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The Value Creation Gap- Part 2- Broadband Gold

2014-06-12 19.29.45Father’s Day greetings from Charlotte, Orlando, Kansas City, and Dallas (pictured are my Mom, who has a milestone birthday on June 16, and Dad).  There are many industry events we should be covering, but, in the interest of depth on broadband issues, will cover these in a “five you may have missed” at the end of this column.

 

Before our strategic discussion of broadband, a quick thanks for the many notes on last week’s article.  Like the Android World series, the comparison of long-term value creation has been a regular topic over the last five years.  While many (including myself) have looked for those windows where the telecommunications industry has bested the Four (now Five) Horsemen, they are few and far between (the last time this happened was in the beginning of 2013 when Apple stock slipped back to early 2012 levels – gasp!).

 

One of you asked/ noted the following:

Does relative risk help explain some of this discrepancy in return (vs management competence, etc.).  The guys providing the pipes face less market risk than the guys leveraging the pipes with their software.  Google or Facebook are more likely (as unlikely as it may seem today) to face disruptive competitors than VZ or ATT because of the capital cost to compete is so much lower and innovation so much more important.  Some of the difference in return could be seen as a risk premium.

 

This note could not serve as a better lead to a discussion of the broadband industry.  For years, the prevailing mentality in the industry had been to “play it safe.”  The world would progress in a staged, orderly manner, with bandwith speeds rising as lines were “conditioned” (fixed) or “upgraded” (from one-way to two-way) to deliver higher speeds.  And, while the returns would be slower, they would be steadier.  The traditional telco world would steadily progress, and eventually the tortise would defeat the hare.  Telcos are the redcoats, and the Valley are the guerrilla warfare experts.

 

George_Gilder_handwaving_at_CHM_Apr_2005This mentality also pervaded the deployment of fiber.  With great consistency, futurists such as George Gilder (pictured) predicted a “DS3 out of every home within five years” and the engineering departments of the telcos torpedoed these assumptions.   There were not enough resources to accommodate rosy demand outlooks.  In turn, those same engineering departments cited the maximum bandwidth that could be delivered out of servers – 3 to 5 Mbps – as proof that a 30, 40, or 50 Mbps world would be the home of a few early adopters and no more.  Is it surprising, then, that Netflix was not created out of the telecommunications industry but out of the Valley?

 

In the last five years, here’s what has happened with broadband:

 

  1. The maximum speed offered by US cable companies, has increased from 30 to 105 Mbps.  Comcast today offers their Blast! Speed product (up to 105 Mbps) for $60/ month for the first twelve months (no contract).  From our checks with six cable providers, the most common speed purchased is somewhere between 30 and 100 Mbps
  2. Over 51% of FiOS Internet customers subscribe to their Quantum speed level, which offers 50-500Mbps to the home (this grew 500 basis points from 4Q 2013 to 1Q 2014).
  3. Five years ago, there were a limited number of devices that could connect directly to cable modems (Roku had been in market less than a year).  Now there is an expectation that every device connects into the Wi-Fi equipped modem or router (and that Wi-Fi functions at the advertised speeds described above, even for older devices).  Time Warner Cable and others allow several third party devices, including the Xbox 360/ One, to function as digital set top boxes.
  4. At the end of 2009, Netflix had no streaming customers in the United States (As of the end of March 2014, that number is nearly 36 million).
  5. As of their year ending 2009 report, Zayo Group had just over $150 million in revenues and just over that amount in debt and lease obligations.  Zayo reported Q1 2014 revenues at an annualized run rate of $1.1 billion with over $3.0 billion in debt and lease obligations.  Zayo is now a leader in fiber services to the North American telecommunications market.
  6. Time Warner Telecom ended 2009 with 11,598 on-net (fiber-connected) buildings.  As of Q1 2014, this figure was 78% higher to 20,800.
  7. In 2009, Google had not announced plans to deploy Gigabit-speed metropolitan fiber networks.  Now, one large Metropolitan Statistical Area has been deployed, two are finalizing deployments (Provo and Austin) and 34 others are in discussions.

 

There are many more events to cite, including AT&T’s Project VIP and GigaPower announcements, or the nearly tripling of fiber-fed towers by CenturyLink over the same period, or the fact that Amazon’s AWS service was about $220 million in revenues in 2009 (see 2009 estimate here; this year, most analysts expect that figure to be close to $3 billion).

 

The broadband world has continued to expand despite poor economic conditions.  What will happen as the economy continues to recover?  Here are some thoughts on what the next five years hold:

 

  1. google-fiber-bunnyGoogle Fiber.  We will look back on Google in five years in the same manner as many saw Netflix streaming services in 2009.  In Kansas City, Google Fiber is prevalent.  For early adopters, the allure of fastest speeds is driving penetration in some “fiberhoods” past 80% penetration (see Kansas City Star article here).  With remarably little advertisement, customers fill wait lists for the service.  Cable companies and telcos provide little reason to return to legacy products, and, as a result, many customers are “splitting tickets” and taking Google for Internet and keeping cable with AT&T and Time Warner Cable (for now).  With its current cash on hand, and an $800/ home fiber deployment cost (slightly higher than FiOS), Google could deploy fiber to 66 million homes with their current cash on hand (see last week’s article for their cash and markable securities balance).

 

  1. Low-hanging clouds.  This article does (and will) not go into great depth on the content types that are being delivered by faster networks, but the “string and bead” analogy should serve as a reminder that when volumes grow, the ability to locate commonly requested content becomes economically justifiable.  Netflix, who originally sourced all streaming content out of Sunnyvale, now caches popular content around the country so delivery times are minimized.  As 4K video content delivery emerges, the ability to locate Netflix servers in secondary and tertiary markets will be possible.

 

  1. Fibered Buildings the norm, not the exception.  I look at fiber-fed buildings in the same manner as I looked at fiber-fed cell towers five years ago, except in the case of buildings, the case is even stronger.  Fiber to the Tower (FTTT) relied solely on mobile device usage and growth.  Fiber to the Building relies on the same device growth plus Wi-Fi (only) tablet growth plus business Ethernet growth (driven by distributed computing and storage).  Wireless carriers need consistent and reliable access to each building floor to ensure that carrier data can reach customers with acceptable speeds (and, in a world of metered data, there are real revenues at risk).  With the right wireless partnership, tw telecom (or Level3 or Zayo) could easily double the number of fiber-connected buildings in the next five years.  This is great news for wireless users, and also for CIOs who yearn for better Ethernet pricing.

 

Many more drivers exist in residences and businesses.  However, the most critical measurement is service consistency.  If Google Fiber’s consistency varies widely, they leave the door wide open for service doubt (at any price).  If potential homebuyers need to see who the underlying cable provider is before they make a moving decision, Netflix’s meteoric growth will likely come back to earth.  If in-building coverage is dramatically different between buildings because of landlord greed, rents and relative utilizaiton will suffer.

 

The next wave in risk-taking belongs to the broadband world.  Google will lead the way.  Who will follow?

 

Given the length of this week’s column, here are the Five You May Have Missed:

  1. This Light Reading article outlines AT&T’s use of multiple technologies, including DOCSIS, for small cell backhaul.
  2. FCC Chairman Tom Wheeler has posted a blog advocating minimal restrictions on the deployment of municipal broadband networks.
  3. Fierce Wireless has posted their Fierce 15 start-ups to watch.
  4. An excellent explanation of iOS8 features/ functionality, especially the concept of extensibility, is described in this (lengthy) Ars Technica article.
  5. Blog site Game Debate has a lengthy index of everything that mattered at the E3 conference.

 

Next week, we’ll outline the key strategic issues facing the wireless industry.  If you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can (and they can go to www.mysundaybrief.com for the full archive).

 

Thanks again for your support, and have a terrific week!

 

 

The Value Creation Gap- Part 1

June greeting2014-06-07 10.28.57s from my 25th college reunion in Davidson, NC.  Pictured with me is a terrific friend and mentor (but not a Davidson grad) Bob Guth who now lives on Lake Norman just north of Charlotte (as do several other current and former entrepreneurs and telecomunications executives).  Bob is a veteran of the telecom industry and recently helped restructure RDA Holding Co.,  the parent company of Reader’s Digest Magazine.   In between events, Bob and I had a chance to catch up on work and life.

 

This week, we begin part one of a three part strategic planning series.  The first part will highlight the gap the industry faces versus other investment alternatives.  The last two parts will highlight how companies are creating (or can create) competitive advantage in the broadband and wireless telecommunications subsegments.

 

Palm webOS – One Million New Customers (?)

webOS_500Before diving into the analysis, a couple of quick news items.  First, LG announced that they have sold more than one million webOS-enabled TVs since the launch of their new lineup in March.  This is no small feat for the electronics market, and LG predicted that there would be more than 10 million TVs running on the card-based platform by the first half of 2015.

 

From a quick glance of the Amazon store reviews of the webOS-enabled LG smart TVs (see here for reviews of the LG 55LB7200), reaction to the interface is very positive.  The biggest hurdle, it seems, is getting the webOS app developer community on board to populate the app store.

 

While the resurrection of Palm’s operating system is nostalgic (it was five years ago that Palm released the Palm Pre to heavy acclaim), it also goes to show the value of connectivity platforms to multiple types of devices.  Could LG have the ultimate OTT OS on its hands ?  Stay tuned.

 

Meanwhile, Samsung Announces the First Tizen Phone

tizenIn case you missed it, this week the Tizen faithful gathered in San Francisco for the third annual Tizen Developers Summit (the timing with Apple’s WWDC is no coincidence).  Ever since Samsung’s announcement that their Gear wearables lineup would run on the Tizen operating system, many analysts have been wondering if Samsung would announce an expansion into the smartphone community.

 

This week, Samsung made the move, announcing the 3Q 2014 availability of the Samsung Z…  in Russia.  The device appears to look like a more angular version of the Galaxy S5, with many similar features (including fingerprint recognition on the home key and heartbeat recognition near the rear-facing camera lens).  However, Samsung promises to take full advantage fo Tizen’s superior memory management and optimal performance.

 

What’s most interesting about Samsung’s approach is that Tizen has more interoperability with Android than any other operating system.  This is the first time that inter-OSS functionality has been widely deployed (in this case, from the Android-powered Galaxy platform to the Tizen-powered Gear platform).  If there is proximity-based interoperability between Android and Gear, what’s to prevent interoperability between Android and the Samsung Z?  This seems like a very stealth way to systematically lure away Android developers – make it easy to interoperate, and then drive up the base through efficiency/ ease of use.  Google is not worried, yet, but they should be.  As we described in last week’s post, it was a mere two years ago that Samsung introduced the device that vaulted Samsung into the smartphone lead – the Galaxy SIII.  If they can sell 50 million units in nine months, imagine what a low-price, developer-supported Tizen can do in 2015.

 

The Value Creation Gap

June begins the strategic planning session for much of the telecommunications industry.  For some companies, this serves as a mid-year checkpoint on 2014’s plans.  For example, AT&T will be examining how much fuel to put on the U-Verse fire in light of their announcement to purchase DirecTV.  In fact, AT&T provided an excellent mid-point review this week, projecting 800,000 net postpaid additions, low (< 0.95%) monthly postpaid churn,  “solid” U-Verse brodband performance, and 5% consolidated revenue growth.

 

While AT&T’s performance continued to be strong compared to expectations (and likely VZW’s followed suit as they matched AT&T’s plans in early April), the question usually posed during executive planning sessions is “as compared to what?”

 

Let’s take AT&T’s and Verizon’s performance since the beginning of 2013 (roughly 18 months).  For AT&T, excluding dividends, investors have enjoyed a 3.9% equity return over the 18 months, roughly a 2.6% return per year.  Tack on a 5.2% dividend, and the result is a nearly 8% total annual return to investors since the beginning of 2013.

 

Verizon’s figures are higher than AT&T’s – 9.3% annualized equity return (14.2% total over 18 months) plus a 4.3% annual dividend yield driving a 13.6% total annual return since the beginning of 2013.

 

Both of these numbers are very healthy… until you compare them to Microsoft, Google, Apple, Amazon and Facebook.  Here’s how VZ and AT&T stack up against them:

 

Table 1:  Annualized Shareholder Return (including Dividends) from Jan 1, 2013 to June 6, 2014

 

Company             Return

Facebook            77.2%

Microsoft            36.7%

Google                 35.5%

Comcast               28.0%

Amazon               20.1%

Apple                    15.7%

Verizon                                13.6%

AT&T                       7.8%

 

 

This chart clearly shows that there is a value/ return gap between large traditional communications services providers and their challengers.  Amazon’s return over the past 18 months is 50% higher than Verizon’s and more than double that of AT&T’s.  Microsoft’s resurgence shows the difference between Steve Ballmer’s divisive Jack Welch-esque “lowest 10%” policy that pitted employees and divisions against each other, and Satya Nadella’s rallying cries that unite teams and produce more functional and integrated products.

 

Without a doubt, there is a gap.  This column has highlighted the total value created by the “Four Horsemen” (Microsoft, Amazon, Facebook, and Google) over the past five years (Facebook was private until mid-2012).    Excluding gains from Facebook (which has a market cap of $160 billion), but including dividends, the Four Horsemen have created more than $280 billion over the past 1.5 and $340 billion in value over the past 2.5 years ($58.33 billion in 2012, $219.44 billion in 2013, and $62.25 billion thus far in 2014 – complete analyses available upon request).  Including Facebook’s market capitalization, that number is a staggering $500 billion.  Add in Netflix, and… you get the point:  There’s more value in disruptive content than there is in building bandwidth. 

 

These are sobering numbers for the Board room.  But it gets worse from there.  Here are the cash-less-total debt balances for each of the Four Horsemen as of March 31, 2014:

 

Table 2:  Net Cash (Cash and Marketable Securities less Total Debt) for Four Horsemen + Facebook as of March 31, 2014

 

Company             Cash/ MS Minus Total Debt

Apple                    $113.6 billion

Microsoft            $  65.7 billion

Google                 $  53.1 billion

Facebook            $  12.6 billion

Amazon               $    5.5 billion

Total                      $250.5 billion

 

Again, these numbers are for high-level comparative purposes only.  For example, there are a lot of funds being held abroad that cannot be expatriated to the U.S. without paying taxes.  And there are other restrictions and comparisons that might drive the $250.5 billion figure above to something closer to $240 billion of useful cash.  But the bottom line is unchanged:  A decade of disruption has birthed a (nearly) debt-free, cash-rich, multi-headed challenger to incumbents.  Regardless of the FCC’s stance toward a particular merger, spectrum caps, or net neutrality, software has won. 

 

As many of you start the conversations with your teams about investments, improvements, and offers, ask three questions:

 

  1. If we could change three things about our company’s position within the industry, what would they be?  (Size, scope, etc.)
  2. What’s our company’s Google defensive strategy?  (For those of you who are very long-term Sunday Brief readers, you can find the first Sunday Brief article on that here in the RCR Wireless Reality Check archives).
  3. Where will we need to beat Microsoft/ Google/ Amazon/ Facebook/ Apple to remain a viable investment?  How will we do this?

 

The current (June 6) market value of Google + Apple + Microsoft + Facebook + Amazon exceeds $1.4 trillion.  Nearly 20% of this is cash.  How will your company play to win?

 

Next week, we’ll continue this discussion with a look at how the broadband industry can re-energize itself to relatively meaningful returns.  If you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can (and they can go to www.mysundaybrief.com for the full archive).

 

Thanks again for your support, and have a terrific week!

 

 

Is it Still an Android World? -11th Edition

June greetings from Austin and Dallas.  As many of us took a holiday break, news continued to generate over the past two weeks.  We’ll cover a couple of major developments as well as our semi-annual handset assessment in this week’s Sunday Brief.

2007_saturn_ion_red_line_base-pic-300

Blackberry Introduces Project Ion

First, a shoutout to my friends at Blackberry with the boldest move over the past two weeks (and you thought it was the AT&T purchase of DirecTV – think again!).  At the O’Reilly
Solid Conference in San Francisco, Blackberry announced Project Ion, the “cornerstone of BlackBerry’s vision to offer end-to-end solutions for the Internet of Things.” While this is merely a temporary name, there is something about ION – just ask Sprint ($2+ Billion write-off from last decade’s Project ION – see article on Sprint ION’s demise here) or GM’s former Saturn division (Saturn ION shown in picture – article on Saturn’s brand departure here).  A bold move from Blackberry with a very unfortunate name – hopefully it turns out better for them than it did for GM and Sprint.

 

The Implications of AT&T’s Purchase of DirecTV

After the Sunday Brief weat&t DirecTV logont to press on May 18, AT&T announced that they were going to buy DirecTV for $95/ share (total purchase price, including DirecTV’s net debt will be $67 billion).  Their official announcement is here.  Many of you reached out to discuss the implications of this announcement on a) the Comcast/ Time Warner Cable approval process, and b) the potential merger of Sprint and T-Mobile (which, if this Reuters article is accurate, faces complicated regulatory hurdles).

 

AT&T bought DirecTV for three reasons:

1)      DirecTV brings an international, but not a European footprint.  AT&T has been looking outside the US (India, Europe, other areas) for the past three years.  AT&T knows the Latin American market well, thanks to their investment in America Movil (which they will be completely divesting as a result of this transaction).  Consumer-based television content in a strengthening Latin America is a terrific long-term play, and the DirecTV Latin America asset is a good starting point for a more comprehensive global strategy.

2)      DirecTV brings exclusive content to the table that can differentiate AT&T Mobility’s (and U-Verse’s) wireless offerings.  It’s an end run around Verizon Wireless’ NFL relationship.  Read the Verizon Wireless multi-year extension announcement here, and you will ask “How is this any different than NFL Sunday Ticket?”  The entire transaction is contingent on DirecTV renewing the Sunday Ticket relationship, which DirecTV executive Mike White indicated is “highly likely” by the end of 2014.  No renewal, and AT&T can walk away from the transaction.  That’s how important live sports content is as a differentiator in today’s telecommunications environment. (We’ll talk more about the importance of content in our three-part Sunday Brief strategy session starting next week).

3)      DirecTV is self-funding.  As we saw with the Comcast/ Time Warner Cable transaction, AT&T is purchasing a company with healthy free cash flow.  In the first quarter, DirecTV generated $880 million in FCF on a global basis, with the US segment generating over $1 billion in quarterly FCF.  DirecTV’s first quarter earnings announcement can be found here.

 

As we have discussed in previous Sunday Briefs (and will discuss over the next three weeks), AT&T seeks to create differentiation through a) integration (Content, High Speed Internet, Mobility), and b) exclusivity (iPhone, RAZR, NFL Sunday Ticket).  Their ability to generate $61 billion in shareholder value is directly dependent on being able to create competitive advantage in these two ways.  More on this in upcoming Sunday Briefs.

 

By One Metric, T-Mobile is Already #3

counterpoint market researchOne of the more interesting analyses came out just before the Memorial Day weekend from Neal Shah at Counterpoint Research.  In his blog post, he reported that T-Mobile had overtaken Sprint as the third largest purchaser of smartphones, and closed a lot of ground with AT&T.  The chart at right shows the mix of devices for each of the carriers in the first quarter.  Shah concludes that TCL-Alcatel has now overtaken Huawei as the fourth largest phone (and fifth largest smartphone) provider, behind Samsung, Apple, and Nokia (and Motorola for smartphones).  This analysis is especially interesting as it implies that many of T-Mobile’s new customers are purchasing new handsets (and not simply swapping SIM cards) when they switch.  It’s also interesting to note that Blackberry’s volumes have been relegated to the “Other” category.

 

Is it Still an Android World? 

Speaking of handsets, we have updated our semi-annual look at smartphone models by carrier.  There are many surprises and changes since we last analyzed the marketplace last October.  The research can be access here – it’s best to read the attachment in conjunction with the analysis below:

 

  1. T-Mobile sells a lot more with fewer Stock Keeping Units (SKUs).  Assuming the analysis cited earlier is true, T-Mobile is taking a “less is more” tack with handset providers.  Since last October, T-Mobile has dropped 33% of their total SKUs (from 24 to 16).  Unlike their carrier peers, they do not carry the iPhone 4s through their website.  They have kicked Blackberry to the curb (only selling refurbished units).  And no market-leading Nokia device either (unlike Verizon and AT&T).

 

T-Mobile does carry the Google Nexus 5 and the Sony Xperia Z15.    And, they carry the Alcatel OneTouch Fierce and Evolve, which are two of their better selling smartphones.

The result of this strategy is that T-Mobile sells fewer iPhones as a percentage of their total devices (or others sell more because they have $0 iPhone 4s devices).  And they sell a lot more Samsung devices than Sprint (and perhaps as many Samsung devices as AT&T given the number of suppliers).

The implications of more sales across fewer SKUs are enormous:  Less inventory obsolescense, better informed in-store reps, focused customer service.  Winnowing the number of handsets offered to 16 while growing overall volumes is one reason to be optimistic about T-Mobile’s profit future.

  1. Carrier-specific network uniqueness is driving much of today’s handset differentiation.  This characteristic was solely Sprint’s with their tri-band Spark-enabled devices, but now has been adopted by Verizon with their XLTE network marketing campaign.  In the last two Android World write-ups, we noted that there was a lot of consolidation around large handset brands, specifically Apple and Samsung.  We also noted in the first quarter earnings analysis that without network differentiation, the industry would quickly devolve into SIM card swaps.

The pendulum is beginning to swing back to the carriers.  While Sprint’s Spark network is still in its embryonic stages, having a consistent 20-30 Mbps experience throughout North Dallas and in most of Austin is a welcome customer experience (and can consume one’s total Wi-Fi Hotspot monthly allotment in one afternoon).  The ability to have widespread marketing of the Spark network happens when Apple builds tri-band into their next iPhone.  Today, Android devices are the only beneficiaries (see attachment for the ten Spark-enabled devices).  Until Spark-enabled devices are in the hands of every high-bandwidth data user, the congestion currently experienced in Sprint markets will not be alleviated.

However, Verizon’s XLTE network is equipped on every iPhone 5s and 5c, and pretty much every device they have introduced this year.  As we have discussed in several Sunday Briefs, Verizon’s AWS spectrum quantity leads to exceptional outdoor quality.  In Verizon’s ideal world, pairing low-band 700 MHz spectrum (to battle in-building issues) with AWS bands creates the best customer experience.  The XLTE advertising campaign turns the message back to the network, and it also informs their loyal Android, Apple, Windows, and Blackberry base that faster networks are ready.  The initial reaction to the network changes has been positive  – see here and skip down to the user comments section to see some of the bandwidth speeds achieved.

  1. Handset pricing is changing, thanks to T-Mobile.  It’s hard to believe, but when we wrote last June’s Sunday Brief on handset selection, the only provider of installment plans was T-Mobile.  AT&T Next was announced in mid-July, and Verizon followed shortly thereafter with their EDGE announcement.  Next and EDGE were minimally effective until AT&T and Verizon paired them with attractive plans (AT&T in February, and Verizon in April).  In the next Android World, we’ll move to more of an installment plan format, noting that the terms and conditions vary widely between carriers.

The implications of an installment-based wireless world are enormous.  Because the cost of the device has been detached from any subsidy, wireless handset makers will be increasingly pressured to deliver the most valuable devices.  Also, refurbished device availability is going to increase – dramatically – as the costs to upgrade faster have already been borne by the customer.  Finally, the price/ device bifurcation will provide some buffer against MRC penetration.  As we have noted, AT&T’s $160 for 4 device plan turns from $40 ARPU into $65-70 ARPU when AT&T NEXT is added.  As we will see with the migration to installment plans, the carriers have more ability to make money on low end/ end of life devices (as opposed to the “free phone” floor in today’s subsidy-driven model).

 

The handset world has changed dramatically in the past two years.  Samsung’s release of the Galaxy S III in May and June 2012 changed the handset world, and moved the Android operating system from “low end smartphone entry” to “broad based global competitor.”  The S III eliminated any chance for Nokia to be successful in the US, and Blackberry’s misses on the Z and Q series are technology case studies in market misunderstanding.  As the Counterpoint research shows this has allowed Apple and Samsung to drive 67% smartphone purchasing market share in the first quarter.

 

Next week, we’ll start our three-part strategic planning primer series (yes, the telecommunications community begins their strategic planning sessions in June and July).  The first part will provide a look at the tablet and connected device market across each wireless carrier.  If you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can (and they can go to www.mysundaybrief.com for the full archive).

 

Thanks again for your support, and have a terrific week!