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Monthly Archives: October 2014

Key Insights From This Week’s Third Quarter Earnings

G2014-10-20 10.39.53reetings from Paris and Dallas.  This has been an event-filled week outside of third quarter earnings news, with the FCC placing both the Comcast/ Time Warner Cable and the AT&T/ DirecTV merger review processes on hold (see announcement here).  Also, Friday afternoon, the FCC announced that the 600 MHz auction was going to be delayed until 2016, the second delay in a year for this critical and valuable asset (see the FCC blog post on the topic here).

 

The delay in the incentive auction is the more troubling of the two announcements.  With data consumption continuing to grow at a rapid clip, delays place more pressure on an efficient auction process and will undoubtedly drive up bids when it ocurrs.  It will slow down development of equipment and other technologies that are needed to maximize speeds and utilization for the 600 MHz frequency.  This event may even drive up prices for the AWS auctions which begin in a few weeks.

 

The US regulatory process is not the primary topic of The Sunday Brief, but when the government acts (or, in this case, fails to act), the consequences can be significant.  The placement of this auction in the eighth year of a two-term administration will bring new challenges.  Based on the case that is currently in the courts, I would not be surprised to see an actual late 2016/ early 2017 auction date (presumably under a new FCC Chairman).

 

Key Insights From Verizon and AT&T Earnings

Both Verizon and AT&T announced earnings this week, and their results confirmed several standing hypotheses:  1) Scale matters; 2) Accelerating change is hard with larger companies; 3) Transitions between technologies take more time than most expect.  These insights are not news to most of The Sunday Brief subscribers.

 

One of the hypotheses that is new, however, is that AT&T and Verizon are creating competitive advantage in different ways.  Both are at scale in LTE, and both have implemented metered plans and are reaping the benefits of increased data usage.  While Verizon had an excellent quarter of tablet sales  (1.1 million of 1.5 million postpaid retail net adds were from tablets), AT&T has a huge headstart with five years of embedded Amazon Kindle and iPad sales.

 

Verizon seeks to create competitive advantage through operational excellence in wireless.  Whether it’s increasing use of fiber Indefeasible Rights to Use (IRUs) for cellsite backhaul in major metropolitan areas or the structured rollout of the AWS spectrum over the past year, or the acceleration of their eMBMS (wireless multicast) efforts, Verizon focuses on delivering technology consistently and efficiently to each of its subscribers.

 

However, Verizon is also a financially focused company, especially in the non-Vodaphone world ($109 billion in gross and $102 billion in net debt after their buyout).  This discipline is one of the reasons why Verizon did not follow AT&T’s move to allow existing customers (under subsidized devices) to opt into more attractively priced bundled data plans.  Both Verizon and AT&T offer 10 Gigabyte shared plans with unlimited voice and text for four lines for $160, but existing customers cannot make the transition to these plans as easily at Verizon. As a result, service revenues continue to grow at Verizon (4.8% annually) and are flat at AT&T.

 

Verizon 4G activationsAs a result, Verizon touts a 49.5% EBITDA margin (AT&T’s comparable margin = 35%) and has no issues with 12% of 3Q gross additions selecting the Verizon Edge (monthly phone payment) plans (although they noted that this figure will be 20-25% in the fourth quarter).  With Verizon, the issue is the pace of change and the associated financial impacts of acceleration, not the overall direction.

 

AT&T, however, takes a very different view, focusing instead on intermediate to long-term financial impacts and product/ system-related competitive advantage.  The integration of technology, especially in the home, drives AT&T’s investments.  Verizon has no equivalent product to Digital Life (currently at 140,000 subscribers in 82 markets, and which will be a big grower for AT&T in 2015).  They have different approaches to connected vehicle (AT&T had 500,000 embedded modules in 3Q and this figure will be in the millions in 2015).  Even U-Verse and FiOS take very different approaches to address marketplace needs (FiOS added 162K broadband customers in the quarter; U-Verse 601K).

 

AT&T clearly sees the transition to Mobile Share accounts as “Phase 1” of a multi-part strategy.  The first step is to make the transition to shared plans easy by allowing existing customers to make the change with no immediate penalty (all of these customers will need to upgrade to their monthly phone payment plan called AT&T Next when their contracts expire).  Have customers get used to the concept of sharing data before adding on the additional phone payment charges.  Nearly 17 million accounts representing 47 million connections have made the change, and this customer-friendly policy has resulted in record low post-paid churn.

 

In parallel with the migration efforts, continue to develop products and services (or partnerships) to make the Mobile Share a competitive weapon.  Want to add your car’s data consumption to your Mobile Share plan?  No problem.  Want to add data used by your home security (camera) system to the mix?  No issue.  Want to use AT&T’s in-flight services but afraid of increased data consumption?  It all comes from the same data bucket.  (On the flip side, AT&T also has fully developed sponsored data platforms which could add to monthly bucket levels).

 

If Digital Life, connected vehicle, and in-flight services were not enough, AT&T is currently creating a software development platform that is designed to be compatible with Silicon Valley and not (traditional telco) Basking Ridge partners.  While the risks from this platform development are enormous, AT&T will be able to activate new products and services more quickly than their competitors when the IT is implemented.

 

2014-chevrolet-corvette-stingray-convertible-front-viewAT&T has expanded their scope to include their wireline assets as well.  On their conference call, AT&T announced that two thirds of their U-Verse video platform footprint has access to 45 Mbps speeds and that their overall broadband footprint now reaches 57 million locations.  While their speeds cannot match those of FiOS today, AT&T’s GigaPower fiber initiatives across 17 markets will be able to compete with multi-hundred Mbps cable offerings.

 

AT&T is changing their structure:  From systems to products to internal organization, the theme of an “integrated end” is clear.  It’s a very hard path to execute, especially with T-Mobile and Sprint strengthening their competitive offerings.  If they are successful, the opportunity to drive long-term shareholder value will not be in doubt.

 

For full access to the latest Verizon earnings, click here.  For the AT&T investor package, click here.  AT&T’s conference call transcript from Seeking Alpha is also here.

 

Microsoft Overtakes Google

While there is not enough time or space to chronicle Microsoft’s earnings, the result of their earnings announcement was very clear:

msft vs goog picture

Over the past six months, Microsoft has quietly overtaken Google in market capitalization (as of October 24, MSFT’s market cap was $380 billion, and GOOG’s was $366 billion).  This would have been unthinkable in a pre-Nadella era.  We’ll go into greater detail about how this is occurring in a future Sunday Brief, but Microsoft’s transformation is headed to be one of the big stories of 2014 (and 2015).

 

This reiterates a theme noted by several of you that the Valley is too volatile (“daily TechCrunch headline-focused” was one term) to create competitive advantage.  While that might be true (I think it’s overblown, but there’s some evidence that the Valley is receiving significant competition from Austin, Chicago, Kansas City and Atlanta), this is more about the changes occurring in Seattle, not Valley happenings.

 

We’ll devote one entire issue to Microsoft’s strategic transformation in early December.  It’s an impressive and sustainable story.

 

The Level3/ tw telecom Merger is Approved:  What’s Next?

Rather than doing a poor job of covering Comcast’s terrific earnings (see here for full set – we’ll cover more when Time Warner Cable, Cablevision and Charter announce earnings), the closing comment will be devoted to Level3.  On Friday, they received word that their merger with tw telecom was approved by the FCC (announcement here).

 

Besides acquiring a great company, the tw telecom acquisiiton strengthens their domestic footprint and creates an opportunity to drive additional cloud and data center services to tw telecom’s customers.  Level3 has a storied history of implementing locally-focused acquisiitons (Telcove, ICG, Progress Telecom, and Looking Glass Networks were difficult to integrate and created a lot of customer headaches), but tw telecom has a terrific back office and has no acquisition history.

 

The resulting asset (Tier 1 backbone, 21K+ fiber-fed buildings, lots of fiber, enterprise and carrier focus) is ready made for Sprint or T-Mobile (or both) to form an in-building high-speed data network.  Level3’s ability to create an additional $5-10 billion in shareholder value depends on better asset utilization.  Looks like the seeds of a successful partnership are in the making.  For a good overview of the asset Level3 is buying, click here for the latest (and probably last) Investor Presentation from tw telecom.

 

Next week, we’ll continue our discussion of third quarter earnings.  Until then, 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 readership, and have a terrific week!  LET’S GO ROYALS!

The Best Kept Secret (Not Again!)

opening pic (3)October Friday Night Lights greetings from Atlanta, Dallas, and (by the time most of you read this) Paris.  After a brief respite for the Columbus Day holiday, this week’s Sunday Brief focuses on several meaningful events in the telecom industry which will shape the quarter and 2014.

 

What a Week for Zayo to Go Public

Rule #1 in the investment banking industry is “There is never a perfect time to go public.”  That certainly was the case with Zayo Group Holdings this week, with stock market voliatility related to a probable European slowdown creating one of the more wild weeks in recent years.

 

Despite the volatility and a share price at the low end of the desired range ($21-24/ share), fiber provider Zayo holdings went public Friday at $19/ share, and closed the day at $22/ share (or a $5.3 billion valuation).

 

Zayo is a collection of network assets knitted together by the common need for fiber-based (primarily local/ metro) infrastructure.  Without local/metro fiber, we’ll all get five bars (strong signals) on our smartphones but have extra long  wait times for web page renderings (reminiscent of AT&T’s problems with the early iPhone launches).  Zayo’s product portfolio has grown from fiber and infratructure to data center and Ethernet services.  They are not a secret to wireless providers, or their Colorado-based competitors (soon to be combined Level3 Communications and twTelecom), but are a secret to much of the world.  More on the company here.

 

dan_caruso__professional_pcitureI could detail the myriad of acquisitions that came together to create Zayo (see full list from LightReading here), or talk about the rich history of their founder, Dan Caruso (pictured; see this old but informing video about Dan  here).  The most telling item comes from Caruso’s comment to the Wall Street Journal that, while the IPO raised $400 million, the company actually received $280 million because “private equity backers sold fewer shares in the offering.”  M/C Ventures, Columbia Capital, Charlesbank, and Oak Intestment Partners know the value that Zayo will bring over time.   When the original investors are hesitant to sell at $19, that’s a sign there’s more value on the horizon.

 

Kudos to Dan, Stephanie, Ken, Matt, Chris, Glenn, and the rest of the Zayo team.  Welcome to the public world.  From one cautious but convicted wireline bull to another, congrats on the IPO.

 

Google’s Quarterly Earnings – Spread Too Thin? 

Google announced earnings after the markets closed on Thursday, and the results were impressive:  20% overall revenue growth, 23% of revenues in Total Acquisition Costs, and 23% operating margins.  Google added 3,000 new employees in the quarter.  Total cash grew $3.4 billion even after $2.4 billion in quarterly capital expenditures.  What’s wrong with this picture?

 

The proliferation of mobile devices is a big crack in Google’s search foundation.  Simply put, mobile users click less on Google ads.  Total clicks are up, but not as fast as the total devices (and users) who use Google search every day.  The prices that advertisers paid Google for clicks fell 6% on an annual basis, which was more than most financial analysts expected.

 

We have discussed this potential (more with Facebook’s struggles to monetize their mobile presence than Google’s) several times in The Sunday Brief.  The application level is a direct challenge to the browser, and if applications get better at solving mobile user’s problems, the need to  search through the browser diminishes.

 

On their quarterly conference call, Google highlighted several new initiatives that they are putting into place to grow their business.  One of these new initiatives focuses on combining offline data (e.g., I purchased a gas grill at Sears in 2012 but did not use a Sears credit card) with online data (e.g., I just searched Google for gas grills in 2014).  There is a lot of offline data to correlate to online search, and this drives both computing capex and storage costs (not to mention a lot of algorithm development).  Combining offline and online data to create more meaningful search results stretches the limits of data correlation and contextualization.  This is one example of where Google is investing to increase the relevance of search to traditional (retail) businesses.

 

google stock priceWhile there are encouraging signs that Google will be able to monetize these new lines of business, many analysts openly express concern that Google is spreading itself too thin: Android, Android One, AdWords, AdMob, and other efforts across the globe are creating an unsustainable company.  Google, on the other hand, looks at their hiring (3,000 undergrads from the top computer science schools this quarter), changes in over the top video viewing habits, growth of low-end smartphones, and the previously mentioned integration of offline and online content and says “We’ve only just begun.” With more than $62 billion in the bank (or more than $1.1 million per current employee), it’s hard to argue against Google.

 

The Nexus 6:  The Best Kept Secret (Not Again!)

Given the collaboration that came through their acquisition, it’s no surprise that the Nexus 6 is made by Motorola.  And it’s no surprise that while the Nexus 6 packs a 6 inch screen (what a coincidence!), it is  surprising to see how similar the flagship device is to the Moto X, a 5.2 inch smartphone that was highly reviewed but bombed at the carriers (see TheVerge review of the Moto X and the Nexus 6  here).

 

What’s most interesting about the previous article is how reviewers gush about the Moto X (not just TheVerge – check out reviews here and here and here).  It’s fast, functional, and fairly priced.  Battery life is concerning, but with Motorola’s Turbo charging system (which is included in the Nexus 6), and various enhancements to Google’s latest Android operating system (called Lollipop) that extend phone life by 60-75 minutes, those concerns are largely addressed.  Even with the might of Google’s industrial and software design teams, Motorola barely moved the market share needle.  Why?

 

If the carriers were unsuccessful with the Moto X (either the first or second generation), and Google’s Nexus product hits the shelves against the iPhone 6 Plus and the Samsung Galaxy Note 4 (which will run Android KitKat but eventually be upgraded to Lollipop), what can Google do to ensure the success of the Nexus 6?  Here’s an idea:  While the full retail price of the device is $649 ($27/ mo. for 24 months), give Nexus 6 users a discount on the lease price.

 

With a $19.99 promotional monthly lease price across all US carriers (while supplies last), Google will turn heads.  The Nexus 6 will move from “nice to compare against in a store” to “nice to hold in my hand.”  Buyers of the device will be treated to a bloatware-free eperience which will allow them to focus on the apps that matter most (and tend to consume bandwidth).  Bottom line:  If the phone is this good, make it a slam dunk to lease.  The cost to Google over 24 months is neglible, and the benefits to the carriers and to Google are enormous.  If 2014 is the year of the smartphone trade-in, then 2015 is the year of the lease rate.  Let’s get the party started a little earlier.

 

HBO, and now CBS, Begin the Streaming Parade

I would be remiss if I did not comment on the HBO and CBS announcements this week (actual news release for HBO is here.  CBS link is below).  For those of you who missed it, HBO announced that sometime in 2015, it will introduce an “over the top” service designed to provide customers who have Internet but do not have cable an opportunity to watch Game of Thrones and other series.  Given the type of content HBO shows (non-live content such as movies and series), this makes a lot of sense.

 

CBS followed suit the next day with specifics on their digital streaming product (full announcement is here).  If you live in one of the fourteen markets that will feature live streaming of the local CBS affiliate, this is about as close to cord cutting as you can get.

 

Both of these announcements are bad news for Netflix, which saw it’s market capitalization decline by 20% or about $4 billion in two days (mediocre earnings were also released on Wednesday which didn’t help).  Netflix CEO Reed Hastings tried to put a positive spin on the annoucnement, citing the existence of both providers in an over the top in Nordic countries (customers buy both services, not just HBO), but the prevalence of 10-12 providers by the end of 2015 will drive up Netflix’s marketing costs (and likely drive down rates).

netflix stock priceCan Netflix and cable come together to fight the common content enemy?  How will Comcast-owned NBC Universal  respond?  How does this impact the FCC’s decision on the Comcast/ Time Warner Cable merger?  The answers to these questions will unfold over the next 90 days.  Suffice it to say, the need to plant upgrades (capital expenditures) for the telecommunications providers will be accelerated in 2015.  Cord cutting will increase for some types of customers, and be surprisingly stable for others.  And satellite will suffer the greatest losses because of their inability to offer 50-100 Mbps High Speed Internet services that over the top will require (at least for families).

 

One thing is for sure – this change will come faster than any of the infrastructure providers expected.

 

Next week, we’ll review Verizon, AT&T, Amazon, Apple, Microsoft, and other related company earnings.  Until then, 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 readership, and have a terrific week!  LET’S GO ROYALS!

The Winning Formula for Wireline

NM_19tex12.jpgTexas State Fair greetings from Dallas, Texas (the all new Big Tex is pictured), home of this year’s COMPTEL Plus Convention & Expo.  This year promises to be extra special as FCC Chairman Tom Wheeler delivers the keynote address on Monday.  If any of you are attending, it might be worth it to read Chairman Wheeler’s September 4 speech titled “The Facts and Future of Broadband Competition” prior to attending.

 

One of my summer projects has been to relearn the economics of broadband connectivity.  While this column focuses on the intersection of wireless and wired networks (and their relationship to content that uses them), the dynamic with wireless has dominated the column in recent months.  This column focuses on the intersection of wireless and cloud from a wired perspective.

 

Connectivity to homes and businesses has been steadily on the rise.  In the Chairman’s comments relayed in the link above, Wheeler cites more than two competitors at the 10 Mbps down/ 768Kbps up level for what??.  While speeds and penetration need to be improved to maintain global competitiveness, reaching a competitive state where 20-30-50-100 Mbps (now symmetrical if you live in Verizon FiOS territory) has become an option is remarkable.

 

Wireless competition is robust for the 250 million Americans who live in a Metropolitan Statistical Area (total population of the US = 316 million).  Approximately 80% of the US population lives in an MSA, and over 50 MSAs have a population of one million or more people.  That these areas happen to coincide with minimum wireless carrier LTE footprints is no coincidence (T-Mobile has the smallest LTE footprint at 235 million as of September 2014 and plans to grow this to 280 million by mid-2015.  See Dave Mayo interview here).

 

With unlimited voice becoming the standard for wireless carriers (especially with metered data/ family plans), in 80%+ of the country there is robust competition for a voice minute if wireless coverage is available.  This leads us to the first key ingredient to wireline success:  support wireless voice (and SMS).

 

This is a tough pill to swallow for the industry because their roots are based on switched (voice) access and interconnection.  The revenue streams are small, but the legacy is deep.  “We own the office” was the phrase that one of them used with me over the summer.  “Our company cannot survive without voice” was a mantra I heard from many competitors.  “Poor in-home coverage drives more [wireline] phone – why would I want to enable that?” came from more than one cable company.

 

Competition is a two way street.  To ask others to overturn their view of the competitive landscape involves rethinking current business models.  The first traditional Competitive Local Exchange Carrier to enable wireless in-building coverage with substance will create a competitive advantage.

 

Information Technology Management

For those of you who have not studied the effects of cloud computing on infratructure expectations, this next section will be a brain bender.  For decades, computing instructions (software) have been stored locally in hard drives in local offices.  Software was licensed per using destop, and customer-specific  applications were written for local (or, at worst case wide) area networking environments.

 

With the advent of the Internet, and especially the advent of broadband speeds in the past five years, the business model began to change.  Software became more sophisticated and at the same time specialized.  Customer-specific modifications abated.

 

Three key trends began to accelerate at this point:  1) Software revisions began to favor efficiency over product robustness (and code overall became more efficient); 2) Broadband speeds increased to homes and businesses alike, and cable began to accelerate their small business passings; 3) Mobile computing expectations began to increase, first through smartphones and applications, and then with tablets (both are critical today).

 

On top of these trends, high-end server prices continued to drop steeply, and bandwidth price/value (local, national, and international) contined to improve.  At some point, it was going to be cheaper to keep software in the cloud and manage updates on a “rolling” basis.  That point occurred sometime in 2010-2012.

stagedmigrationMicrosoft introduced Office 365 to the masses in June 2011 with more stability in 2013.  In March 2014, Microsoft introduced Office for iPad applications to generally wide acclaim (and 12 million downloads in the first week).   The fulfillment of the previous decade’s vision of “apps on tap” became a reality.  A decade from now, many will wonder why the CD-ROM drive exists.

 

This presents a unique issue for all wired Communications Service Providers (CSP):  When is it the network’s fault?  In the old days, the blue screen of death meant that the local network was failing.  In a cloud environment, who fixes traditional errors?  How do you diagnose that the bandwidth provider is at fault?  Most importantly, how do you restore/ fix problems driven by network/ software configurations?

 

This leads to the next key ingredient:  Information technology management.  Understanding the effects of software changes on the network is more critical than ever.  The compexity of “technical help” questions directed to wired CSPs is increasing as traditional applications that have not been moved to the cloud (yet) have to interface with new cloud-based software.  One CIO put the “cloud conundrum” to me best at a conference this summer:  “We are one software update away from network chaos.”  CIOs could not have made that statement a decade ago, but with business software increasingly residing at the regional data center and not at the branch office, the troubleshooting process could be a nightmare.

 

Network operators are not software developers.  They generally have minimal understanding of the development process, and have had little success in expanding into software services (except cloud storage and security).  The first traditional CLEC to show better than average IT competence will create a competitive advantage.  The one who makes IT superiority to be the cornerstone of Home Office and Small Business offerings will create a multi-billion dollar dynasty.

 

Disruptive Innovation

community wide wifiLastly, the concept of disruptive innovation has yet to take hold of the wired community.  Even Google Fiber, which many laud as disruptive and innovative, is a far cry from where the industry needs to go.

 

In the early days of the Internet, cable and DSL providers loathed the idea of having broadband routers connect to Wi-Fi access points, especially in homes.  After the widespread adoption of the laptop computer, and then the smartphone, that concern quickly abated.

 

However, as the picture demonstrates, there are many opportunities, particularly in metropolitan areas, to provide equal or greater bandwidth to Internet-hungry consumers through shared modems.  Imagine an apartment complex where instead of 90 modems interfering with each other there were 9.  This is entirely possible today from a technical perspective (deciding who would regulate the service and how everyone would pay for it is a different matter).  One problem:  No traditional cable or telco would provide the service today.

 

If the regulatory bodies were to get involved in the broadband provisioning, monitoring and maintenace process (and they appear to be heading in that direction), why not use existing technologies to eliminate the concept of an individual subscription?  With multiple Gigabits per second to the neighborhood, an individual cable subscription would become a luxury.  A few strokes of the FCC pen outlawing sections of the Acceptable Use Policies (AUPs) of current broadband providers would open up a wealth of options.  Instead, the Commission focuses on restricting today’s outdated model.

 

We need this decade’s MCI, one who challenges the status quo and then uses regulations to complement their arguments.  Innovation will never eminate from bureaucracy, but they can open up holes to allow good ideas to see the light of day.

 

Disruptive innovation creates new industries.  Today’s wired community needs a dose of disruption.  Replacing the individual subscription model for broadband services is a good starting point.  Wireless service providers have started to pave the way with shared plans.  The time is ripe to apply this model on a much larger scale to communities where 100-200-500-1000 GB of monthly usage makes sense.

 

That’s it for the COMPTEL preview issue.  Next week, we’ll update numbers and forecasts in advance of Verizon and AT&T’s earnings announcements, and also cover Sprint’s massive layoff announcement.  Until then, 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 readership, and have a terrific week!  LET’S GO ROYALS!