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Tax Day greetings from Washington DC (where I chaired a terrific discussion at INCOMPAS), Chicago, Charlotte, and Dallas. Thanks to everyone who showed up at the panel and participated – all of the speakers on Monday were great, including Chairman Tom Wheeler (pictured).
This week, we continue to chronicle the developments of the Set Top Box saga as the Obama administration weighed in through the NTIA with comments. We’ll also weigh in on the controversial “Ghettogate” ad. First, however, we’ll look at a study of balance sheets across the telecom industry which was released last week by Craig Moffett.
Redefining Leverage Ratios
With continued densification (smaller cell sites in more places), spectrum acquisition, and competition, many investors turn to leverage ratios to benchmark long-term financial health and viability. These ratios are not the first thing that companies highlight in their press releases, but many calculate and discuss their net debt to EBITDA metric. Here’s that definition according to Investopedia:
The net debt to EBITDA ratio is a measurement of leverage, calculated as a company’s interest-bearing liabilities minus cash or cash equivalents, divided by its EBITDA. The net debt to EBITDA ratio is a debt ratio that shows how many years it would take for a company to pay back its debt if net debt and EBITDA are held constant. If a company has more cash than debt, the ratio can be negative.
Using that standard definition, communications company metrics would look like this:
From a first glance, this looks as expected to most who follow the telecom industry. Verizon and AT&T maintain low leverage ratios and as a result are afforded low interest rates. Cablevision, Dish, Sprint, and Charter have historically been able to use high-yield debt markets to finance operations, spectrum purchases, stock buybacks, and other investments. T-Mobile and Time Warner Cable lie somewhere in between.
Telecom is not a typical industry, however. With Equipment Installment Plans (which entails moving away from subsidy and into subscriber-paid devices) and phone leasing proliferating, more “debt” is being created and sold to third parties at growing rates. Operating leases create pressure on EBITDA but also frequently mean long and non-cancelable commitments for telecommunications carriers. And pension obligations represent a promise to employees that rarely enters into leverage discussion dialogue.
MoffettNathanson’s adjusted leverage ratio schedule is shown to the right. In this view, the relative health of each carrier is different than what was previously reported. Verizon and AT&T look more like Cablevision and Charter thanks to large pension liabilities, even when the undiscounted size of the pension contribution tax credit is considered. Comcast appears to be the healthiest of the industry with Time Warner a distant second. Sprint’s revised ratio is a whopping 7.9x driven in large part by the reversing of the leasing construct. While it should be emphasized that nothing is truly “real” in the accounting world, this analysis provides some insights into the high-yield market’s reluctance to lend the company money at reasonable rates.
Craig Moffett did a Bloomberg interview on the topic (see here) and his detailed analysis is only available to MoffettNathanson clients. However, if you can get a copy of their work, it’s worth digesting and is on par with the seminal analysis on telecom affordability Craig did in his Bernstein days.
President Obama and the Set Top Box Kerfuffle
Since our article analyzing the Notice of Proposed Rulemaking was written (see here), there has been a lot of discussion across many constituencies as to who would benefit and suffer the most. In the Sunday Brief devoted to the topic, we mentioned how this is pitting entrepreneurs against established programmers. It’s also pitting Democrat Congresswoman Anna Eshoo (California), the ranking member of the House Energy and Commerce Subcommittee on Communications and Technology against Democrat Senator Bill Nelson (Florida), the ranking member of the Senate Commerce Committee. Representative Eshoo is a supporter of the FCC’s initiative while Senator Nelson wants to study the implications of opening up the Set Top Box market in greater detail (Nelson is supported by the National Urban League, the National Action Network, and the Rainbow/ PUSH Coalition).
To make matters more complex for policymakers, President Obama decided to weigh in on Friday, devoting his weekly radio address to the set top box issue. Here’s the situation assessment according to the White House (full blog address here):
… the set-top box is the mascot for a new initiative we’re launching today. That box is a stand-in for what happens when you don’t have the choice to go elsewhere—for all the parts of our economy where competition could do more.
Across our economy, too many consumers are dealing with inferior or overpriced products, too many workers aren’t getting the wage increases they deserve, too many entrepreneurs and small businesses are getting squeezed out unfairly by their bigger competitors, and overall we are not seeing the level of innovative growth we would like to see. And a big piece of why that happens is anti-competitive behavior—companies stacking the deck against their competitors and their workers. We’ve got to fix that, by doing everything we can to make sure that consumers, middle-class and working families, and entrepreneurs are getting a fair deal.
If that weren’t enough, the President’s National Telecommunications and Information Administration (NTIA) filed supportive comments with the FCC (read more about them here). For those of you who are new to the process, the NTIA is managed under the Department of Commerce and the administrator of the Broadband Technology Opportunities Program (BTOP), one of the biggest boondoggles of the past decade (see New York Times article on BTOP titled “Waste is Seen in Program to Give Internet Access to Rural U.S.” here).
As we saw with the President’s actions on Net Neutrality (his YouTube message following the 2014 election is here), this administration is not afraid to use the power of the bully pulpit to influence the FCC. Without rehashing the previous article, and to continue in the spirit of problem-solving, here’s a few questions I would suggest the FCC carefully consider:
- Will the ruling require Google to open up the Google TV Box? In other words, could the Xbox connect to a Google Fiber coax cable and allow customers to launch a Bing or Cortana query to pull up the latest in Google TV programming? If not, why not? (Note: while it is substantially less, Google TV charges a $5/ mo. lease for every TV after the first box).
- Will the new Electronic Programming Guide (EPG) providers be required to show consumers what information they are collecting on customers? How will consumers access this information as well as any other sources that are being used to drive channel selection. For example, if I am shown the Kansas City Royals game as my first option and I have a Google EPG, will Google be required to show me that they recommended this because I have the MLB At Bat application on my Google Android phone?
- Can each customer of the new EPG service opt out of data collection? Will this selection process be easy for customers to access and install? See the previous Sunday Brief here for more detail.
- With the replacement of a relatively simple, channel-driven search process (using up and down arrow keys on a specially designed remote control) with a more sophisticated algorithm-driven process as the likely decision, how can the Commission state that the process will not alter advertising rates (see Wired article here)? Won’t customers bid (and Google profit) from paying for higher page rankings on EPG search results? If so, then what will prevent Black Entertainment Television (BET) from outbidding their apparent competition? As Roza Mendoza, the Executive Director of the Hispanic Technology & Telecommunications Partnership stated in the aforementioned Wired article “They’re asking us to trust Google? All of us know about their diversity record. The only people that are going to benefit from this are Silicon Valley companies.”
Let’s keep the recommendation very simple:
- Require all Multichannel Video Programming Distributors (MVPD) to provide the same set top box on-line and through distribution channels such as WalMart, just as they do with cable modems (see Time Warner Cable disclosure above).
- Require all MVPDs publish a list of boxes that they support (according to the Tivo Bolt FAQ page, all of their devices are compatible with every major cable provider in the US as well as FiOS. Chairman Wheeler carefully omits Tivo’s competitive offer in this Washington Post interview when he says “Today there is no competition in set-top boxes, and therefore the incentive to innovate and come up with all kinds of new alternatives is somewhat limited”).
- If the set-top box order is enacted, require opt-in consent and on-demand publication of how search results are being determined. Allow opt-out capabilities at any time and for any reason with no corresponding financial penalty (including termination penalties on the equipment).
- If the set-top box order is enacted, allow cable companies five years to comply with the decision.
No one can defend the current state of the Electronic Programming Guide (with the exception of the Xfinity X1/X2 and the Tivo Bolt). But to state that there is no set-top box competition when Tivo clearly positions itself as an alternative for digital cable providers is deceptive. And to fail to acknowledge that Google will financially benefit from search result rankings, and that entrepreneurs will have to pay up to achieve a top page ranking, is equally deceptive. The transition of value from cable companies to Google, Apple and Microsoft is apparent to anyone who digs deeper, and should receive the same bright spotlight that communications service providers have received throughout the entire Open Internet process.
Sprint’s Controversial (?) Ad
More than a few heads turned when Sprint released (and subsequently retracted) the following ad:
Lead statement: Real questions. Honest answers. Actual Sprint, T-Mobile, Verizon and AT&T customers. No actors.
Sprint CEO Marcelo Claure, talking to focus group but specifically addressing woman sitting to his right: “I’m going to tell you the carrier name, and I want you to basically tell me what comes to your mind. T-Mobile. When I say T-Mobile to you, just a couple of words.”
Woman sitting to Claure’s right: “Oh my God, the first word that came into my head was ghetto (laughter, Claure nods and smiles in approval). That sounds like terrible. Oh my God, I don’t know. Like, I just felt like that there’s always like three carriers. It’s AT&T, Sprint and Verizon. And people who have T-Mobile, it’s like “Why do you have T-Mobile?” I don’t know.
Claure taps her shoulder in approval. Sprint logo appears. End of ad.
For those of you who are struggling with the definition of ghetto, here’s the version from dictionary.com: a section of a city, especially a thickly populated slum area, inhabited predominantly by members of an ethnic or other minority group, often as a result of social or economic restrictions, pressures, or hardships.
Sprint had the sense to pull the ad, and Claure apologized, but his Twitter posts triggered intense reaction from many of Claure’s followers. Interestingly, John Legere, T-Mobile’s CEO, declined to comment other than the exchange nearby.
This is probably an innocent mistake, a miss due to personnel changes occurring within Sprint’s marketing department. Or perhaps Claure did not understand the racial undertones of the word ghetto. Regardless, it provided some unneeded attention this week for the struggling carrier, and Sprint (and Boost) customers can rest assured that it will not occur again.
Thanks for your readership and continued support of this column. Next week, we’ll dive into Verizon’s earnings as well as the Open Internet Order ruling if it is released. 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 Royals and Sporting KC!
Greetings from the Southland where, contrary to popular belief, business is booming and growth opportunities are expanding. Pictured is half of the bourbon wall from Louisville-based El Toro, one of the fastest-growing start-ups in Kentucky (their current offices are in a restored distillery).
This week, we will take a look at the last quarterly earnings call from Frontier prior to their acquisition of Verizon’s California, Texas, and Florida properties, and also highlight a series of announcements made during February which point to a resurgence in wireline interest.
Before doing this, our thoughts go out to Level3 CEO Jeff Storey and his family as he continues to recover from recent unplanned heart surgery. There are many Level3 readers who are regular readers of The Sunday Brief who were equally surprised by Monday’s announcement. Fortunately, Sunit Patel, Level3’s current CFO and now interim CEO, has the deep understanding and operating experience to continue Level3’s transformation into an enterprise-focused provider. We wish Jeff a speedy recovery and look forward to his return in a few short months.
Frontier’s “To Do” List
- Close the Verizon CA, FL, TX market transaction with as few issues as possible
- Identify and implement $600 million in planned synergies as a result of the VZ transaction starting at transaction close (while minimizing customer-facing impacts)
- Expand current video products to 3-4 million additional homes in 40 markets over the next 3 years. Clearly demonstrate that video growth will be profitable and the best use of incremental capital expenditures
- Translate additional broadband capacity improvements in CT into lower customer churn and improved Average Revenue per Residential Customer
- Manage promotions to grow revenue, increase the customer experience, and reduce the impact of post-promotion churn
- Continue to translate Connect America Fund (CAF) deployments into incremental customer relationships, especially for the 100,000 additional homes planned for 2016
- Translate improved bundle capabilities into lower residential voice churn
- Grow and demonstrate the value of self-service tools
- Improve business (SMB) competitiveness as a result of the Verizon properties acquisition
- Maintain or improve leverage and dividend payout ratios. Use increased cash flow to clean up some of the debt maturities on the balance sheet
Frontier Communications reported decent earnings this week as they prepare to double their size with the acquisition of Verizon properties in California, Texas, and Florida (full earnings report is here and their presentation is here).
Included is a map that management used in their first quarter earnings report describing the company’s footprint evolution (remember, the pending acquisition doubles the company’s size). This map tells us a lot about where Frontier is headed.
First, they are following the general population and moving south and west. Los Angeles and Dallas suburbs are growing faster than West Virginia and Upstate New York (see census data here). More moving equals more (and less costly) choices than overthrowing the incumbent at existing households. Any near term upside in subscriber growth will likely come from this secular trend.
Second, Frontier’s overall footprint density is going to improve with the Verizon transaction. There are real operational and capital cost improvements from this change. Trucks have to travel less, there are more Multi-Dwelling(MDU) / Multi-Tenant Units (MTU), and lower network unit costs are possible. MTUs present a double-edged sword, because this also means that business/ enterprise offerings need to be robust and competition (not only from cable but from fiber-based CLECs such as Alpheus in Texas) will be intense. How Verizon Enterprise supports and grows these legacy connections will be one of the interesting dynamics of a post-close Frontier.
Finally, they set the stage for further clustering. Frontier’s model to date has been “buy and manage” – they have done little if any trading of properties (common in the cable industry after large transactions such as Adelphia Communications acquisition by Comcast and Time Warner Cable). It’s interesting to think about the potential for Central Florida, the Great Lakes region, and Texas from a few transactions. Texas consolidation is especially ripe for this opportunity with Windstream and CenturyLink under-indexed in their exchange presence.
As if these three dynamics were not enough, their cable competition is also involved in a large three-way merger (Tampa is largely served by Bright House Networks, who is being acquired by Charter Communications; Texas and California properties have a decent overlap with Time Warner Cable, who is also being acquired by Charter Communications). Because Bright House and Time Warner Cable are performing quite well (see TWC’s Top 10 list here), it’s unlikely that Charter will make the kinds of dramatic changes that would open up the door for Frontier. Stranger things have happened, however, and the Charter/ TWC/ Bright House transaction is still awaiting California and federal approvals.
Bottom Line: Frontier has managed to do something that other ILECs have not – grow the high speed subscriber base in the middle of speed and technology transitions. The acquisition of selected Verizon properties will improve their customer density, network competitiveness, and product diversity (particularly in the business arena). They should use this opportunity to demonstrate their operating effectiveness and to re-cluster/ re-concentrate their footprint.
Cablevision’s “To Do” List
- Get the Altice transaction approved by the end of 2Q 2016 without compromising the overall terms
- Continue to grow the quantity (2.8 million) and quality (monthly RPC = $155.88) of High Speed Data customers (Cablevision serves 3.2 million customers overall)
- Reduce customer service expenses through fewer trouble calls (down 33% in 2015) and truck rolls (down 23%)
- Improve number of Optimum Wi-Fi users (currently only 1 million or 36% of the HSD base) as well as the quantity consumed (9 GB/ month)
- Maintain competitive positioning and operating cash flows at Cablevision Lightpath (fiber-based business division)
- Respond to market need of “skinnier” video bundles while minimizing revenue write-downs
- Continue to manage capital expenditures to an $800-840 million range
- Keep churn at record-leading levels (4Q represented the lowest voluntary churn in six years)
- Improve cash burn at “other” business units (Newsday, News 12, etc.)
- Get the Altice transaction approved by the end of 2Q 2016 without compromising the overall terms
The headline said a lot more about the economic improvements in their service area than the company overall: Cablevision delivers organic customer growth for the first time since 2008. While this is a great sign, there are plenty of headwinds facing the Bethpage, NY, company. Two of their three primary products are under heavy substitution threats (current video packages from smaller, more selective varieties; home phone service from wireless substitutes), and there’s an opportunity for wireless 5G services to threaten High Speed Data by the end of this decade.
Regardless of when/ if the transaction with Altice NV is approved, Cablevision needs to continue to grow and innovate. Their out-of-home Wi-Fi footprint is the benchmark for their cable peers (see more here), and their overall revenue per customer for High Speed Data is $44.70, among the best in the industry (TWC led the fourth quarter with $48.20/ mo in Average Revenue per High Speed Data customer; Comcast close behind with $47.15/ mo.). Cablevision has historically had strong customer service/ experience metrics compared to their peers but continues to lag behind FiOS, according to last September’s JD Power survey.
Bottom Line: Cablevision is in many respects a victim of their own success. They are maintaining high product penetration in an increasingly competitive environment. And, once the Frontier transaction closes, Verizon will be squarely focused on improving operating metrics in the Northeast. Increased speeds and sponsored data opportunities represent new growth frontiers for the company or their successor. Cablevision is in danger of losing their pioneering reputation, however, because of the Altice transaction uncertainty.
Wireline is Cool Again
I never thought I would be able to use the words “wireline” and “cool” in the same sentence again. But, after AT&T’s announcement that they would be spending $10 billion in 2016 to support enterprise wireline activities (much of this for wireless fiber backhaul in Mexico), and after Verizon’s surprise purchase of XO Communications for $1.8 billion, wireline has gone from a footnote to a headline (XO network map is pictured nearby).
This is the push and pull of the dramatic rise of data consumption from today’s world: If the server is not sitting next to the tower serving the customer, some amount of transport/ backhaul/ longhaul is required. Verizon estimates in the announcement above that they can save $1.5 billion from the transaction in synergies – this is likely only the fiber leverage opportunity, and does not include Verizon’s replacement cost for the aging MCI network (XO leverages the Level3 network – see more from this recent Sunday Brief).
Without a doubt, servers are moving closer to customers (see EdgeConneX for a great example of how this is minimizing friction between cable providers and Netflix). At the same time, however, connectivity to highly-scaled cloud servers for business are increasing the need for reliable national and international connectivity.
Overcapacity was an issue for the wireline industry… in 2002. Thanks to increased DOCSIS, DSL, and Fiber deployments since then to support hundreds of millions of video-hungry broadband and wireless customers, most inter-city capacity has been absorbed. Regional capacity continues to be built out (see companies like Lightower/ Fibertech for a good example in the Northeast), but independent national backbones are largely the same as existed a decade ago: Level3, 360Networks (now owned by Zayo), and XO Communications (now owned by Verizon).
Bottom line: Wireline is cool again, as it should be. More investments will be required.
Next week, we’ll comb through additional headlines and also dive into the set top box debate. 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 Davidson Wildcats!