Vernal equinox and St. Patrick’s Day broken NCAA bracket greetings from Las Vegas (home of this year’s Channel Partners show) and Dallas (Jesuit Rugby vs. Dallas Harlequin Colts pictured – photo taken with my new Samsung Galaxy S7 Edge). We had a terrific response to last week’s column (over 50 comments, 14 new subscribers), and I noticed that one analyst coincidentally revised their guidance to now reflect negative phone additions for Sprint.
As a reminder, we will not have a column next week because of the Easter holiday. If you begin to suffer withdrawal symptoms, pick a column or two that you did not get a chance to fully digest and send me your thoughts on where I could improve my views of the telecom world.
This week, we’ll dive into three headlines that will impact first quarter (and 2016) earnings. But first, a quick look at the latest development with T-Mobile’s Binge On! product and a quick peek at what Apple has up their sleeve for Monday’s “Let Us Loop You In” event.
T-Mobile and YouTube Binge On Together
This week, the telecom and Internet worlds came together with the announcement that T-Mobile’s Binge On! service would now support YouTube. Specifically, T-Mobile announced that they would allow content providers to opt in or out of which video streaming feed they used on an individual case basis.
As most of you know, T-Mobile (including Metro PCS) and Google have had a long-standing relationship. When Google was not announced as a Binge On! partner, many were surprised but we commented that “bringing YouTube into the Binge On! catalogue was a matter of time.”
T-Mobile did this by smartly changing their policies. First, they will allow any video service provider to opt out of the service and will publish this list on their website. Second, they will allow content providers to self-manage their own video streams and optimizations.
This is a big deal, and it’s hard to believe that others will not adopt these policies. As we discussed with T-Mobile a few weeks ago, they received a one-time 10-15% capacity improvement the change to Binge On!, and the total traffic growth should be lower than their un-optimized competitors. Another good move for T-Mobile, and a catch-up opportunity for the rest of the industry.
For more on T-Mobile’s changes, check out this video from T-Mobile CEO John Legere.
Apple’s “Let Us Loop You In” Event: What’s the Big Deal?
On Monday, Apple will likely announce several things, including a smaller (less than 4.7 inch screen) iPhone and (less than 10 inch screen) iPad Pro tablet. Both products could be big deals for the company and for consumers. See previews from Ars Technica and Engadget here and here.
Eighteen months ago, the iPhone 6 and 6 Plus had not been announced. People were used to the tallish but narrow feel of the iPhone 5 and 5s, as well as the compact feel of the iPhone 4s (Apple devotees consistently tell me that the iPhone 4S was a groundbreaking device for its time because of its processing capabilities and overall functionality. I agree). Then came the iPhone 6 which drove lots of volume. Now, however, there is a small but significant “mini crowd” who wants to be able to have a pocket-sized smartphone with the latest processors but not a mega-screen. The closest analogy I can use is in the automotive world with the rise of the “f-Type” from Lexus (5.0-liter engine with 467 hp on a wheelbase less than 110 inches – more specs here).
Can these two announcements, combined with other operating system improvements, lift Apple out of their current doldrums? A smaller iPhone will definitely help, and a smaller iPad Pro will allow many of the previous improvements (including the Apple Pencil) to be leveraged. Net-net, this should be a needle mover for Apple.
Three Headlines That Will Impact First Quarter Broadband Earnings
Headline #1: “Charter’s Merger with Time Warner Cable and Bright House Networks is Approved.” This almost seems inevitable with reports this week that the FCC is circulating a draft of a conditional approval. According to an article in The Wall Street Journal (see here; paid subscription required), it appears that newest concession would bar Charter from “including clauses in its pay TV contracts that restrict a content company’s ability to offer its programming online or to new entrants.” While it’s likely that Charter would not prohibit the development of competitive over-the-top solutions, it’s equally unlikely that they would abandon their volume-based per subscriber pricing from content companies.
According to the North Shore Advisory, the most important item to get hammered out with the FCC is the compliance window. Charter agreed early on in the approval process to 1) no data caps; 2) waived interconnection fees with companies such as Netflix; 3) no paid prioritization and premium services designed to improve their content or services over others. But they only agreed to this for the three-year period following approval. Assuming at least half of the 36-month term is taken up with a) broadband expansion, and b) building systems and processes to handle a prioritized, un-neutral business model, three years could go by pretty quickly. Longer than that could complicate things, especially if the courts rule against some or all of the FCC’s recent Open Internet Order (their decision is due within the next month; click here for the 2014 ruling).
An interesting article also appeared in Investor’s Business Daily this week suggesting that Comcast and the new Charter could enter into a series of property exchanges to further improve their respective company economics after the transaction. While no specific properties were mentioned, there continues to be a lot of fragmentation in Connecticut, New Jersey, South Carolina, Louisiana, and Kansas City (to pair with Charter’s St. Louis property). It’s even possible that Cox Communications could enter the deal-making fray with a swap of their lucrative northern Virginia properties to build a stronger Midwest or California presence. It’s very unlikely that any major properties will be swapped (except Maine), but a lot of incremental value can accrue to trading parties from these after-merger transactions.
After FCC approval, the California PUC still needs to vote on the merger on May 12, and, judging from the hearing held earlier this year, Charter appears willing to cut a deal to get it approved. New York City gave their approval on March 9 with moderate but reasonable concessions (see Bloomberg article here).
The opportunities created by the combined company (especially with some moderate re-clustering) are going to be great. The new Charter will be a stronger competitor to AT&T in California and a stronger defender against a resurgent yet concentrated FiOS footprint in the Northeast. And the new Charter is a few billion dollars of investment away from having very dense Wi-Fi coverage in their top 10 metropolitan markets (see Dallas coverage improvement article here), which is a lot cheaper than buying a wireless company or entering into an MVNO with Sprint or T-Mobile.
Headline #2: “AT&T Loses Broadband Customers.” I hope this headline is wrong and that AT&T will report moderate to significant gains because of their Velocity IP investments (which were great). However, there’s no indication from John Stephens’ latest investor presentation that this headline will take place in the first quarter. Here’s the eight quarter trend from AT&T’s last earnings report:
The issue with AT&T is attraction, not conversion. It no surprise that the DSL platform is shrinking, but one would expect that if AT&T’s broadband platform were valuable and attractive, net additions would exceed DSL losses. However, AT&T’s IP broadband net additions slowed significantly in the last three quarters of 2016, down 51% in Q2, 68% in Q3, and 53% in Q4. As a result, the company lost 200,000 more broadband connections in the last three quarters of 2015 than the last three of 2014. The new product is selling to some existing customers, but is not wooing existing cable customers away.
To be net add positive for broadband customers in the first quarter, AT&T will need to grow at least 290-310K IP broadband subscribers and keep DSL losses on their downward trajectory. Nothing in AT&T’s latest commentary (specifically CFO John Stephens’ comments at the Deutsche Bank conference on March 10) would lead investors to believe that consumer broadband revenue growth is a strategic priority for the company (or that it’s even a priority).
When asked about competitive capabilities, Stephens cited the 14 million home fiber buildout as an FCC “commitment” and he quickly shifted from making home broadband profitability a priority to the value of having a common shared fiber infrastructure (which their cable competitors have been putting into place for close to a decade). There is no doubt that a local fiber presence will help in comparison to Sprint and T-Mobile (or even Verizon in AT&T’s region), but does AT&T face diseconomies of scale because they have under-invested in building a residential broadband brand? Can a residential strategy be complete without including broadband?
Stephens’ comments create a stark contrast to cable: AT&T is focused on everything but broadband (Mexico, DirecTV integration with wireless, cost synergy achievement, enterprise growth), while cable companies, CenturyLink, and Frontier are singularly focused (or nearly so) on broadband. That should give investors pause: the prospects of slow/ no broadband growth in what has historically been a strong quarter for AT&T sets the stage for a rocky 2016 growth picture. More broadband focus (including some soul searching on what will drive competitive advantage versus cable, Google Fiber, and other third party overbuilders) is needed.
Headline #3: “Comcast Business Posts Twenty Percent Growth.” It’s hard not to read a Sunday Brief that does not include something about the commercial services growth, but, in case you are not aware, Comcast and much of the cable industry has been growing commercial services revenues like a weed for the past seven years, and Comcast now has $5 billion in annualized run rate revenues (still 5x+ smaller than AT&T, 3x smaller than Verizon and about 50% smaller than CenturyLink, but a strong showing nonetheless).
In particular, the year-over-year revenue growth for Comcast Business Services has been very consistent and robust over the past eight quarters:
To no one’s surprise, the first quarter tends to be the strongest as projects get kicked off, budgets are approved, and weather improves. What is incredible, however, is the growth rate through the subsequent quarters. With more capital being allocated within Comcast to medium and enterprise services, the opportunity to consistently grow at 20+% rates should exist for the next three years (if they hit it, the result is an $8.7 billion unit in 2018 and might be the largest provider in many/ most of their service footprint). By contrast, the prospects for business services revenue declines of 2-4% at AT&T and 3-6% at Verizon for the next 3-5 years.
As Brian Roberts indicated earlier this month at an investor conference, Business Services is very accretive to earnings and has attractive payback periods. The value proposition is based on fast connectivity at affordable rates and tends to carry 24 to 36-month terms. As was seen at the Channel Partners Show last week, they are definitely investing in distribution. Provided that cooperation continues with their cable peers to provide a national footprint, high growth rates should continue for Comcast Business Services for the foreseeable future.
That’s it for wireline headlines. After our short break for the holiday, we’ll dive back into industry analysis. Until then, please invite one of your colleagues to become a regular Sunday Brief reader by having them drop a quick note to firstname.lastname@example.org. 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 Go Sporting KC!
Greetings from Dallas. That’s right – a week without travel- a “Spring Break” of sorts from January and February’s crazy schedule. Rather than talking with many of you from airports or the car, I called from balmy Texas. I was also able to take in the Jesuit College Prep Rugby Showdown this weekend which is pictured (Jesuit in gold and blue; Memphis, TN, Christian Brothers High School in purple and gold). My batteries are now recharged and I’m ready for a seven-city tour over the next two weeks.
This week, we’ll dive into the set-top box Notice of Proposed Rulemaking that’s underway and estimate the ramifications to the cable industry and over-the-top providers. We’ll also begin to discuss a few events over the past month that are going to impact quarterly and annual earnings.
The FCC’s Set Top Box (STB) Kerfuffle
Fresh off the one-year anniversary of enacting Net Neutrality rules, the FCC turned its attention to section 629 of the Telecom Act of 1996. Yes, the STB has been clinging to the same rules and regulations that we had before Yahoo!, YouTube, Twitter, and the iPhone existed. Innovation at that time was best captured by the America On-Line screen pictured nearby.
It’s hard to argue that the rules shouldn’t be refreshed, but what should they encompass? The current NPRM objective (full link here) is as follows (editor’s note: MVPD stands for Multichannel Video Programming Distributor, a.k.a. a cable/ satellite/ fiber provider):
…Consumers should be able to have the choice of accessing programming through the MVPD-provided interface on a pay-TV set-top box or app, or through devices such as a tablet or smart TV using a competitive app or software. MVPDs and competitors should be able to differentiate themselves and compete based on the experience they offer users, including the quality of the user interface and additional features like suggested content, integration with home entertainment systems, caller ID and future innovations.
It’s important to realize the ramifications of the FCC’s decision. First, the FCC is mandating change that has broad implications to several industries. This should come as no surprise to anyone who has dealt with this FCC, which issues regulatory mandates to counteract the inability of the legislative branch to revise what’s now a 20-year-old-technology focused law. The FCC would like to have a “[World Wide] Web” look and feel to the first screen, which incorporates as many options as possible (compare the AOL screen above to a search results screen from Netflix). This could include “recently watched” or “Facebook friends recommend” or even “Sponsored programming” (let’s not forget that High Speed Internet caps are going to become more prevalent over the next decade). A more sophisticated box could have biometric (fingerprint) detection which would personalize the Electronic Programming Guide (EPG) for each member of the family. Choices would proliferate, and more opportunities leads to more competition, higher quality content, and a better customer experience.
This all sounds good, but is the problem one of content availability, or one of content organization? Is the FCC trying to get rid of broadcast channels (and their scheduling/ organization model) through this process? That would appear to be the likely outcome – an interesting “back door” regulation whereby the FCC alters the structure of set-top box provider, MVPD, and broadcasting industries with one rulemaking (for an excellent read on this ruling’s effect on minorities, see this LA Times article).
Second, the FCC is mandating change when voluntary options currently exist to solve the problem. Before making this proposal, the FCC should have asked “Why has TiVo faltered (see stock price chart here)?” TiVo’s new TiVo Bolt (pictured) is beautiful and does everything the FCC wants it to do (see specs here). But it costs $299 for the first year + $12.50/ month after the first year (this is in addition to cable package costs). To TiVo’s credit, if the customer has multiple TVs, they could save money versus buying a Whole Home DVR system, but there’s still the high cash outlay. While this is worth it to TiVo’s current base of 6.6 million users worldwide, is the extra cost worth it to 50, 60, or even 70 million homes? Someone needs to ask the FCC why TiVo (a company started out of the 1996 Act) has faltered and how these new rules will change the equation.
Then there is the issue of existing equipment like Roku, an over-the-top streaming service providing nearly every streaming option possible (including access to TWC TV and Spectrum (Charter) TV). Roku offers very affordable hardware (pricing here), and their relationship with both TWC and Charter is strong. While Roku does not provide web content that could be delivered from a search (or Google Now recommendation), isn’t a Roku solution also solving most of the objectives laid out by the FCC (with over 10 million devices sold in the US)?
Finally, the FCC’s mandate will likely drive up prices for consumers who have the little interest in expanding their television horizons. To use the original picture in this section as an example, the FCC thinks we are living under the same limitations as “America Online” provided to dial up users. If we had a browser and the web connected to our televisions, things would be better. To many viewers, the ability to watch college basketball in February/ March, opening day of the baseball season in April, the Masters in May, the Olympics over the summer, the opening of college and professional football in September, and the World Series in October is enough. Those sports fans might watch college baseball, but they are not going to search for Episode 9 of “Curling Night in America.”
To be fair, there are many other user viewing segments that could be benefit from the FCC’s proposal. Education channels could emerge that teach children other languages and incorporate those learnings into actual broadcasts (kind of an enhanced Khan Academy). America’s cooking skills could improve through a mix of traditional broadcast media and web-based supplemental data. And Amazon could launch a “channel” that would sit next to QVC and other shopping channels providing alternative (cheaper??) options to those they are viewing.
These options sound appealing, but will television viewers make the switch from their ESPN/ CBS/ NBC/ ABC/ Fox/ Fox News habits to this new mode? If not, will the costs of the mandate exceed the benefits? If my box has issues, who gets the call – Comcast, the EPG developer, Walmart/ BestBuy, or the hardware maker? And, since the FCC chairman has promised that there will be no ad inserts or wrap-around advertising permitted by Google or others, how will the new entrants make money?
Bottom line: The FCC’s proposal sounds good, and no one points to their set-top box as the paragon of technological development (except for the latest version of Comcast’s Xfinity X1, or the TiVo, or perhaps the Roku). But replacing today’s equipment and EPG with new models is going to cost customers more money than $8/ month unless the customer sacrifices its privacy (to improve Google’s profile). The FCC should say to communications providers “Treat your set-top box the same way you treat your cable modems, and make each model available at mass retailers such as Amazon and Wal-Mart.”
However, if the FCC were to move forward with their current proposal, they should mandate that customers of these new devices are allowed to opt out of data collection at any time with no ramifications (including pricing), and to require the opt-out option to be clearly and uniquely presented each year thereafter. This would remove the current perception that that the FCC is in Google’s back pocket.
Five You May Have Missed
- California’s Office of Ratepayer Advocates weighed in Friday against the Time Warner Cable + Charter + Bright House Networks merger. Their arguments against the merger largely mirror those of Dish Networks. This will likely have a minimal effect on the PUC’s decision, but some of the conditions they are attaching up the ante considerably. More in this Multichannel News article here.
- Wall Street research analyst Craig Moffett sent a note out Thursday detailing Google Fiber’s video customer count (obtained through the Copyright Office). (Note: High Speed Data customer counts and home penetration rates are expected to be higher). Of special note: the Provo, Utah, market has grown a whopping 65 customers over the past six months. While Craig’s analysis is not public, there were several articles on his work including here and here.
- Amazon reverses course and says that the next version of the Fire Operating System (OS) will have an encrypted data option. While The Sunday Brief has decided not to weigh in on the current legal activities between Apple and the Justice Department, it is interesting that one of Apple’s biggest supporters admitted this week that they are dropping device encryption support in their latest OS release. An Amazon spokesperson wrote to TechCrunch that “We will return the option for full disk encryption with a Fire OS update coming this spring.” More on the admission and Amazon’s u-turn here, here, and from the Washington Post here.
- Sprint replaced the last of the Dan Hesse operating team with the hiring of Robert Hackyl to lead customer experience and service functions. Hackyl comes from Vodaphone, but also formed T-Mobile USA’s channel strategy “from scratch” during his work there from 2010-2013. More about the change (from “Bob” Johnson to “Robert” Hackly) in this release.
- Sprint has quietly brought back subsidized devices. More in this recent article from FierceWireless.
Next week, we’ll use our previously published “To Do” lists and begin evaluate each carrier’s first quarter progress. We’ll also have our first view at which companies are creating the most shareholder value to date in 2016. Until then, please invite one of your colleagues to become a regular Sunday Brief reader by having them drop a quick note to email@example.com. 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 Go Davidson Wildcats!