Verizon has about 10 million home broadband accounts, with a take rate of 40 percent (a bit high, probably, if we include copper access). That implies housing coverage of some 25.3 million dwellings. 

Leichtman Research Group has estimates of home broadband accounts that vary from company reports. LRG estimates that AT&T has some 15.4 million internet access accounts. The variance might come from business accounts not enumerated. 

Verizon’s consumer accounts might be overstated, as LRG estimates Verizon has about 7.5 million home broadband accounts, not 10 million. Using the LRG account figures, we might estimate Verizon home coverage of about 18.8 million homes, on the high side. 

ISPs

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 

Assume Comcast has 31.2 million accounts, with take rates for home broadband of about 52 percent. That implies something on the order of 60 million households. 

Assume Charter Communications has a take rate of about 45.5 percent where it operates fixed networks. Assume Charter has approximately 30.8 million home broadband accounts. That implies a homes-passed figure of about 67.7 million homes. 

If there are 132.6 million U.S. occupied home locations, then Comcast and Charter can reach about 127.7 million of those locations, or about 96 percent of total, as Comcast and Charter essentially have unduplicated networks, not competing in the same geographies. 

That strikes me as unlikely, on the high side. An older rule of thumb is that Comcast and Charter reach about a third of total U.S. locations, each, for a possible reach of up to 66 percent of total U.S. home locations. 

Using different methodologies, I have in the past estimated that Comcast has (can actually sell service to ) about 57 million homes passed, while the Charter Communications network passes about 50 million homes, the number of potential customer locations it can sell to.

Verizon homes passed might number 18.6 to 20 million. To be generous, use the 20 million figure. 

AT&T’s fixed network represents perhaps 62 million U.S. homes passed. CenturyLink never reports its homes passed figures, but likely has 20-million or so consumer locations it can market services to. 

Ignoring the variance in potential customer locations passed, AT&T would seem to have the greatest opportunity in the home broadband space, if it can build optical access connections faster, as has the biggest home footprint and low home broadband market share. 

On the other hand, AT&T revenue is driven by mobility, not the consumer fixed network. So then the question has to be posed as "how much to invest in the consumer fixed network?" compared to other oportunities. A rational person might argue that answer is "not so much."

Capital availability--and financial returns--are always the issue. Even if it dramatically escalated fiber-to-home capital investment, it is not clear AT&T would gain as much new revenue, compared to investing in mobility or business services, for example.

The point of the wider exercise is that we are forced to guess about how many homes each of the major fixed network contestants actually can reach. That, in turn, affects our ability to estimate adoption rates and potential growth opportunities. 

The key point is that the estimates are imprecise. Pinning down the “homes passed” figure, essential as the denominator in any calculation of take rates, requires estimations with variable degrees of uncertainty, especially for the larger networks.

Product and Customer "Who, What, Where, When, Why" is Evolving

What you sell matters. How you sell it also often matters. Who you sell it to, and where you sell it, also matters. How much you sell always matters. What it costs you to sell those items also always matters.

The rise of digital infrastructure partly raises the issue of how best to organize the production and sale of internet access and other connectivity products, as cloud computing has changed the way we think about how to procure and supply computing and applications.

To a greater extent than ever, asset owners and analysts evaluate the merits of asset-light or asset-lighter approaches. That changes the answers to the questions of what, who, where, when, why products get sold, as well as how much and how profitably.

Access providers tend to have operating margin valuation multiples as much as three times lower than infrastructure-only providers such as tower companies. 

Several aspects seem to account for the disparities. Tower companies sell to all competitors in a market, and therefore are viewed as representing less risk, as the tower companies can theoretically address nearly 100 percent of the market.

No single retail telco or internet service provider ever can claim to acquire as customers more than a fraction of the total market. Additionally, tower companies sell multi-year contracts, often with price escalator clauses to protect against inflation. 

That offers the sort of cash flow predictability that investors value in utility type businesses ranging from electrical and natural gas retailers to airports and toll roads. Also, cell tower assets offer some protection against unrestrained new competition. 

source: Deloitte 

Data center assets also are viewed as having similar characteristics, though perhaps with less moat protection, as, in principle, additional data centers can be built at the same locations. 

Still, there are but a handful of hyperscalers who are potential data center tenants, so there are some moats in that regard. But the total range of enterprise and business tenants is far broader. 

While additional cell towers can be built at similar locations, the number of potential tenants is more limited, as there might be only a handful of potential tenants. 

For such reasons, data center assets might show a broader range of valuations, but still be much higher than EBITDA valuations for access providers. 

source: Oliver Wyman

Why Many "Digital" Firms Must Use Non-Traditional Proxies for Success

There is a good reason why many applications use non-traditional metrics for measuring progress: the sources of their value do not map with traditional financial metrics in a direct way. We sometimes think that is true of “software” companies or “digital” firms, but that is partly a coincidence. 

The internet, layered software and virtualization allow most firms to conduct their existing businesses in different ways, without changing the traditional performance metrics. 

Platform businesses, on the other hand, necessarily must account for their success at creating ecosystems of value creation, which are not measurable using standard accounting conventions. 

That is why we often see metrics that are proxies for user engagement, such as daily active users or monthly active users. We might see citations of time spent on the platform. Perhaps we see data on conversions of visits to sales of merchandise. 

Uber might cite gross bookings paid by rider, or the number of trips riders take, the number of drivers or the number of riders per day or month. 

Airbnb might cite nights booked, gross booking value, host earnings or average daily rates as evidence of success. 

Amazon Marketplace and eBay will cite gross merchandise volume. Amazon might point to units sold, customer satisfaction ratings. 

Ebay might track active buyers or seller ratings. 

Since network effects are critical, we might see numbers about growth in the number of producers, merchants, properties, drivers, listings. We might see evidence of success in terms of growing gross merchandise sales, rides, rentals or other metrics about buying volume. 

User abandonment of the platform also could matter, so we might see evidence provided about churn rates declining. 

Connecting domains in the internet era provides an example of the “death of distance” in wide area networking. 

But non-GAAP metrics have grown in importance, even for firms not using platform business models. Competitive local service providers once cited metrics such as “voice grade equivalents” to show sales progress, at a time when service providers were early into the process of measuring bandwidth supplied--rather than voice lines in service--as a proxy for performance. 

Average revenue per account, or average revenue per unit, now are proxies for progress in boosting revenue. Churn rates also became important in competitive markets, where lost customer accounts also tended to mean that a competitor gained an account. 

For similar reasons, customer acquisition cost became an important and relevant metric. 

These days, marketing battles are fought over metrics such as internet access speed, rather than voice quality; outage performance rather than voice quality. 

Consider also that wide area transport of data was charged using distance and capacity as the cost drivers. These days, distance is basically not a significant driver of cost. Instead, interconnection bandwidth tends to drive prices. 

In fact, large domains often agree to “peer” without major recurring cost, exchanging traffic between domains without costs related to traffic volume, as it is expected that inbound and outbound traffic will roughly balance on an annual basis. 

None of those are standard financial reporting categories, but are important proxies for business success.