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

What does "Communications" Mean, These Days?

Words have meaning, so changes in words also can have meaning. Consider the “communications” segment of the Standard and Poors 500 index.

The "communications" sector of the S&P 500 includes companies involved in advertising, media, internet services, and telecommunications. Each of those segments operates in different parts of the internet ecosystem, with distinct roles and valuation profiles. Lumping them all together might obscure more than it reveals. 

The firms tracked as part of the S&P 500 “communications index include: 

1. Alphabet Inc. Class A (GOOGL)

2. Alphabet Inc. Class C (GOOG)

3. AT&T Inc. (T)

4. Charter Communications Inc. Class A (CHTR)

5. Comcast Corporation Class A (CMCSA)

6. DISH Network Corporation Class A (DISH)

7. Meta (META)

8. Netflix Inc. (NFLX)

9. Omnicom Group Inc. (OMC)

10. The Interpublic Group of Companies Inc. (IPG)

11. Twitter Inc. (TWTR)

12. Verizon Communications Inc. (VZ)

13. Walt Disney Company (DIS)

I don’t know about you, but I evaluate asset-light advertising firms quite differently from capital-intensive connectivity firms, and media content owners different from both those other segments. Likewise, I would not consider Alphabet, Twitter and Meta in the same category as advertising, connectivity or content ownership firms. And even if other firms in the index have some streaming exposure, they are not pure-play streamers like Netflix. 

The point is that knowing how the firms in the index have performed financially does not really tell you much about how each of the sectors performed; what their growth rates are or how they should be valued relative to their “peers.” 

Charter, Comcast, Verizon, Dish and AT&T are in one valuation range. Alphabet, Meta, Twitter are in another range. Mobile firms recently have featured EBITDA multiples in the seven range. 

Advertising and marketing firms have had multiples in the 10.6 range. Cable TV companies have been valued at about 7.5 multiples. “Integrated telecommunications services: have a 6.8 multiple. “Online services” garner a multiple of 15.9. 

It does not necessarily illuminate our understanding that firms with such disparate multiples are considered to be in a single index. 

By some estimates, The average P/E ratio for U.S. telcos  was around 20 as of 2021.Online services provider average P/E ratio was around 50 in 2021. By other estimates the ratios were lower. 

Using TTM/GAAP metrics, Verizon’s early 2023 P/E ratio was about 7.7. Comcast in the same period had a 31 P/E while Charter had a 12 ratio. Netflix had a 35 P/E ratio. Alphabet and Meta had ratios close to 20. 

Omnicom had a ratio of about 14.4. Disney, meanwhile, traded at about 55 times earnings. Netflix traded at 34.7 times earnings. 

To be sure, ratios are affected by firm size, growth rates, firm efficiency, debt loads and investor sentiment. 

But you get the point: S&P assembles a single index including firms with wildly-different earnings or price ratios, producing an “average” performance index that might actually obscure more than it reveals.

"Communications" as Viewed by S&P Index Has Lost Meaning

Words have meaning, so changes in words also can have meaning. Consider the “communications” segment of the Standard and Poors 500 index.

The "communications" sector of the S&P 500 includes companies involved in advertising, media, internet services, and telecommunications. Each of those segments operates in different parts of the internet ecosystem, with distinct roles and valuation profiles. Lumping them all together might obscure more than it reveals. 

The firms tracked as part of the S&P 500 “communications index include: 

1. Alphabet Inc. Class A (GOOGL)

2. Alphabet Inc. Class C (GOOG)

3. AT&T Inc. (T)

4. Charter Communications Inc. Class A (CHTR)

5. Comcast Corporation Class A (CMCSA)

6. DISH Network Corporation Class A (DISH)

7. Meta (META)

8. Netflix Inc. (NFLX)

9. Omnicom Group Inc. (OMC)

10. The Interpublic Group of Companies Inc. (IPG)

11. Twitter Inc. (TWTR)

12. Verizon Communications Inc. (VZ)

13. Walt Disney Company (DIS)

I don’t know about you, but I evaluate asset-light advertising firms quite differently from capital-intensive connectivity firms, and media content owners different from both those other segments. Likewise, I would not consider Alphabet, Twitter and Meta in the same category as advertising, connectivity or content ownership firms. And even if other firms in the index have some streaming exposure, they are not pure-play streamers like Netflix. 

The point is that knowing how the firms in the index have performed financially does not really tell you much about how each of the sectors performed; what their growth rates are or how they should be valued relative to their “peers.” 

Charter, Comcast, Verizon, Dish and AT&T are in one valuation range. Alphabet, Meta, Twitter are in another range. Mobile firms recently have featured EBITDA multiples in the seven range. 

Advertising and marketing firms have had multiples in the 10.6 range. Cable TV companies have been valued at about 7.5 multiples. “Integrated telecommunications services: have a 6.8 multiple. “Online services” garner a multiple of 15.9. 

It does not necessarily illuminate our understanding that firms with such disparate multiples are considered to be in a single index.

Nomenclature Change Shows Business Change

Private equity firms say they invest in fiber to premises providers instead of “telcos.” That is the key to understanding the restructuring opportunity they see.

Access providers don’t want to be known as “telcos” anymore. They don’t want to be known as “cable TV” companies, either. Instead, they are internet service providers, or home broadband providers. That trend has been nearly two decades in the making and tells us much about how the business has changed. 

But the very fact that private equity firms invest in digital infrastructure also tells us some other possible things about the business.  

Historically, the private equity business model requires acquiring assets that can be transformed in some way to add value. Sale of those assets is the exit. That might imply there is a “problem” of some type with the asset that PE can fix, before flipping the asset. 

 Institutional investors are the other group that traditionally buys real estate type assets ranging from hotels to airports and toll roads to gas pipelines and electrical utilities. They are more interested in predictable cash flow generated from slow-growth assets with some degree of natural advantage in the form of business moats that protect them from competition. 

The issue that we might contemplate is what the new interest in digital infra assets indicates about business models. Some PE investments are vertical: airport operation, gas pipeline operations, toll road operations and produced cash flow are the value. The physical assets underpin operations. 

In other cases, the model is more horizontal. The value of a wholesale broadband access network is the ability to lease access to the network, rather than operating the retail business to generate cash flow. 

The analogy in the classic real estate business is the “asset light” model used by some hotel, hospitality or entertainment businesses where the retail business operates without land ownership, sometimes without building ownership, sometimes without indigenous management or branding. 

So the issue is how far similar concepts can be applied within the connectivity industry. Everyone is familiar with the “asset light” mobile virtual network operator model in the mobile industry. 

Fixed network operators are moving, in parts of their businesses, in that direction, at least in the form of joint ventures that share ownership of access network assets. 

Up to a point, hyperscale app providers have moved vertically, to integrate transport functions (wide area networks). Google Fiber is an example of full vertical integration, in some ways. So are hyperscale data centers. 

Just how far the fixed network unbundling can go is a question, as is the degree of vertical integration by hyperscalers. 

AT&T Gigapower Joint Venture Raises Questions

The Gigapower joint venture between AT&T and BlackRock is one more illustration of how the local connectivity business model is evolving. First of all, the venture will operate on a wholesale basis outside AT&T’s core fixed network footprint. AT&T will be an anchor tenant on the network.

The open access network initially will target about 1.5 million locations outside the 21-state AT&T fixed network footprint. AT&T might not traditionally have been a fan of wholesale local access, but the capital requirements to build out networks in 29 states where it has no existing fixed network operations is daunting.  

Cost sharing appears to be the way AT&T has concluded it must operate to expand its own retail operations in those 29 states, as a fixed network services provider. \

T-Mobile also is reportedly looking at some form of joint venture to start building its own fixed network capabilities. Cable One also looks to use joint ventures to fund its own ISP footprint out of its current footprint. In the United Kingdom Virgin Media O2 likewise has chosen to create a joint venture to build new facilities out of its current footprint.  

Other service providers are taking other steps to boost capacity and internet access revenues outside their core region. Verizon is using fixed wireless for that purpose, as is T-Mobile, which historically has had zero fixed network assets able to provider customers with internet access. 

Many independent ISPs are building their own networks as well. The point is that huge amounts of capital are required to expand fiber-to-home networks and it no longer appears ISPs can do so by themselves. 

In the mobile segment of the business, though facilities-based competition has been the norm, there are some moves towards single-network patterns where wholesale access to a common platform is viewed as the only way, or the best way, to ensure rapid uptake of 5G and future mobile platforms. 

Difficult business models for facilities-based competition are part of that analysis. 

The growing joint venture movement in the fixed networks business also suggests a model change. At least where it comes to building out-of-region networks, full network ownership might not be viewed as the best strategy. But if the alternative is full wholesale, which might not be viewed so favorably, either, the alternative of owning some of the infrastructure might be viewed as a reasonable compromise. 

That hybrid approach--own some of what you need or sell--could be an important developing trend, compared to the alternative of “own 100 percent” of what you need or sell. Even if desired, competitive market dynamics might make that solution unobtainable. 

Business strategies that are more asset light have been proposed and considered for some time. In some markets, structural separation creating a wholesale-only model sets the ground rules. In the mobile segment of the business, asset disposals have become common, as mobile operators conclude they can monetize some of their infrastructure without sacrificing competitiveness.  

The broad issue is how far this reevaluation of asset value can go. It is one thing to spin off tower assets. It is another to use joint ventures to expand into new geographies. It might be quite something else to conclude that the actual access network provides so little value that it can be procured using wholesale mechanisms, and that network ownership confers less competitive advantage than it once did. 

It is too early to say a tipping point, in that regard, has been reached. Out of region, capital requirements are large enough that partial ownership might be the only alternative. 

In region, leading access providers still prefer to own their core access infrastructure. But change is happening. How much change is possible is the next question.

What is an Access Provider's Core Competence?

Liberty Global is looking at selling its Belgian tower network. Separately, Liberty and Telefonica are investigating selling  U.K. towers as well. Both deals illustrate the changing value of asset infrastructure in the mobility business. Where once tower ownership was considered essential, it now is considered optional. 

That in turn raises logical questions about the value of towers as business moats. As it turns out, ownership of radios on towers, and not the towers, is considered important. Ownership of spectrum licenses also remains strategic. 

In a tactical sense, mobile operators have found they can raise capital to reduce debt or increase investments by selling tower assets. In a strategic sense, the move to divest towers, create joint ventures or wholesale-only access in the fixed networks business raises questions about the business moats formerly provided by ownership of scarce access networks. 

Many of the same questions could be raised about digital infrastructure assets of other types, including data centers and optical fiber assets. To the extent that owners are willing to sell off all or parts of their infra assets, that suggests a business decision that such actions preserve what is essential to the business while creating greater liquidity. 

But the corollary is that those assets might not be sources of business advantage they once were thought to be, in whole or in part. 

As the asset light business model gains more traction, issues about structural separation, once thought to be a regulatory issue, not become matters of business strategy. In a growing number of cases, access providers are choosing to deemphasize asset ownership in favor of a more asset-light approach. 

Often forced by necessity, such moves still show a belief that some parts of the digital infra asset base can be shed without loss of too much competitive advantage. 

There are other corollaries. Telco executives once claimed that their core competence was “knowing how to run networks.” That makes less sense once ownership of the networks is given up, in part or in whole. 

So “running networks” turns out not to be the core competence. That might come as a shock to many who work in the industry, but is an inescapable conclusion. The ability to shape the regulatory process might arguably be closer to “core competence” than the ability to run networks. 

The Lesser of Two (Maybe Four) Evils

On*Net Fibra, the Chilean digital infrastructure company 60 percent owned by KKR and 40 percent by Telefonica, is buying rival service provider Entel’s fiber to home network for US$358, and will continue to operate as an open access wholesale network. 

Selling your network might seem the lesser of several evils: capital investment one cannot afford; inability to differentitate services; becoming a commodity or maintaining business moats. Basically, Entel is choosing to reduce capex, the virtue, at the cost of the other evils.

Entel’s FTTH network passes 1.2 million homes and businesses. On*Net Fibra will, after the deal closes, pass 3.9 million premises. The goal is to grow home and business passings to 4.3 million by 2024.

Telefonica had sold “non-core” Central America network assets in 2021, selling 40 percent of its towers business Telxius to KKR in 2017 before agreeing to flip the whole business to American Tower for €7.7 billion in 2021. Entel also sold its data centers to Equinix.  

One has to wonder whether an asset-light business model is emerging in many parts of the connectivity business. In addition to operating as would a mobile virtual network operator, some access providers might choose to specialize, narrow the scope of their services or radically reshape their customer-facing marketing, sales and support processes to achieve lower costs. 

source: EY 

Telcos using public hyperscale cloud computing services instead of managing their own private clouds provides another example of this trend. To a degree once unthinkable, access providers are reshaping, in some instances, their roles as infrastructure owners. 

In part, that is because open access fiber-to-home networks enable operating modes that cost less, while still offering required levels of network performance. The trade off is a loss of pricing flexibility, as retail prices have to reflect the wholesale costs of securing access. 

Since all competitors have the ability to purchase the same services, wholesale customers also lose some amount of ability to differentiate service levels. If every ISP offers symmetrical gigabit per second or multi-gigabit-per-second access, that ceases to be an area where competitive differentiation is possible.

So the bad news for access providers going asset light is that their products might become more commoditized than they are today. The “plus” of lower capital investment is accompanied by the “minus” of higher degrees of commoditization. 

But such trade offs have been happening for a while. Access providers have been selling physical infrastructure assets to raise cash to reduce debt, for example. Were debt not a problem, would they sell? Perhaps not. 

But most access providers struggle with the economics of building the next generations of mobile and fixed networks. Getting out of substantial parts of the digital infra ownership business seems the lesser of several evils.

Vodafone Gets New "Activist" Investor Atlas Investissement and Might See Push for Divesting or Monetizing Some Digital Infrastructure

Atlas Investissement, a private equity firm, has taken a 2.5-percent stake in Vodafone, presumably to push Vodafone into further actions to streamline and consolidate its businesses. 

Among the possible moves is pressure to encourage Vodafone to structurally separate parts of its infrastructure beyond cell towers, which the company already has said it is contemplating. 

“Atlas Investissement is supportive of Vodafone’s publicly-stated intention to pursue consolidation opportunities in selected geographies, as well as its efforts in infrastructure separation,” the firm said in announcing the investment. 

In recent days we have seen former Brazilian incumbent telco Oi essentially adopt a mobile virtual network operator model where it runs on leased facilities owned by a separate entity. 

Oi, which had entered bankruptcy in 2016, is moving ahead with a slimmed-down and “asset light” operating model wher it leases wholesale capacity and services from a facilities-based entity rather than owning the assets outright. 

To make that shift, and shed debt, Oi has shed its mobile assets, cell towers, data centers, video entertainment operations. It also is structurally separating its fixed network infrastructure operations from its retail fixed network operations, but will retain a minority stake in the infrastructure assets supplier. 

Structural separation of Telecom Italia’s fixed network also has been the subject of extensive consideration. Mergers also have been discussed for parts of the existing business, including fiber access infra. 

In other cases, joint ventures or co-invesment has been the path chosen to reduce capital investment in digital infrastructure, especially access networks.  

The future question is digital infrastructure assets might eventually be monetized. Data centers, of course, already have been purchased by private equity and other institutional investors. But perhaps there could be some further interest in related assets such as:

• Structured cabling 

• Distributed antenna systems (DAS)

• Electrical, aerial and underground fiber deployment 

• Civil construction 

• Small cell or micro cell installations 

• Indoor DAS and outdoor DAS integration

None of those assets historically have been of interest to buyers who have purchased real estate assets. Lack of scale is an issue for most of these sorts of assets, for example.

How Far can Asset Light Business Models be Extended?

One hears quite a lot about connectivity provider “asset light” business models these days. Aside from new interest on the part of institutional investors and private equity in owning communications infrastructure in alternative asset portfolios, service providers also are pondering new ways to redeploy assets. 

source: American Tower 

An early example was ownership of mobile cell towers, which in all markets is getting traction. There also is high interest in optical fiber infrastructure, including transport and access; consumer and business assets. 

More recently, mobile and fixed network operators have concluded their internal cloud computing operations, necessary to support virtualized networks, can be done using hyperscale cloud computing suppliers, rather than building and owning an internal cloud computing infrastructure.

How Far Can "Asset Light" Model Go?

In addition to network virtualization, private equity and institutional investor interest in communications infrastructure might be part of a reconceptualization of where value lies in the connectivity business, from the standpoint of service providers. 

For investors, fiber assets, for example, represent an alternative asset similar to airports, seaports or other physical infrastructure. For service providers, there are new ways to conceive of where sustainable business advantage can be gained. 

As the competitive era of telecommunications dawned, service providers gradually moved away from developing and creating their own platforms, from switches and access media to applications. They almost universally now rely on third parties for infrastructure. 

So the issue is how far the trend can extend. 

As mobile operators have concluded that owning tower assets does not provide as much value as other uses for cash, if such assets are sold, so there could be new thinking about the value of copper access assets and access networks generally.

Specifically, service providers might decide that, though still valuable, access assets need not be 100-percent owned. Partial ownership might still provide the required business value, but at less overall capital investment. Freed up capital from asset sales might then be applied to other more-strategic growth initiatives. 

That is not to say there is a general rethinking of operating solely on the basis of wholesale access. “Owner’s economics” and the ability to differentiate still flow from network ownership and control. 

Also, mobile operators increasingly are comfortable outsourcing their core network information platforms to public cloud providers, showing yet another way that service providers are rethinking the ownership versus leasing of platforms and capabilities. 

All of this should lead to a rethinking of where sustainable advantage lies, for service providers. How much of the core infrastructure they once developed and owned becomes less strategic over time. How far can the “asset light” approach be carried?

Reemergence of "Structural Separation?"

Structural separation of retail opeations from network ownership was a bigger idea several decades ago than at present, even if a handful of markets have moved that way in a formal sense in Southeast Asia, Australia, New Zealand and the United Kingdom.

The key idea is to create an independent network faciltiies supplier and allow all retail service providers to use that one platform.

Whether mandated by regulators or as a business choice, wholesale access remains contentious in both fixed and mobile segments of the business. Over the decades, one has heard much criticism of the “I build it, you get to use it” argument from facilities providers selling wholesale capacity and services to retail competitors. 

Such complaints happen in a variety of settings, including mobile and fixed network wholesale; whether featuring mandated pricing set by regulators or market mechanisms; and by business strategy and market share (attacking or smaller facilities-based suppliers often see greater advantages than dominant providers). 

It remains unclear how attitudes of underlying carriers could change in the future, if greater functional separation of mobile or fixed assets were to occur, especially if it is not mandated by government authorities. 

In other words, if the ownership of access or core network  facilities continues to evolve, with greater ownership by private equity, institutional investors and other “patient” investors, how much could attitudes shift?

If “core” network assets are only partially owned or even divested by dominant retail suppliers, do attitudes also shift? If core infrastructure no longer is considered strategic by dominant suppliers--as unlikely as that might seem--do most, if not all retail service providers wind up having similar attitudes about the value of wholesale access and their business models?

As an example, what if BT Openreach is fully separated from BT? How does BT’s valuation of core network assets (access, especially) evolve? Does BT not acquire the same positon as any existing wholesale customer of Openreach?

Beyond that, what emerges as the core competency of a dominant retailer once ownership of the scarce access facilities is no longer an issue? The perhaps obvious answers are market share itself, installed name, brand name awareness and value, influence on the regulatory process, other complementary assets and so forth. 

Right now, the mobile virtual network operator business model provides some baselines. 

MVNOs are not legal in every market, but in some markets represent  significant portions of the installed base and market share. That is especially true in Europe. 

source: McKinsey 

Margin potential varies. Simple branded “resellers” who add little additional value also face the least risk, at the cost of expected profit margins. Basically, this business model relies on sales and marketing skill, as the basic “product” is sourced completely from a facilities-based service provider, with no fundamental differentiation. The reseller is not able to set its own retail prices. 

An MVNO operating as a “service provider” assumes more risk, for more potential reward.  A service provider operates its own direct billing and customer care operations and can set its own prices. Revenue is typically earned on outbound traffic. 

The “asset light” MVNO earns revenue on both outbound and inbound traffic, and is obliged to pay the underlying carrier on a pattern similar to the “service provider” MVNO. The main advantage is that this type of MVNO is free to add any sort of additional value and differentiation. 

A “full MVNO” itself supplies all of the infrastructure except the radio access network, which is leased from a facilities-based mobile operator. This model offers perhaps the highest ability to differentiate the user experience, with the highest amount of risk, however. 

As a rule, an MVNO has to have operating costs 30 percent or more lower than the host provider’s cost structure. Perhaps for that reason, the full MVNO model is rarely chosen. The center of gravity is arguably either the service provider or asset light approach. 

Much can hinge on the anticipated gross revenue and  profit margins to the wholesale services supplier. Bulk accounts have their attractions. If some customers want to defect to a lower-cost mobile virtual network operator--and that is the primary attraction for nearly all MVNOs--then supplying access to a retail competitor still makes business sense.

The underlying carrier makes revenue off a “lost” customer account. Some argue that asset-light MVNOs can earn higher profit margins than facilities-based retailers. 

source: Oxio 

If a dominant mobile service provider could achieve margins between 15 percent and 20 percent as do other light MVNOs, but avoid capex and opex, further boosting margins, would that not be a reasonable choice? 

And if so, the historic value of owning scarce access assets decreases substantially, perhaps nearly entirely. So the business model becomes more disaggregated.

Structural separation, in past decades mostly viewed as a regulatory solution, might eventually become a preferred marketplace solution.