Thursday, March 05, 2015

Why we love to hate the entertainment industry

The entertainment industry is suing Bredbandsbolaget, the Swedish ISP, over refusing to block The Pirate Bay. The trial is set for October 23, 2015, in Stockholm.

Bredbandsbolaget has a compelling argument: “It is an important principle that Internet providers of Internet infrastructure shall not be held responsible for the content that is transported over the Internet. In the same way that the Post should not meddle in what people write in the letter or where people send letters”. From the article it is not clear what the entertainment industry's fundamental argument is, beyond The Pirate Bay being illegal.

Why do we 'love to hate' the entertainment industry anyway?
  • The industry is completely commercialised. Unhampered by any originality whatsoever, more of the same is produced, resulting in a global mass of morons. There is no internal urge to create, there is just the urge to produce crap that all the morons of the earth want to consume.
  • They have been forcing even worse junk upon ignorant consumers in the form of lousy 'b-sides', album fill-ups and worthless sequels and prequels.
  • They claim to have an important role in safeguarding diversity and funding upcoming stars, but in fact they are very bad at that. Only one in 10 movies reaches break-even.
  • Remember the days of PolyGram, runs by overpaid windbags. And not just PolyGram.
  • They have been overcharging for ages, when sales were focused on physical formats.
  • They have completely missed the distribution technology evolution away from physical to file-sharing, downloads and streaming. In this respect, they are totally responsible for creating piracy in the first place.
In short, unless they come up with a compelling argument, and unless they start to put creativity before money again, we passionately support Bredbandsbolaget.

Friday, January 02, 2015

Structural separation revisited

Premise #1: Telecoms market characteristsics
  • High entry barriers (network duplication cost, mobile license cost).
  • Scale business. The network effect is essential.
  • There is ample legacy (incumbent operators inherited formerly state-owned assets).
  • Telcos have a tendency to outsource network management to specialised firms such as Ericsson. Apparently, it is not considered core-business by many.

Premise #2: Private company characteristics
  • The agency problem: management has its own personal agenda, targeted at personal wealth maximisation.
  • Company targets are aligned with private management targets through stock & options rewards.
  • Listed companies focus on short-term rather than long-term value creation in order to be able to pay out a predictable dividend.
  • They have a tendency to repair instead of replace in order to minimise capex & maximise dividends. This comes at the risk of supporting outdated technology with 'regret investments'.
  • Companies strive for low risk i.e. steady returns and hence predictable capex.

Premise #3: Government characteristics
  • Civil servants are not entrepreneurs.
  • Governments have extensive experience in running passive network grids (electricity, gas, water, roads, railroads).

Premise #4: Infrastructure vs. services
  • Grids are vital for the economy & national security.
  • They are typically long-lived assets, providing a steady but low return.
  • Building a network requires high capex; technology shifts lead to periodical capex spikes.
  • Networks thrive at a maximum utility level. More service providers means more business and a higher utility level.
  • Services are high-risk business, requiring high opex, in a highly competitive market.

Premise #5: Regulation
  • Regulation is a way to repair market failure.
  • Market failure occures when cometition is insufficient.
  • Insufficient competition leads to sub-optimal prices, quality, service levels, innovation, investment.

Issue #1: How to measure market failure?
  • It should not be a matter of opinion, but of thorough & independent research.
  • When are prices 'low'? How to benchmark?

Issue #2: How much is enough?
  • In fixed, it famously sounds 'two is not enough'.
  • In mobile, the OECD recently said 'three is not enough' (please do network sharing instead).
  • Does network duplication make sense or destruct value since it undermines the utility level?

Issue #3: Are OTT services full substitutes for managed?
  • Are managed services, with 99.999% availability & reliability, required for vital communication (emergency calls)?
  • Which level of QoS or QoE is required or sufficient?

Issue #4: Is the active layer part of the network or part of the services layer?
  • Active equipment coupled with a passive network raises the technology risk, leads to frequent technology shifts & capex spikes and thus undermines the low risk/return profile of grids.
  • Active equipment coupled with the service provider layer introduces technology risk to the services business & raises the entry barrier. It also creates physical space-related & technology issues for service providers trying to compete.

Issue #5: Which role fits a government agency?
  • Can a governement-controlled body act as an entrepreneur and run a business?
  • Which role suits such a body (passive only, providing permits? or active, investing goverment funds & taking ownership?).

Solution: Structural separation. This model ...
  • ... creates a state-owned natural monopoly grid (NetCo), which maximises the utility rate. Goverments are well-equipped for this. It doesn't compete with any company at the services level.
  • ... could be a joint venture of market participants in a different model. For instance, all interested Italian telcos (Telecom Italia, Vodafone, Wind, ...) could jointly buy Metroweb and injects their network assets to create a national jointly owned grid. The NetCo in time may be spun off because of its low risk/low return profile that doesn't match the profile of its owners.
  • ... frees up funds for services companies (ServCo) to improve services, to innovate & to keep prices low.
  • ... creates an incentive to maximise competition at the services level in order to maximise the utility rate. In other words, the NetCo will treat all ServCos equally.
  • ... incentivises the NetCo to support net neutrality because it raises the utility rate. As a result, competition is enhanced with pure OTT providers.
  • ... connects to operator strategies of outsourcing network management.
  • ... probably caters to the markets best if it allows for both access at the passive layer (unbundling) and at the active layer (resale). Service providers can chose what fits them best. This also allows for a specialised OpCo to arise (as in Singapore).

Thursday, December 11, 2014

What next for KPN in 2015?

Let's look at the big picture:
  • KPN heavily outsources and offshores functions. This implies de-emphasising the network, at least at the management level. Things are left to vendors such as Ericsson. NFV/SDN will only add to this. As a consequence, the emphasis is more on services.
  • Market shares are high in general, leaving little room for domestic takeovers.
  • There is ample cash, even taking into account debt reduction (€ 2 bn), pension fund (€ 200 mn), the Reggefiber buy-out (€ 770 mn) and cash outflow at Reggefiber (a total of probably half a billion or so over the next few years). The sale of E-Plus left KPN with € 5 bn and a 20.5% stake in Telefonica Deutschland (value € 2.5). Further, Base (€ 800 mn or more) and iBasis (pocket change) can be sold. In all, the war chest could be € 5.5 to 6 bn.
  • KPN ended its pan-European MVNO strategy a few years ago.
  • KPN wasn't willing to sell to America Movil (at 8 €/share), a very unfortunate decision.
Based on this, KPN is more of a hunter than a target (E-Plus was the company's prime asset). Assets for sale:
  • Netherlands: Caiway, Delta Cable, T-Mobile NL,  Eurofiber (all impossible because of concentration issues), Film 1 (no interest), M7 Group.
  • Europe: Bouygues Telecom, Orange Swiss, Sunrise, Yoigo, fibre operators in Germany & Italy, Telefonica Deutschland.
Creating value, other than focusing on the core businesses, could involve a major strategy shift:
  • Structural separation. Spinning off is a good idea. Network & services are different animals. KPN could retain a stake in the NetCo. Vodafone and Tele2 could buy into the NetCo to speed up FTTH overbuilding.
  • Acquire M7 Group (compare AT&T/DirecTV). This will strengthen KPN's position on the TV market. Vodafone and Tele2 may also be interested.
  • Gain control of Telefonica Deutschland to re-enter Germany, but now as a full-service provider.
  • Buy fibre operators abroad to export the expertise built up in Reggefiber.
  • Buy independent mobile operators across Europe. A tie-up with Proximus could be considered. Or even TeliaSonera, bundling together more incumbents.
  • Takeovers in other parts of the value chain (compare Telstra/Ooyala or Verizon/EdgeCast).
  • Expand in content through a broadcaster: SBS or RTL (compare Comcast/NBC).
  • Sell the company. Possible buyers: Altice, private equity.

Capex: up for differentiation, down for extortion

Capex is weighed carefully against dividends. Capex is for longer term competitiveness, dividends are for short term investor satisfaction.

Reducing capex is hazardous, since it endangers the operator's competitive position. Capex enables differentiation. Smart investors will not be fooled.

If capex is reduced across the board, the cause may not be clear and can be any of these:

  • It's typical herd behaviour of management executives lacking vision, focusing too much on short term dividends for personal gain.
  • It's proof of insufficient competition among ISPs.
  • Market conditions deteriorate for all players, due to general developments (economy, regulation, technology development).
At the end of the day, capex still enables differentiation. Hence, capex reduction seems to point to insufficient competition or bad management.

Threatening to reduce capex appears to be a form of bluff as well as extortion or black mail of governments.

Wednesday, December 10, 2014

Data-only providers: do they add to mobile competition?

There are several new entrants waiting to enter the mobile markets. Most are using LTE as the new, more spectrally efficient technology, which allows players without legacy to disrupt the market.
This is interesting in two ways:
  • How will it affect the market? Will prices drop, as they did in France? How will the incumbent operators respond?
  • Do data-only providers (in Finland, Slovakia, Norway, Sweden and Denmark) add to competition, even if they provide no (legacy) voice/SMS services? Are services such as Skype/Skype Out and Viber/Viber Out considered fully-fledged voice services? And how about WhatsApp, Facebook Messenger, Kik etc. on the texting market?
The latter issue is especially relevant in Norway, where the regulator objects to TeliaSonera and Tele2 merging, even though Ice is launching its mobile data services (the other operator is Telenor). Is this a reduction from 3 to 2 players, or from 4 to 3? Parties have until December 22 to respond.

(In Denmark, TeliaSonera and Telenor are trying to merge, reducing the market from 4 to 3 players (not counting Net 1, only TDC and Hutch 3) or from 5 to 4, depending on your view.)

PwC to telcos: focus on RoI

PwC tells telcos to focus on RoI in its new report 'Capex is king: A new playbook for telecoms execs'.

It provides a clever ranking of telcos, based on IRR and WACC. The winners, 'Value Leaders', have the highest share price CAGR & investor return. They had Capital Value turn positive during the last 3-5 years. "Investors reliably reward such behaviour with superior EBITDA multiples."

PwC's lessons for telcos:
  1. Growth is gone and it’s not coming back.
  2. Focusing on EBITDA and cash does not equate to focusing on value. Your investors know that already, so there is no premium multiple for directly pursuing those objectives.
  3. The key to premium EBITDA multiples has been hiding in plain sight: delivering on the ROI that flows from economies of scale originally promised to investors. Welcome to capital value.
"Delivering on the capex agenda is conceptually simple, but it is not easy to implement, and it puts pressure on execs to have better answers to tough questions."

Friday, October 24, 2014

KPN Q3 ahead: results due October 28

KPN entered the quiet period leading up to the Q3 results, due October 28. Interim CFO Steven van Schilfgaarde will probably be present at the call, since he exits Nov. 1, but new CFO Jan-Kees de Jager may be introduced as well.

Focus is on the question: can KPN maintain its guidance, specifically: can it stand by its previous expectation of 'stabilisation' of consumer trends 'towards the end of 2014'?

It is based on price increases, competitor response and upselling (multiplays).

Consensus: revenue € 1.97 bn, EBITDA € 640 mln, EPS € 0.02, capex € 300 mln.

14Q2 trends:
  • Consumer Mobile organic revenue improved to -9.0% but still in the same magnitude it has been since 12Q1. EBITDA has been going down rapidly in the last 4 quarters and this will probably continue for one more quarter.
  • Consumer Residential organic revenue growth has been negative for 2 quarters and it looks like this could continue. EBITDA growth has been solid, but that may now drop off.
By market:
  • A big issue is competition on the fixed-line market. The Ziggo/UPC merger was approved. It will be followed by ACM's decision on KPN/Reggefiber and regulation of the market until 2018. Europe is now moving toward fixed-voice deregulation, but broadband is a different matter. Vodafone appears to have found its strategy for NL: resale & unbundling. It remains to be seen what Tele2 is up to. Potentially, Vodafone could allow Tele2 access to its unbundled network. Continued unbundling may be a condition for approval of the Reggefiber deal, but then what about cable regulation? And beneath all that is the question: is unbundling good (more sales power, high-margin wholesale revenues, Vodafone not just a competitor but a partner as well) or bad (the message KPN puts forward to the regulator) for KPN?
  • On the TV market the question is what the impact of Netflix is. Are consumers canceling pay-TV yet? What is happening to VOD revenues?
  • On the mobile market, much depends on Tele2 and when it will launch its LTE network.
Recent news:
  • John van Vianen, head of Corporate Market, to exit at the end of 2014. No new job and no successor named.
  • America Movil once more reduced its stake, now by 1.2 pp to 21.4%. Above 20% they retain the right to appoint 2 members of the Supervisory Board.
  • Results Tele2: not impressive. Mobile subs growth slowing. Tele2 hosts an analyst briefing December 12, presumably to launch the Dutch LTE network.
  • Eurofiber was put up for sale by ite PE owner Doughty Hanson. CIF, BT and Zayo may be candidates.
Conclusions: pressure remains in the mobile market (Tele2 launch) and in the business market (Eurofiber takeover, Ziggo/UPC merger).

Thursday, September 25, 2014

Newsletter All Things KPN launches on TidBitts platform

I use the TidBitts subscription platform to manage All things KPN so click Subscribe when you get to my page on their site. It is located here.

All things KPN is a new weekly newsletter, arriving each Friday: weekly assessments of everything related to KPN: strategy, M&A, financials, regulation, competition and much more.

Wednesday, August 06, 2014

KPN's very disappointing road to VDSL, away from FTTH

It's becoming a new reality: KPN no longer is the torchbearer of the fiber community.

This historic chain of events:
  • 2008: acquires 41% of Reggeborgh's Reggefiber FTTH venture, with calls/puts for the remaining 59%. Pays in assets (its own FTTH efforts) + EUR 100m cash. Accepts regulation as part of the deal. At the time, Reggefiber Newco had just 10k HP.
  • 2011: acquires other FTTH assets (mainly ISPs) from Reggeborgh and Reggefiber, alters joint venture agreement with Reggeborgh.
  • 2012: raises Reggefiber stake to 51% for EUR 99m upon reaching 1m HC.
  • Oct. 2013: cuts Reggefiber expansion plans to 250k HP/annum (from 350-400k). Capex per HP down to EUR 800 and falling.
The recent developments:
  • Jan. 2014: to expand Reggefiber stake by 9% to 60% + consolidation & control.
  • Price to be paid (as becomes clear recently) EUR 161m, i.e. at the upper end of the range (EUR 116-161m). This suggest Reggefiber's equity is valued at (at least) EUR 1.789bn.
  • At this time, Reggefiber (passive network) had 1.688m HP and 547k HA. KPN (active network) does not disclose its number of HP anymore, but has 484k HA.
  • When this call option is exercised, Reggeborgh may immediately exercise its put option for selling its 40% stake to KPN. At the above valuation, fair value would be EUR 716m. This suggests, that Reggeborgh will indeed exercise immediately. As a result, KPN will go to 100% of Reggefiber for a total of EUR 877m once ACM approves.
The ACM process:
  • Despite the initital approval by OPTA + NMa (now ACM), going to full control (60%) once again requires ACM approval.
  • ACM reportedly pushes its judgement beyond the EC's judgement on the Ziggo/UPC merger. The latter had a Oct. 17 2014 deadline, but this is pushed back for an unknown period of time. Further, ACM plans its market assessments for regulation until 2018.
  • It is now questionable if ACM can delay its judgement of the full Reggefiber takeover for much longer.
Considerations for ACM:
  • As with Ziggo/UPC, one might primarily expect approval. Not much changes, after all. But looking a bit deeper, reveals that changes may be coming.
  • Originally, KPN acknowledged that FTTH was clearly on its roadmap, with DSL technologies (VDSL, bonding, vectoring) for the interim. Moreover, the open access Reggefiber network enables competition, both from unbundlers (ODF access) and resellers (layer 3). This is all changing now.
  • Recently, KPN decided to:
    • Slow down the FTTH roll-out (see above).
    • Abandon the FTTH USPs (gigabit, symmetry), in order to market broadband and triple plays nationwide, independent of the access network.
      • Despite the clear benefits for ARPU.
      • And despite the fact that years of investments in VDSL (since 2009) haven't delivered yet. DSL net additions are still solidly negative. BB growth is clearly in FTTH.
    • Move focus to VDSL. But it has clear disadvantages:
      • KPN never discloses the capex cost per HP, which are not just a fraction of FTTH capex. Apparently, the true cost of VDSL could be several hundred EUR/HP. The topology is entirely different from what Reggefiber is doing, so there is no re-use of VDSL assets (including inner rings and outer rings).
      • Vectoring is still largely unproven.
      • Performance dropps off sharply at distances larger than 100 meters or so.
      • We all know that "up to 100 Mb/s" really means: "don't expect anything better than 50 Mb/s".
    • As we feared, there are now rumours of KPN switching to GPON technologies on FTTH networks. This means: a shared network (like cable and cellular), slower speeds, no open access. And yes, perhaps a few percent savings per HP.

What does all this suggest:
  • Taking over Reggefiber wasn't about overbuilding with FTTH. With hindsight, is was all about taking out a dangerous newcomer.
  • KPN turns out to be a copper company after all, just like incumbents in surrounding countries (Germany, Belgium, UK). The Netherlands are set to drop in international fiber rankings.
  • Reggefiber was hard to push to include rural areas, imagine what KPN intends to do (hint: LTE).
  • KPN appears to be steering toward a cozy duopoly with New Ziggo - each minimising capex and maximising dividends. Unbundling will become a thing of the past and resellers will be marginalised - unless ACM steps in.
  • This creates opportunities for full fiber companies such as seen in the UK (B4RN, CityFibre, Gigaclear, Hyperoptic).
  • Indeed, Google Fiber! It wanted to work with CityFibre in the UK, but the latter didn't want to give up its plans with Sky and TalkTalk. Google Fiber walked away and could very well be looking at the Netherlands, Belgium and Germany right now.
  • Rumor has it that there is a gentlemen's agreement with Reggeborgh that precludes Reggeborgh's return to the Dutch market as a newcomer on the FTTH market. With a fresh EUR 877m it could clearly do so. Instead, Reggeborgh now focuses on Germany (Deutsche Glasfaser) and (as is rumoured) Belgium.

Tuesday, July 29, 2014

Shifting bargaining power in the NN debate

In the net neutrality debate, this is how bargaining power is shifting:
  1. OTTs are afraid ISPs will extort money from them, hence claim strong NN regulation is needed.
  2. Netflix turned this upside down and hinted at being able to charge ISPs - but added that it won't.
  3. Now, Time Warner Cable appears to be afraid of being charged by OTTs.
  4. Comcast came out as a defender of NN regulation.
And so:
  • Everybody is in favour of weak NN.
  • ISPs and OTTs both have bargaining power.
Conclusion: all regulators need to do is:
  • Keep an eye on weak NN not being violated.
  • Make sure peering is made free (in Google's words: it's a win-win-win not to charge for peering), as long as OTTs and ISPs do their utmost to interconnect in such a way that traffic is not hindered, i.e. OTTs deliver traffic at the ISP and ISPs add capacity when needed.