Home » General » The Value Creation Gap- Part 2- Broadband Gold

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!

 

 


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