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 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 Royals and Sporting KC!
April greetings from Louisville (pictured is the view of the Muhammed Ali Center and the Ohio River from my room at the Galt House Hotel) and Dallas. This week, we begin the earnings watch list with some questions for AT&T, Verizon, Sprint, and T-Mobile.
Before diving into the questions, I wanted to let you know that Roger Entner, Jan Dawson, and I will be hosting a conference call a few days after the Appeals Court Open Internet Ruling comes out. Please check my LinkedIn feed or check www.mysundaybrief.com for the details. If the ruling comes out next Friday, I’ll provide the details on the conference call on Monday.
Also, for those of you who will be at the INCOMPAS (f.k.a. COMPTEL) show this week, I’ll be leading a panel discussion Monday morning on trends in wireless with representatives from Microsoft, T-Mobile, and Lumos networks. Please join if you are at the show and ask a probing question or two.
Four (or more) Earnings Questions We’d Like to Ask
- At what point should AT&T be viewed as a global communications network provider and not as a traditional wireless service company? It was reported by Telecompaper this week that AT&T will post net additions of ~1 million in Mexico. For those of you who are familiar with this market, that equates to about 350-400K US post-paid wireless net additions from a revenue perspective, and likely less from an EBITDA view. All of this has happened without really turning up most of Mexico City on the new platform. How should investors look at AT&T Mexico?
As of the end of last year, AT&T Mexico had 8.7 million wireless subscribers, while Telefonica and Telcel (America Movil) had 23.4 and 73 million wireless subscribers. That equates to just over 8% market share for a brand that’s worth at least 15% market share just for showing up. Adding a million customers in a quarter is newsworthy, but, considering the capital investment AT&T is making ($3 billion) as well as the brand, it’s not an unexpected number.
While AT&T has not disclosed a long-term target number, it’s hard to imagine that 20% market share by the end of 2020 is a moonshot given their fiber and LTE funding levels. Assuming the market in 2020 is at least 120 million subscribers (~2.7% wireless subscriber annualized growth rate), that would equate to 32 million subscribers by the end of 2020 or roughly a $10 billion unit (it entered 2016 at a $2.5 billion annualized revenue run rate). Said another way, AT&T has completed 1.6 million net adds or 7% of their (minimum) 23 million net addition five-year goal.
With $7.5 billion in growth over the next five years in Mexico alone, AT&T deserves a global communications provider designation. The follow up question is “What’s the halo effect of the Mexico investment on US (likely Cricket) wireless growth?” We commented a few weeks ago that Cricket is poised to have a very strong quarter (~400K net additions which will be their fourth consecutive quarter at this level), and, while a lot of this is attributed to solid execution, some of their growth has to be tied to a stronger Mexican operation. Note: the Sunday Brief post mentioned above focused on the possibility of bundling Cricket with DirecTV. There’s a growing sentiment that more Mexico success will spill over into retail prepaid net additions.
Bottom line: AT&T’s broad and global strategy needs a corresponding scorecard if they are to receive the credit due for their execution in the financial markets. If they fail to steer the conversation, they will fall into the same retail postpaid wireless comparisons that will mask the full extent of their efforts. Communicating the full impact of Mexico is a good starting point.
- Can Verizon become a content and applications company? There was lots of speculation this week that Verizon is going to proceed with a bid for Yahoo (see Bloomberg article here). As was the case with the AOL acquisition, Yahoo brings with it some ad platform assets (enhanced through 2014’s acquisition of Brightroll) and also a legacy brand associated with web portals, news, and email. There is no doubt that Yahoo’s acquisition would bolster Verizon’s content/ media position.
To answer the question above, let’s look at the performance of AOL since Verizon acquired the company:
- Verizon has kept key talent, including CEO Tim Armstrong, through the past year (the one-year anniversary of the closing is late June, and we might see some activity then, but the transition has been smooth). This is a good sign for integration with Yahoo assets.
AOL/ Verizon’s first acquisition, Millennial Media (closed October 2015), has gone extremely well. Recently, AOL promoted Mark Connon, a top Millennial exec, into a key role in the company. Given Millennial Media’s previous operating relationship with Verizon, it’s not a real surprise that the integration went smoothly, but it provides evidence that integrating most Yahoo ad platform operations should not be a challenge.
- Both aol.com and Verizonwireless.com websites have been performing better since the acquisition (see Alexa measurement results for Verizon wireless and aol.com nearby). In comparison, AT&T has had a slight rise over the same period (and is US ranked #70), T-Mobile’s ranking is #200, and Sprint’s is #302.
The old thesis that “Verizon will screw it up” just isn’t holding up. Go90 is doing well (top 5 in the Entertainment category in both the iTunes and Google Play stores and Top 100 in free apps overall), and signing up new content (see latest signings here).
Verizon’s potential acquisition of Yahoo would add $8 billion to the bet (using the figures from the Bloomberg article). That would bring the total media investment to $13 billion and make Verizon one of the top online/ app content producers in the world. It’s a long way from DSL, Private Lines, collocation and wireless voice, but there’s a growing body of evidence that they could pull it off.
- Can Sprint use their current network collateral and lease financing vehicles to transform the company? This week, Sprint announced that they will be selling network equipment assets for $3 billion and receiving proceeds from these assets of $2.2 billion. This will provide immediate liquidity to pay down debt maturities of approximately $4 billion due in the next 12 months. With this transaction, Sprint has emerged as the pioneer with customer handset leases and company equipment leases.
We have shown this chart from Morningstar several times (link is here), but it is worth providing one more time:
Sprint has approximately $34 billion in debt with $5.3 billion due in the next 18 months. They have been cutting costs with vigor and constantly looking for ways to improve their network performance (we reported in a previous column that cost cutting will likely take precedent over growth in the first quarter results and result in negative postpaid phone additions). A sale leaseback of network assets solves the December maturity but March is a different story.
Bottom line: If the repayment of the December note restores bond market confidence, Sprint’s leasing transaction could trigger a refinancing of some of the March 2017 maturities. However, if Sprint has to collateralize additional assets, including spectrum, the cash committed to repaying bankruptcy remote lenders could exceed the projected discounted cash flows of the company. More to come with their April earnings announcement.
- Will T-Mobile preannounce first quarter operating results this week? In 2015, T-Mobile waited until the actual news release to disclose earnings (they were terrific – see here). Right now T-Mobile is in the middle of the 600 MHz auction and has not scheduled any events prior to May that would serve as a pre-announcement venue. Most analysts expect that they will have a strong quarter driven by increased advertising (albeit they are competing with more political ads as a result of a competitive primary season) and lower churn (Binge On has been a “churn stopper” according to the company).
The biggest questions raised by many of you are “Does Binge On help or hurt growth?” and “What are the long-term effects of Binge On?” We’ll devote an entire Sunday Brief to the overall network pressure that their latest program brings, but the long and short of it is that Binge On helped the network in 2015 and will further help the network in 2016, and will hurt network performance in 2017 and beyond (when T-Mobile has network densification completed and more 600 MHz spectrum to deploy). Overall, Binge On will put to rest the argument that consumers would gladly trade off paying more for higher resolution. In fact, the results will likely show the exact opposite.
To support the “it has not hurt network performance so far” let’s examine the RootScore results since the beginning of the year. As of last Friday (April 8), RootMetrics released 59 market results (out of 125 they review semi-annually). Of these 59 that have been released, T-Mobile has won (including ties) 13 markets and finished second (including ties) 15 times. Of these 28 first or second place finishes, they have beaten AT&T 10 times and tied with them 15 times (the other 3 times AT&T finished first and T-Mobile finished second). These figures represent a big improvement over 2013 and 2014 and continue their LTE expansion and densification started in 2015.
There are no signs of a weakening network from these recent reports. In fact, it’s very likely that T-Mobile’s quality metrics are improving because of the immediate network benefit Binge On provided. SD quality is OK for consumers while they are out and about, but at home or in the office, WiFi speeds take over.
Bottom line: While the long-term prospects of zero-rated data are uncertain, the short-term benefits are clear – Binge On will be shown to attract and (more importantly) retain customers. We will know more when earnings are (pre)announced.
Thanks for your readership and continued support of this column. Next week, we’ll dive into the implications of the Appeals Court ruling on the Open Internet Order (due out this week). 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!
April greetings from Dallas, Charlotte, and Effingham, South Carolina (home of Margaret Holmes’ Peanut Patch Hot Boiled Peanuts – sign pictured). The past two weeks have been busy; rather than diving too deep into one event, we’ll cover several important items instead. But first, a quick roundup of the April Fools jokes from the telecom and Internet industries.
April Fool’s Day: Some of These Ideas Are Good!
We could do an entire article on the creativity of April Fools pranksters. In the interest of discussing more substantive matters, however, we’ll limit ourselves to five that we thought were particularly innovative:
- Samsung’s Internet of Trousers (IoT) features Wi-Fly (which sends you an alert that you need to XYZ), Get Up alert (which provides mild shocks to your posterior If you have not moved in three hours), and the ever popular Fridge Lock mode. More here.
- Google’s Parallel Universe (of Cats) Discovered. One of the best Nat and Lo episodes ever on the latest advances in String Theory. Make sure you watch to the end. More here.
- T-Mobile Binge on Up! Leave it the folks in Seattle to come up with a way to have a good April Fool’s joke and also poke fun at the competition. I especially enjoyed the “Real Reality” mode. Full video here.
- MarkForH&M. The all new clothing lineup designed by Facebook founder Mark Zuckerberg consists of seven identical grey t-shirts and one pair of jeans. And many 20-something guys are saying “When can I get it?”
- Google’s “Send + Mic Drop” feature (see here). We need this back. However, it’s understandable that a few unsuspecting folks might have inadvertently sent messages to potential employers or bosses without knowledge that “Mic Drop” meant “you cannot reply to this message.” For those of you who did, chill out and make the most of it.
Some Questions for Netflix (and the FCC)
The Wall Street Journal reported last Thursday (not on April Fool’s Day) that Netflix has been throttling their video content to 600 Kbps when it is destined for AT&T and Verizon (and most other wireless carriers across the globe), but not when it is headed to Sprint or T-Mobile.
Netflix has been muted in their responses since the report has been issued, with only the Director of Corporate Communications commenting through a carefully scripted blog post that basically says “We’re working on it” (see here).
Here’re some questions that Netflix should answer:
- How did/ does this disclosure change current the customer service responses (FAQ, on-line help, one of two 800 numbers, etc.) to mobile connectivity issues (note: no changes to the FAQs have been made since the original disclosure)? Did customer service reps know that Netflix was throttling wireless traffic to some carriers and not others?
- How often were the plans to throttle AT&T and Verizon revisited? What criteria were used? For example, when Cricket was purchased by AT&T (which likely would have involved a change in Internet backbone providers), were all Cricket customers throttled as well? Or, when AT&T re-introduced unlimited wireless data plans for DirecTV customers, did Netflix contemplate removing (or actually remove) the speed caps?
- Will Netflix now begin to post a wireless bandwidth index? Can customers clearly see the speed options available to them on an un-throttled basis so they can make an intelligent choice?
Of biggest concern is the customer service aspect. If Netflix service agents were not given the information or tools to accurately describe their wireless throttling policies, then there were likely thousands of calls per month made to AT&T and Verizon wireless agents trying to solve issues that originated with Netflix. Verizon and AT&T could have had (and likely did have) network issues that prevented a good viewing experience, but Netflix made the troubleshooting issue more difficult by withholding their network practice.
On top of this, Verizon and AT&T missed out on the opportunity to upsell customers to higher data plans because of the Netflix practice. The two largest wireless carriers received a double whammy: higher customer service costs based on the assumption that the ISP must be at fault, and the missed opportunity to upsell customers to higher data plans faster because of the Netflix throttling policy.
Netflix is not the only one who is at fault here, however. How the Open Internet Order was ultimately determined at the end of 2014/ beginning of 2015 should also be scrutinized. The FCC faced a choice to increase their potential regulatory reach to edge providers such as Google, Netflix, Hulu, and Amazon Prime. Here’re a few questions for each of the commissioners and Chairman Wheeler:
- When did the FCC engineers determine that Netflix was throttling wireless data (I’m willing to bet they were not surprised by the WSJ article)? When this data was received, what was done with it? Who decided that this piece of information was not important or relevant?
- Did the FCC explicitly ask if Netflix had ever throttled data as a part of normal commercial operations? Did Netflix respond truthfully and completely?
- Has the FCC learned since this disclosure that other edge providers throttle data to selected wireless providers? Will the FCC require edge providers to publish their throttling policies and disclose them in their FAQs and advertising?
Given the unprecedented editorial influence over the final Open Internet Order draft that edge providers were rumored to have had, there should be a full reconciliation and publication of the “voted on” version and the final publication of the Order. A simple redline could shed a lot of light on the process.
Bottom line: Netflix has a lot of explaining to do. The FCC also has a lot of explaining to do. The foundational assumption that content streaming companies will be indiscriminate in their network streaming policies has been shattered by this disclosure. Netflix should be held to a standard that is commensurate with a large and growing (~40% of US homes) market share.
AT&T is Becoming an Unlimited Company
“Bundle and Benefit.” With these three words, AT&T has taken a page out of the cable playbook and used it against them. It’s hard to believe, but there was a time when we paid for voice by the minute. Voice customers had to know where the other person lived and whether that would result in additional charges. Because of the uncertainty, customers held back, called at different times during the day, or made sure that they were “Friends” or “Family.”
Those were the early days of wireless voice, a similar model to what existed in the archane world of fixed/ landline service. Longer distance calling meant higher charges, potential international settlements, and the like.
Cable’s Triple Play (and the introduction of unlimited wireless services from now forgotten MVNOs like Helio) made unlimited products an easy to understand and essential part of the telecom vocabulary. Cable TV has always been unlimited (much to the chagrin of many parents). High Speed Internet started as unlimited, although to a select few some caps may kick in for certain speeds. When voice was introduced, it followed the unlimited pattern (and was priced at a slight premium to most fully featured local phone services).
It was the easiest sell on the planet: Unlimited usage of home entertainment and communications essentials for $99 (then $89 and now in some promotions even $79). Service was correspondingly easy – calls continued for standard network issues, but for the first year, the price remained constant.
AT&T watched what remained of the wireline voice market migrate to cable. They also saw the unlimited message begin to penetrate the wireless carrier community as well (ironic as AT&T wireless pioneered single rate pricing a few years earlier). Sprint began to offer truly unlimited wireless service for $99 (later $109) per line in 2008. T-Mobile followed, as did other smaller providers. All of this happened just as 3G networks were being replaced by 4G/ LTE speeds. At this time, AT&T had the exclusive distribution rights to the bandwidth-intensive iPhone, so following their competition would have had significant network consequences.
AT&T ended unlimited data plans for wireless customers in June 2010. This hiatus continued for over five years until the DirecTV merger was completed. In January 2016, AT&T resumed offering unlimited LTE data (no throttling until 22GB per line threshold is reached) but there was a catch: Customers needed to subscribe to DirecTV and AT&T Wireless. The Double Play (Video + Wireless) was born.
The two-fer has enjoyed some success with over 2 million new or existing customers signing up for service. Analysts predict that an additional 5-6 million will sign up for the service in 2016. While this is a mere 10% of AT&T’s postpaid smartphone base, it’s not crazy to assume that 30-40% of the base could move to unlimited if the plan structure is right (this includes reasonable costs for DirecTV). Four lines of unlimited wireless voice/ text/ data service for $180 is a very attractive rate.
This week, AT&T sweetened the pot even more as they announced new High Speed Internet pricing structures. If a customer wants truly unlimited data, they will have to pay an additional $30 or have a qualifying DirecTV or U-Verse TV service (AT&T’s full announcement is here). This means that a stand-alone customer in Dallas selecting 18 Mbps service (only) would pay $75 ($45 + $30 unlimited premium) per month for their service (Time Warner Cable charges $45 for 5x the speed with no caps). That’s $30 more for 20% of the total throughput with Charter committing to keep the “no caps” policy provided that their merger with TWC and Bright House Networks is approved.
High Speed Internet pricing is not rocket science. There are high gross margins and low product costs. Also, AT&T is not remotely close to winning their share of decisions versus cable (AT&T lost 248K broadband customers in the past year – Comcast gained 1.4 million). More AT&T penetration would have downstream effects on wireless network consumption as well (more Wi-Fi = less carrier spectrum radio capacity consumed and more Voice over Wi-Fi calling opportunities).
Bottom line: AT&T got it right when they reintroduced unlimited wireless with DirecTV. They started to get it right with unlimited U-Verse Internet with DirecTV (or U-Verse TV) but forgot to give consumers what they wanted most – more speed. They need to introduce a free speed upgrades, and not the threat of capped surcharges, as a part of the bundle to compete against cable.
Thanks for your readership and continued support of this column. You will not want to miss next week’s “First Quarter Earnings Watchlist” issue. 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 Royals!
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 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 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!