KPN's broadband market share is down, not up

After assessing the KPN Q3 results,

• Below expectations, guidance maintained.
• Hit by regulation and restructuring.
• Performace analysis by division.
• Guidance and other targets.

the question remains: were they good or bad? The organic performance was solid in Mobile International, and weak in the Netherlands. Cable is forcing KPN's broadband market share down. VDSL is no cure, not even interim. FTTH needs an accelerated roll-out, and indeed is now playing the 'captive market' card: Reggefiber has up to now entered no fewer than 155 municipalities, out of the nation's total of 418. KPN's customer base will keep shrinking, but what is left over will take more RGUs per customer. It opens an opportunity to once more grow by acquistition, especially when the broadband market share  goes further down below 40%.
In mobile, Consumer NL is weak, but other areas are strong.

Group revenues
Results were hit by regulation (MTA, roaming) and restructuring (mostly KPN Corporate Market), and benefitted from minor takeovers and release of provisions:

Reported:

• Group growth: revenue -3.4%, EBITDA -11.6%
• Netherlands (includes iBasis and Getronics) growth: revenue -5.2%, EBITDA -13.6%
• Mobile International growth: revenue flat, EBITDA -4.9%

Underlying (organic):

• Group growth: revenues +0.8%, EBITDA -0.1%
• Netherlands growth: revenue -2.9%, EBITDA -1.5%
• Mobile International growth: revenue +8.3%, EBITDA +5.9%

The Netherlands then perform dismally, obviously a result of cable competition. Mobile International benefits from Rest of World reaching break-even at the EBITDA level, but most of all from playing challenger. It remains to be seen how sustainable that is.

Coming in below market consensus caused a small share price decline. Investors must be wondering: how can free cash flow for 2011 be > EUR 2.4bn when YTD FCF is only EUR 1.5bn? KPN maintains guidance and points to less MTA impact, no payment of any dividend and no share buy-backs in Q4. Of course it has capex and asset (real estate) sales to play with, so when they say they will meet guidance, that probably will happen.

One question remains: why is organic EBITDA growth weaker than organic revenue growth? It must be the price of expanding networks (mobile) and services (IPTV), which take a toll on work contracted out.

Dutch broadband market

KPN lost 11k subs, despite gaining 16k FTTH subs. In other words, 27k DSL subs were lost. Indeed, VDSL is not much of a weapon against cable. FTTH additions are not impressive, but will probably accelerate going forward (unless heavy frost hits the country once again). The total number of BB subs is back to the level of mid 2008. Market share is going down to 40% now, but in fiber areas KPN claims 44%. Overall, the target still is to raise the market share to 45% by 2015. A stretch.

Dutch TV market

The TV market share is up to 17% (in fiber areas 27%), but associated revenues are just EUR 43m this quarter as a result of the low ARPU. Cable ARPU for TV alone is not published, but is probably at least twice this number. Cable is migrating analog subs to digital, at a conversion rate of roughly 80% (i.e. 20% of customers lost are moving to IPTV, FTTH or DTT). KPN is doing a similar thing: migrating DTT subs to IPTV. Dynamics are a bit different, and overall KPN is growing the number of video subs, so the coversion ratio would be something like 500%.

Dutch customers base

KPN doesn't publish customer numbers, like cable does, only RGUs. But it now reports the RGU per customer metric, which must increase to 2.4 by 2015. It now stands at 1.9, which implies roughly 3.5m customers. Compare Ziggo's 3.02m (its network has a population coverage of 57%) and UPC's 1.86m (population coverage 38%).

Mobile

• Consumer NL: subs are going down steadily. Contrary to what KPN states, MoU is holding up, but SMS is going down rapidly. ARPU is down slightly. Revenues are down.
• Business NL: both MoU and SMS/sub are going down, but subs are up strongly. Revenues roughly flat.
• E-Plus: subs and revenues are up, but MoU is flat/down.
• Base: subs up strongly, but MoU slightly down and revenues are up only slightly.
• RoW: no sub numbers, but EBITDA is positive for the first time.

KPN: what to look for in the Q3 results?

KPN will report on 11Q3 tomorrow. First, see what the Q2 report looked like:

• Job cuts at Getronics.
• Revenues down in NL, up at Mobile International, EBITDA down.
• Weak in NL, solid abroad.
• But maybe not so bad as to warrant a profit warning.

Next: guidance:

• 2011: EBITDA > EUR 5.3bn, Capex < EUR 2bn, FCF: up (2010: EUR 2428m), DPS: > EUR 0.85
• 2012: FCF EUR 2.4bn, DPS EUR 0.90
• 2013: DPS EUR 0.95

Market consensus:

• Revenue: EUR 3303m (last year: 3378)
• EBITDA: EUR 1320m (last year: 1408)
• EBIT: EUR 760m (last year: 847)
• Net result: EUR 431m (last year: 406)
• EPS: EUR 0.28 (last year: 0.27)

General:

• Will guidance be maintained? How is the new strategy (Strengthen, Simplify, Grow) progressing?
• Economic crisis (mostly felt at Getronics and KPN Business)? Getronics benefitted from the certificate problems at DigiNotar.
• Job cuts planned: 4-5k of which 2.0-2.5k at Getronics (now: KPN Corporate Market).
• How will the mobile international activities (Simyo) in France and Spain be ended? Will Ortel (now in 6 countries) be involved?
• Pension fund coverage was OK in Q2 (108%), but if below 105% needs extra cash.
• Will a share buy-back be planned (probably at the Q4 results)?
• Where is the planned takeover of Caiway (still at NMa)?
• Any sign yet of the new company structure as of Jan 1 2012 (i.e. new heads for Consumer Wireless NL and Consumer Wireline NL)?
• Expectations for the spectrum auction of 12Q2 and a possible Reggefiber buy-out?
• More deals such as the Spotify deal coming?

Mobile NL:

• What is the impact on voice & SMS of apps such as WhatsApp?
• What is the impact of new pricing at KPN and Hi (Telfort to follow 12Q1)?
• How many iPads were sold?

BB NL:

• How do the net adds hold up against Ziggo (+38k) and Tele2 (-16k)?
• How does the RGUs/customer ratio develop (1.9 in Q2)?
• How is FTTH doing (HP, net adds, XS4ALL, Telfort)? When/where will the 500 Mb/s service be offered?
• Where is VDSL (roll-out of outer rings), both VDSL@CO and FTTC?

Google Fiber coming to Europe

Google is considering building fiber in a European country, expanding its infrastructure assets base. This would be a follow-up to the Google Fiber project in the Kansas Cities in Kansas and Missouri and at Stanford University.

It's a bit too early to start guessing where Google Fiber might land.





The first questions would be:

• Are we talking FTTH here, or perhaps a middle mile strategy?
• Will it be nationwide, regional, on a city-by-city basis (like Kansas) or focusing on university campuses (like Stanford, or the Gig.U project)?
• Will it focus on rural areas, like Fujitsu in the UK?
• Could it be done through a takeover of an existing challenger, or even a cable company (and then overbuild with fiber, like CIF does in the Netherlands - that takes out the strongest competitor with one stroke).
• Will Google do just the financing, or act as an ISP as well? Will it be an open network?
• Point-to-point (Active Ethernet) of point-to-multipoint (PON)?
• Will it be a gigabit network?

Factors to consider when choosing a country include:

• Regulation.
• Size of the country.
• Current plans of the local telco incumbent. Many of them have such plans, but mostly very limited.
• Current plans of any challengers. Most, if any, are still small.
• Coverage of cable (HFC) networks.
• Current broadband and Internet penetration rates.
• GDP growth rates, living standards.
• Geographical factors: is aerial build allowed, what is the state of the sewer system, can the pavements easily be opened up, etc?
• Are long-haul networks in place to connect to?
• Will the government welcome Google and reduce frictions involved in getting permits etc.? Or does the government have strong ties with the incumbent?
• Are cooperative local partners available, such as a whole host of them in Kansas (University of Kansas Medical Center, Kansas City Power & Light, Kansas City Area Development Council, KCnext, Kauffman Foundation, Economic Development Corporation of Kansas City (Mo), Kansas City Missouri School District, Brush Creek Partners, The Greater Kansas City Chamber of Commerce, The Black Economic Union, Mid-America Regional Council).

Implications of a Google/Yahoo! deal

Yahoo!'s days as an independent company appear to be numbered. Following Carol Bartz' removal as CEO, more than one investor has shown interest in acquiring it:

• Jerry Yang, Peter Chernin
• Andreessen Horowitz, Silver Lake, Canada Pension Plan Investment board, Hellman & Friedman, DST, Bain Capital, Providence, Blackstone
• News Corp, Walt Disney
• Glam Media, Alibaba, AOL
• Microsoft, and now Google

Google's involvement has some interesting implications (apart from the obvious sale of assets and restructuring):

• Combining Google Search with Yahoo! Search, i.e. the former Inktomi and Overture Services.
• Will antitrust regulators approve such a deal?
• Google would most likely end the Yahoo!/Microsoft partnership, which would be bad news for Bing.
• Combination of Google TV and Yahoo! Connected TV.
• Flickr would become part of Google.
• Gmail and Yahoo! Mail must be hard to combine.

VDSL doesn't stop Tele2 NL bleeding broadband subs

VDSL (FTTC) may be an interesting technology option for underserved areas (no cable, but telco street cabinets availaible), as inexio is proving in Germany. But in the Dutch market, it is less convincing. In theory, it could be an answer to cable's Docsis 3 by more or less matching its capabilities. However, Ziggo's growth reached a record level recently, while Tele2's results show another loss of market share. Tele2 NL has finished rolling out VDSL@CO, but this isn't enough to stop the loss of broadband subscribers (since 10Q4). In fact, losses have accelerated to 16k during 11Q3. Of course you can always say that Tele2's losses would have been even steeper without VDSL, but VDSL starts to look like a 'regret investment'. The millions of euros involved would have better been spent on readying systems for Tele2's launch on FTTH.

Further, Ziggo showed how rapid growth negatively impacts margins because it requires investments in all directions. Nothing unusual about that. Tele2, bleeding subscribers, now boasts rising margins at Tele2 NL. (How about TheStreet including European statements for their weekly '5 Dumbest Things on Wall Street'?).

Other noteworthy aspects of Tele2's 11Q3 report for Tele2 NL:

• Guidance, both long-term and short-term, was unchanged. No surprise here, since the capital markets day was just a month ago. One of the LT targets: 'The capability to reach a top 2 position in terms of customer market share, in an individual country or region'. This remains a vexing point.
• The core markets (Sweden, Norway, Russia, Kazakhstan, Croatia) each have their own individual public targets, but not Tele2 NL.
• The contribution of Tele2 NL to group sales dropped to 14.0% (from 14.8% a quarter ago).
• Sales growth sans currencies was a reported +7.2% due to the BBned takeover. We calculate +8.6%, down from +12.1%, +10.8% and +11.4% during the previous three quarters. (The lower growth rate could be the result of the unreported divestment of some voice related business.) From 11Q4, the BBned effect will vanish from the growth figures. Revenue growth will most likely be flattish.
• Mobile: subs -5k qoq (mostly prepaid). This is unremarkable in light of the recent performance. MTA redux leads to lower costs. EBITDA margin up 1.5 points qoq to 18.4%.
• Broadband: subs -16k qoq, much worse than during the previous quarters. ARPU was up. Triple play net additions were again higher than double play net additions. EBITDA margin up 2.9 points qoq at 34.6%.
• Fixed telephony: subs -15k qoq. Unremarkable. EBITDA margin up almost 2 points qoq at 27.9%.
• Total RGUs were down to 1.005 million (early 2007 there were 1.5m). Next quarter, it will go under the 1m milestone.

VDSL as an interim solution isn't going to save KPN

The Netherlands isn't the first place to see wide VDSL deployment, but it will be an interesting test case to see how VDSL holds up against cable and FTTH.




The current situation in a nutshell:

• ADSL: available nationwide, but with very low bandwidths in rural areas (which could number as many as 500k on a household total of 7.3m).
• ADSL2+: available to around 60%.
• VDSL2: roll-out by Tele2 is probably finished, but applied at MDF locations (VDSL@CO). KPN does the same. Coverage of this technology is probably 2m homes, delivering speeds of up to 50 Mb/s. In reality, that probably means 20-25 Mb/s. KPN is also deploying VDSL from street cabinets, giving it a coverage of roughly 6%. KPN is also constructing fiber rings ('outer rings'), enabling more SDF locations for VDSL. It is not exactly clear where this will take VDSL coverage. Further, techniques including pair bonding, vectoring and phantom mode will raise VDSL's powers to 100 Mb/s and more (maximum speeds).
• Cable/Docsis 3: near nationwide (our guess would be 90-95%).
• FTTH: available to probably almost 900k homes by now (the 1m milestone could be passed at YE 2011).

Today, Ziggo's results over 11Q3 proved to be extremely strong, with 38k broadband net additions. That raises the question: how much of an interim strategy is VDSL against cable? It is a bit early to tell, because the VDSL roll-out isn't completed yet. However, given VDSL's limited reach, the fact that Tele2 is done building and Ziggo's results, it doesn't look good. VDSL is a defensive strategy against cable, but probably is insufficient. It can only work where it has the first mover advantage and nationwide street cabinet coverage (see Belgacom's 19k cabinets), or where cable is absent altogether (see inexio in Germany).

It will be interesting to see where KPN is going with VDSL (results are due October 25). It is rather ambiguous about the chances of xDSL against cable. To investors, KPN claims that it can match cable speeds with its xDSL network, but to the regulator KPN appears to be much less self-assured. Tele2 (results: October 19) so far hasn't been able to impress (negative net additions since 10Q4), although one can always say that without VDSL Tele2's net additions would have been a lot worse.

HKBN: "we like being a very fat and dumb pipe"

City Telecom (HKBN) was present at the recent Broadband World Forum in Paris. The CEO and CTO talks were put online and gave some background on the company's strategy, the bottom line of which is to provide 1 Gb/s at EUR 18 (USD 26) per month.

They have stated before that they are "out to commoditise bandwidth". The new catch phrase could be: "we like being a very fat and dumb pipe".

Some of the highlights:

• Its BHAG was to become #1 after 10 years i.e. in 2016 in the four-player Hong Kong market. By 2011, it is #2. And HKBN is larger than #3 and #4 combined.
• There are 3 drivers: the receding recession, dense population and the geography.
• Lacking any legacy networks also determines the strategy.
• Capex is just USD 200 per home.
• In highrises, routers are installed every 10-12 floors, with Cat 5E cabling reaching to every home. It guarantees 100/100 Mb/s to 80%.
• For running the company, there are the three E's: entrepreneurship, execution and engagement.
• It has to be kept in mind that the 1 Gb/s at EUR 18 is just a starting point for the company's marketing machine. Within three weeks, the sales organisation starts calling new subscribers to upsell services such as VoIP and IPTV.