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April greetings from Louisville (last night’s Thunder Over Louisville pictured), Dallas, and, by the time most of you read this, Paris. There has been no verdict yet from the Appeals Court on the Open Internet Order (kind of surprising), so this week’s column will focus on Verizon’s earnings. However, to get started, we’ll talk about the latest foray from Comcast in the set top box kerfuffle.
Comcast’s Xfinity Partner Program Announcement and the FCC’s Reaction
This week, Comcast announced an alternative to the FCC’s set top box mandate: the development of the Xfinity TV Partner Program (and App). This enables Comcast subscribers to access their programming from Roku boxes, Samsung Smart TVs, and other devices that enable access (Comcast even committed to customizing their app for devices that do not support HTML5).
In the aforementioned blog post, Comcast has an interesting reference to its search feature:
As part of the Xfinity TV Partner Program, Comcast is prepared to provide consumers with a capability to search through Comcast’s video assets from a device’s user interface with playback of a selected asset via the Xfinity TV Partner app. However, in order to provide a cohesive customer experience, such integrated search needs to include more than just this app; it must also include similar data from other video apps as well.
Comcast appears from this paragraph to not only be providing an alternative to the $230/ yr annual expense many pay for set top boxes, but also appears very open to allowing other video content to be shown alongside their app.
In a related announcement, Comcast and Roku (see nearby picture) have joined forces to bring the Xfinity TV app to the Roku player and Roku TV. As we discussed in our first column on the topic, Roku has a meaningful market share in the streaming device market alongside Amazon, Apple, and Google (see nearby chart). Enabling each of their devices with Comcast’s app will reduce the number of Xfinity set-top box rentals that are needed. This also might allow expansion of existing video services to rooms where set-top boxes do not exist (Time Warner Cable used this tactic when launching their Roku partnership in 2013 and has a very unique trial going on with Roku in the NYC area described here).
Comcast enabling Xfinity without a cable box; Time Warner trialing plans that include free Roku equipment instead of a traditional cable box; Suddenlink actively offering TiVo in lieu of their cable boxes. All of these innovations should make the FCC happy, right? Their regulatory initiative forced Comcast’s hand and now consumers will have a choice between a cable box and more innovative solutions. Here was the FCC’c comment on the Comcast announcement to electronics publisher CNET:
While we do not know all of the details of this announcement, it appears to offer only a proprietary, Comcast-controlled user interface and seems to allow only Comcast content on different devices, rather than allowing those devices to integrate or search across Comcast content as well as other content consumers subscribe to.
This seems to indicate a “goal post move” by the FCC. President Obama clearly stated that the FCC was trying to solve the $230/ yr set top box rental problem in last week’s weekly radio address (device competition is the basis of section 629 of the 1996 Communications Act which gives the FCC the authority to issue the NPRM). Now that Comcast has announced their willingness to allow Xfinity content in a manner that is not tied to owning/renting a Comcast box, but the FCC has redefined the problem to be unintegrated content and the lack of comingled choices. Simply put, the FCC does not believe that Comcast, Time Warner Cable, Charter, or their partners Tivo or Roku solve the content organization problem, which has replaced the set top box affordability problem.
Bottom line: Comcast’s actions are a step in the right direction. The FCC is wrong to move the goalposts, and it’s highly unlikely that they have the authority to define how Electronic Programming Guide content is organized. They should let the market determine how channels are presented (if you do not have a Roku or Tivo box, I would urge you to find a friend who does, look at their experience and imagine a Comcast TV channel alongside the current pay and free choices).
Looking for Meaning in Verizon’s Quarterly Earnings
Verizon reported earnings (link here) that generally met expectations on Thursday. They have already completed several items on their 2016 “To Do” list. Here’re some takeaways on their earnings release:
- The Frontier transaction is closed. As a result, debt is being reduced, and cost structure rationalization is continuing for the remaining wireline unit (Verizon reported that the EBITDA margin for the wireline unit without the divested properties is 19% – see nearby chart). Realizing a lower cost structure has been a long-time initiative for Verizon, but the divestiture of a more profitable unit clearly brings the labor cost challenge into focus. Less debt, but more sales required in a geography that is growing more slowly than in the South and West. Reducing the cost structure is going to be a big challenge, and the cost attribution to wireless/ 5G is likely how they will achieve it (see point #2 below).
- The XO acquisition is going to provide Verizon with a lot of intra-city fiber. In discussing the Boston FiOS buildout, CFO Fran Shammo stated that $300 million of incremental capital expenditures would be needed over the next 5-6 years to complete the footprint expansion. That’s a rounding error to Verizon’s overall annual expenditures, likely attributable to both 5G and FiOS, which should help Verizon’s ability to competitively price services in Boston (building out Baltimore and Virginia will likely require more new capital due to XO’s lack of fiber in these markets).
- Wireless customers are holding on to their smart devices longer than they did during previous years. Verizon’s postpaid upgrade rate was 5.8%, down from 6.5% in Q1 2015 and lower than most analysts expected. This had a mixed benefit: Fewer upgrades helps churn (0.96%, a strong figure), but fewer Equipment Installment Plan upgrades lowers in-quarter revenue. Verizon also commented that more wireless subscribers renewed their devices on traditional subsidy-based plans than they expected.
- “The Tracfone brand is our prepaid product.” That’s a huge admission from Verizon and perhaps the first time they have been that bold and clear. Here’s the full quote from Fran Shammo in response to a question about AT&T and T-Mobile’s prepaid gains:
Our retail prepaid is above market. We’re really not competitive in that environment for a whole host of reasons and it’s because we have to make sure that we don’t migrate our high-quality postpaid base over to a prepaid product. If you look at the competitive nature, they are doing it with sub brands. They are not really doing it with their brands. And quite honestly, we use the Tracfone brand as our prepaid product. Tracfone has been extremely successful for us. It’s not something that we disclose any more on reseller, but it continues to increase on the high-quality base of Tracfone, so that’s really where we use and go after the prepaid market. More to come on this during the year, but currently that’s how we operate under the prepaid model.
This alliance makes a lot of sense. AT&T is likely to bundle Cricket with DirecTV in the (near) future, and T-Mobile is using MetroPCS to take share from Boost/ Virgin (Sprint) and Tracfone, so the opportunity to have a strong relationship with any particular carrier is limited. While not surprising to those who follow the wholesale wireless industry, it was a pretty big statement from Verizon. It will be interesting to see if America Movil, the parent company of Tracfone (and a direct competitor to AT&T Mexico), views the relationship in the same manner.
- Verizon is aggressively pursuing new content acquisition. Their strategy, which involves investing in content creation companies with well-known media outlets such as Hearst (see announcement here), is in its infancy. But Verizon is not playing for second place. On the conference call, they announced that they were focusing on leading mobile-first content that did not originate in the home. Awesomeness TV (Verizon now a 25% owner) is the #1 digital brand for females ages 12-24 with 160 million views and 53% growth, and Complex TV (acquired with Hearst – see announcement link above) is the #1 digital brand for males aged 18-24 with monthly unique viewers of 54 million and 300 million total views per month.
Since many teens do not watch content in the den or family room, this is a different but wise strategy nonetheless. For most in this demographic, the screen in their pocket is their TV.
Here’s the rub: While available to all wireless subscribers, Go90 isn’t zero-rated unless you are a Verizon postpaid wireless customer. Perhaps the announcement to which Verizon was alluding in the quote above with Tracfone was a deal that zero-rates Go90 content. That would be a game changer.
Verizon is changing. They led off their investor presentation with the chart to the right. While this may seem like déjà vu for those of us who remember the AOL/ Time Warner merger, it is different. Mobile advertising and targeting did not exist, and Time Warner Cable did not have a national wireless footprint capable of distributing zero-rated content to 100 million existing customers. Verizon has the unique opportunity to create a vertically integrated entertainment company, and, unlike AT&T, will emerge as a focused challenger.
History is not kind to transformations like the one Verizon is pursuing. Regulations change (although Title II freedom from the anticipated Court ruling would be a plus to this strategy), organizational catharsis sets in, and cost challenges tend to take these ambitious efforts off track. As soon as Verizon shows signs that their content strategy is impacting their wireless gross additions, we at the Sunday Brief will become believers. There are many risks to this strategy, however, and we remain skeptical.
Thanks for your readership and continued support of this column. Next week, we’ll compare AT&T and Verizon’s wireless and broadband results as well as examine the implications of 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 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 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!
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 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!
This morning’s interview with Betty Liu on Bloomberg’s “In the Loop with Betty Liu” is here. Many of the same points emphasized in the Sunday Brief are in the interview. Marcelo, you have your work cut out for you. Best of luck!
Also, don’t post here, but if you have tips on how I could have a better interview presence, I’m all ears.
** Editor’s Note: This was originally sent to SB readers on June 22, 2014 **
June greetings from Dallas, where, as the picture shows, we are enjoying needed rain. Thanks for the many comments on last week’s column. Many of you shared your experiences with Google Fiber (those of you who have it in Kansas City don’t appear to be going back to cable or U-Verse in the near future), while others accused me of oversimpifying in-building wireless efforts (admittedly, I did leave the concept of obtaining Building Authorization Agreements out of the Brief. They are hard to get and involve specialized real estate/ legal expertise). Thanks for your readership, and please keep the comments coming!
Over the past two weeks, we have written about major changes in the telecom industry, including:
- The half trillion dollar value and multi-hundred billion dollar capital shift from network to software providers
- The threat of Google as a new entrant to the residential and small business markets
- Fundamental architecture changes that will take place as content is pushed to the edge
- In-building data capacity needs will accelerate fibered metro building deployments (which drove Level3 to offer to buy tw telecom this week for 12.5x EBITDA).
The last three points are “take it to the bank” certainties that will impact some parts of the telecommunications industry more than others. Amid the hype, remember this: If one carrier can deliver consistent experiences while outside, en route, near building, and in-building, all of the other carriers will need to follow suit. The top three carriers (Verizon, AT&T, and Sprint) are driven to do this because most of their current data pricing plans are capped. Not only is third-party Wi-Fi offloading viewed as inferior and inconsistent when compared to the increasing affordability of in-building small cell solutions, in-building Wi-Fi now has become a revenue threat to the carriers.
There are many drivers of change in the wireless industry, but four deserve special mention:
- The ripples of T-Mobile’s Uncarrier strategy are beginning to be seen throughout the industry. First, it was the introduction of Equipment Installment Plans (EIP), and the separation it has driven between equipment sale and service revenue quality. As AT&T, Verizon, and Sprint transition their bases from traditional subsidy (which, at the end of the two-year term and beyond, can have attractive economics) to EIP models, the pressure on service revenues (particularly data ARPA/ ARPU growth) becomes greater. As we covered in Sunday Brief Q1 earnings reviews, the transition of T-Mobile’s base will be nearly complete by the end of 2014.
The most important thing to remember with these shifts, however, is the increased flexibility it provides the incumbent providers’ base of customers. Under the traditional $325-350 subsidy model termination penalty scheme, the perception among the base was that they were “locked” until the end of the two years. None of the new plans carry two-year contract terms, and, as Sprint and T-Mobile have shown, they are willing to pay multi-hundred dollar termination fees to drive up gross additions . A more unstable base should have AT&T and Verizon on edge.
To add fuel to the fire, T-Mobile will launch a new program to the AT&T/ Verizon base this week. For a $700 hold on your credit
card, T-Mobile will send you a new iPhone 5s for a free one week test drive (I have confirmed with T-Mobile that the one week starts upon iPhone receipt – something to consider when you sign up). This is not a plan that is aimed at the traditional T-Mobile base, but one that gets current (Sprint/AT&T/Verizon) iPhone 5s users into a T-Mobile store to have a conversation. (If the customer is a current iPhone 4s user, they will receive a double benefit due to the 64bit processing and LTE capabilities inherent in the 5s – a very clever move on the part of T-Mobile).
Will this plan have the same effect as equalizing the cost of an Android Wi-Fi only tablet? Likely not. But it could erase perceptions of poor network coverage for some. While many see this move as more “Carrier” than “Uncarrier”, I see this as Part 1 of a multi-part plan to reintroduce the T-Mobile network (voice, text, data) to millions of skeptical AT&T and Verizon customers (some of whom may have previously been T-Mobile customers). At worst, this program will provide real-time feedback on their network improvements and identify coverage gaps (and hopefully reiterate the need to begin a substantial in-building coverage initiative for T-Mobile hopefuls who are captive to multi-story living/ working environments). At best, it will propel 2-3 million gross additions through the end of 2014.
- The drive for spectrum outside of the FCC auction process will continue. There have been a lot of discussions this week about Verizon’s interest in Dish network spectrum (this article places a $17 billion value on the asset, and it’s very likely that Verizon’s interest is focused on Dish’s AWS-4 holdings as opposed to the 700MHz spectrum band), and also T-Mobile’s interest in acquiring additional 700 MHz A-Block (a.k.a., “low band”) spectrum from the likes of Paul Allen’s Vulcan Ventures (who holds the Seattle and Portland licenses) and spectrum management companies King Street LLC and Cavalier Wireless (the full list of original A-Block winners can be found here).
We have already seen AT&T actively pursuing spectrum purchases since 2012 in the 2.3 GHz/ WCS band (see here for their Sprint spectrum purchase that escaped most media headlines), and this week Sprint announced their first wave of rural partnerships which will leverage their Tri-Band capabilities.
With the frequency-sharing rules of the upcoming AWS-3 auction, and the “reserved/ unreserved” designation for the 600 MHz auction discussed in a previous Sunday Brief, is anyone surprised that unrestrained and adjacent spectrum would be interesting to larger carriers? Absolutely not. Announcements serve to entice more broadcasters to participate in the 600 MHz auction process, and hopefully keep additional regulations to a minimum.
Interestingly, if there are a wave of spectrum sale transactions prior to the end of the year, look for new categories of bidders (e.g., non-traditional wireless providers) to emerge for the licensed spectrum.
- Consolidation efforts will fail, not because of Sprint’s lackluster efforts, but because of T-Mobile’s unbelievable success. In second quarter earnings, we will see the full fruits of T-Mobile’s Early Termination Fee buyout initiative announced in January. Surprisingly to most (although not all), T-Mobile’s results will equally impact Sprint and AT&T (given the process ease of SIM-card swapping between AT&T and T-Mobile, this might be viewed as a slight victory for AT&T).
As we have shown in previous Sunday Briefs (see picture), the retail postpaid gap between T-Mobile and Sprint is shrinking (if one exists in retail prepaid after 2014 I’ll be very surprised). The eleven million subscriber gap at the beginning of 2013 could be as small as four million as we exit 2014. And, considering the composition of T-Mobile’s (smartphones) vs. Sprint’s (tablet) net additions, the revenue gap will be even smaller.
While there will be many traditional regulatory concerns (link to the Herfindahl index definition is here), the trends beg the question “Why should T-Mobile take on Sprint?” Does Sprint’s base of customers provide unique differentiation (and, given a large portion of the base is still on unlimited and unthrottled LTE data plans, can the value of the customer base increase)? Does Sprint’s base allow T-Mobile to build unique capabilities in the enterprise segment (which Sprint largely abandoned in 2013 to focus on small and medium customers)? Can Sprint out-innovate T-Mobile with a new management team (or, as one of you wrote recently, “Where is the Sprint problem – with the quality of the clay or with the potter?”).
Time is not on Sprint’s side: Service revenues are shrinking, management is leaving, and customers (particularly Corporate Liable enterprise customers) are questioning. No doubt, there is a value to scale, but T-Mobile is worth much more than $40/ share in a couple of years without Sprint. Could a cash infusion from Comcast/ Time Warner or a cable consortium be a viable alternative? Does T-Mobile even need cable as a strategic investor?
Consolidation makes good headlines, but every month that goes by without an announcement opens up better alternatives for T-Mobile than Sprint (and makes the “Why?” question more difficult to answer). Remember – at the beginning of 2006, Sprint Nextel, AT&T Wireless, and Verizon were basically the same size. One non-traditional strategic partner/ investor could reset the equation for T-Mobile and the industry.
4. The cable industry (as opposed to FiOS or U-Verse) will unveil Wi-Fi capabilities in 2015 that will be easier to use and intensify the battle for data in the home and office. The blind spot in wireless carrier strategic plans is cable. Their Wi-Fi efforts are very close to tackling the issue of in-home (and in-office) data usage. The rollout of an additional 100MHz of 5GHz Wi-Fi capacity will also fuel the bandwidth fire. More to come on this in a future Sunday Brief, but, given the arguments presented above and in previous analyses, cable would easily eliminate 10-20% of the data upside from the wireless carriers in 2015. (Editor’s note: for a view of the extra expansion from the cable industry’s point of view, check out this CableLabs blog post).
These are a few of the issues wireless service providers face, but they cover nearly every aspect of the business environment: non-traditional competitors presenting real substitutes, traditional competitors redefining the buying process, increases in supply, new regulations, and the increasing sophistication of smartphones and tablets are but a few of the dynamics that will be discussed around the strategic planning table. Who wins is anyone’s guess. But every carrier will attempt to move the needle.
In other important news this week, we do not have space to do a full analysis of the new Amazon smartphone (we will try to tackle the new Fire Phone in depth next week). In the meantime, check out two in-depth reviews here and here, and an excellent interview with Ian Freed from Amazon here.
Have a terrific week!