"Sum of the Parts" is Going to be More Important in the Future

As much as connectivity providers envy the valuation multiples earned by app providers, so long as data access and transport remains a distinct part of the value chain and ecosystem, it is going to command a valuation set by the market.

For example, mobile operators have an EV/EBITDA multiple of about 8.7, according to an analysis by NYU’s Stern School of ratios in January 2023. That is close to the cable TV multiple of about seven. Telecom ratios are a bit below six. Internet software earns a multiple close to 15. 

As always, firms are evaluated differently even within the same industry. A recent analysis suggests that small ISPs that also are cable operators get a higher multiple than the largest and larger service providers.

source: Cobank, CapitalIQ, Telecompetitor 

According to Equidam, telecom services and mobile service have EV/EBITDA ratios of nearly seven. Online services have a multiple of nearly 16. In other words, online services are valued at more than twice that of integrated telecom providers. 

Likewise, Equidam estimates telecom EV/EBITA at a multiple of 6.4, while information technology carries a 16 multiple. Other analyses by McKinsey suggest a telecom service provider EV/EBITDA median ratio around 10 and a median information technology radio a bit over 15. 

source: McKinsey 

Since “telecom” often is lumped in with “telecom, technology and media” as a category, the aggregate indices often obscure more than they reveal. “Worldwide, the average value of enterprise value to earnings before interest, tax, depreciation and amortization (EV/EBITDA) in the technology and telecommunications sector as of 2022 was a multiple of approximately 20.8 times,” says Statista. But the “software (internet) industry saw the highest valuation multiples with 44.9 times.” So the “telecommunications” ratios were far lower. 

According to Siblis Research, the EV/EBITDA ratio for “communications” firms in the large capitalization category was about 8.6, while the ratio for “information technology” was about 16.  

To be sure, valuation metrics change over time, and specific valuations of any particular firm, at any particular time, geography, revenue magnitude and strategic value, can vary. 

But you get the point: different industries are evaluated differently in financial markets. 

The complication comes when firms in different industries start to “converge,” offering services and products historically offered by other industries. When revenue magnitudes are low, it is likely that a unit of revenue earned by a firm in a high EV/EBITDA industry is valued at that industry’s norms. 

The same unit of revenue earned by a firm in lower EV/EBITDA industry then is valued at that industry’s norms. At low revenue magnitudes, that makes sense. But when revenue contribution grows in significance, creating a business model that is similar to a conglomerate, then a “sum of the parts”. analysis might be helpful. 

Looking at products rather than industries. If a certain product has a valuation multiple of X, that product should nearly always be valued at the X multiple, no matter what firm in which industry segment earns that unit of revenue. 

source: Corporate Finance Institute

That sort of process is highly useful for evaluating firms such as Amazon, which is a mixture of e-commerce and computing-as-a-service segments, each with distinct growth profiles and valuation metrics. Sum of the parts historically also has been useful when evaluating conglomerates that operate in multiple lines of business. 

Increasingly, with virtualization, that is going to apply to firms in the cloud computing, data center and connectivity businesses as each segment begins to earn revenue in different “industries.”

How Will Connectivity Providers Escape the Commoditization Trap?

“If you look at what we do on a daily basis as it relates to connectivity, that's increasingly getting commoditized,” says Christopher Stansbury, Lumen Technologies EVP. “So that's not an interesting ending to the story.”

Which is why Lumen and just about everyone in the business always talks about, and strives, for “value add.” Here’s the problem: for at least 25 years, industry leaders have been telling that story and trying to execute on the vision. 

One might conclude that nothing really has worked. 

The answer is not simple. Connectivity providers have successfully added new lead revenue drivers. Mobile subscriptions now drive global revenue. Revenue growth often is driven by getting customers to add mobile internet access services; to shift up to more-expensive plans; or do the same with home broadband. 

In past decades, expansion into new geographies has staved off revenue decline, as has asset acquisitions to bolster scale. 

The key point is that the near evaporation of voice revenue was counteracted by shifting to home broadband, video services, mobility services, then mobile internet access, bundling of multiple services and enticing customers to buy more-pricey service plans. 

It is not so clear we would characterize those as “value add” achievements. They are more on the order of creating new products to replace legacy products. That is arguably a bigger achievement than creating more “value add.”

To the extent there are other successes, they mostly might revolve around connectivity providers getting into new lines of business beyond connectivity. Some connectivity providers generate revenue from advertising, data center operations, content ownership or services, banking or payment services, 

“Success” often depends on how one categorizes the value add or “new” revenue sources. Is mobile internet access a new service, or a value add? How about internet of things connections or cell tower backhaul? What about data center operations or cloud computing as a service? 

IoT connections might be viewed as a value add. Data center operations or cloud computing might be better characterized as a new line of business. Mobile internet is a “new” service, but arguably a core business activity, not necessarily a value add or new line of business. 

If one looks at global revenue figures, that observation might be concealed. After all, global growth these days is largely driven by net additions of mobile service accounts, with some contribution from home broadband account growth. 

Globally, IDC sees perhaps two percent annual revenue growth for the global connectivity services market. 

source: IDC 

Most of that growth will come from more mobile service subscriptions, though average revenue per account is an issue. 

source: Omdia 

Account totals will grow, but the problem is that average revenue per account is dropping, and has been almost the entire period during which competition has been encouraged in the connectivity business, starting in some markets in the 1980s. 

All of that is important. “Commoditization,” or at least a trend of lower per-unit prices, is not likely something the industry can escape. But neither has the industry failed to create whole new product categories to replace lost legacy revenue. 

Some have made a business of mobile payments, cloud computing or operating data centers or offering applications (consumer or business), even if global success is uneven. 

We do not yet know how important internet of things, private networks, edge computing, application programming interface revenues or other products will become. 

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.