KPN: looking back to the Eelco Blok era

The end of the current KPN executive board could be near, so let's take a moment to look back to the Eelco Blok era, that started April 6, 2011. Let's first focus on things that didn't go so well.

• Finance/corporate
• Profit warnings: at 11Q1, and 11Q4.
• Dividend reductions: at 12Q2, 12Q4 and 13Q1.
• Rights issue: at 12Q4.
• Failed sale plans: Base (2012) and E-Plus (2012).
• Failed acquisitions: Caiway (2012).
• Overpaying (that is, what the market perceives) for Dutch 4G licenses: Dec. 2012.
• Sale of E-Plus to Telefonica: no consent form major shareholder and silence on what the cash will be used for (having just raised EUR 4bn in a rights issue): at 13Q2.
• Replacing most executives, threatening continuity.
• Business/government relations
• Raid by cartel office: Dec. 2011.
• Increased oversight by regulator: Dec. 2011.
• Attempts to control OTT services, leading to Net Neutrality regulation.
• Hassle over large government contract, in the end losing it to Tele2: 2011-2013.
• Fine KPN Business over illegal discounts: Jan. 2013
• Business/strategy
• Ortel expands into Europe, then is sold.
• Handset lease model introduced (2012) and abolished (2013).

As a result of all this, the share price dropped and the interest of investors was aroused. In the end, America Movil stepped in and will most likely replace current management.

The roll-out of new networks was somewhat successful. The LTE network was largely constructed even before the auction ended, allowing KPN to launch services just six weeks later. Pricing however hasn't been convincing. The FTTH efforts were strengthened by expanding the Reggefiber stake, by acquiring Reggefiber and Reggeborgh units, and by signing Vodafone, Tele2 and CanalDigitaal as wholesale customers. Still, adding 400k HP per annum is just too slow (see next post). When it comes to WiFi, the deal with FON took a long time to materialise and be implemented.

How about the services? TV and triple play services haven't been convincing for a long time. On the OTT front, cooperation was limited to Spotify.

All in all, there hasn't been a clear focus or growth strategy. Management was surprised by changing market conditions on many occasions, leading to a long list of profit warnings and dividend reductions. KPN turned into a defensive player with a hybrid strategy on several fronts.

No need to be afraid of America Movil

America Movil's planned offer for KPN worries some people. There are probably two reasons for this:

• Security: the importance of vital national infrastructure. Roads, railroads, water, gas, even electricity: they remain in government hands, even if services companies have been sold.
• Financial: the risk of breaking up the company, load it with debt, sell-off subsidiaries, extract cash, etc. The TDC scenario looms, i.e. the risk of under-investment.

As to the first, infrastructure is abundantly present and most routes have probably long been duplicated by the likes of Eurofiber (now majority-controlled by Doughty Hanson), Tele2 (incl. Versatel, BBned), Relined (government), BT, Verizon, etc. KPN is still dominant in the access network (DSL, FTTH, FTTO), but not in backhaul and long haul or in connecting network nodes and data centers. Business customers in many cases require redundant connections, i.e. from different providers. Further, there is ample regulation in place that KPN has to adhere to.

There is probably a sentimental reason for being worried as well: after all, America Movil is led by the world's wealthiest man, who unashamedly collected his wealth in a poor country. You can read all about it in this chapter. But if you read carefully, you will learn that:

• Carlos Slim is crazy about money. It is not he who fails (!), it is the Mexican government, that granted Telmex a 6 year monopoly and has since been unable to regulate the market in a proper way. You can blame Slim, but he acts merely like the hacker (or a Nick Leeson) who is looking for weaknesses in the system. It is the country that fails, and if it weren't for Slim, somebody else would have taken advantage.
• The Slim empire and Mexico have an 'unhealthy symbiosis', the writers claim. A monopoly does lots of harm, especially in a poor country. It remains to be seen where Mexico would have been without this company gathering all this wealth around it.
• Slim is now a major philanthropist, but this is all dismissed as 'white-coating', for PR reasons. He is also accused of 'green-washing'. While donating to charity and investing in green technology, Slim supposedly maintains an empire of companies that violate everything charitable or green. However, this is only underpinned by his stakes in cigarette production and by "customers who complain about high consumer rates and unstable connections". This doesn't seem to be enough to completely dismiss his good intentions.

Judge for yourself, but it is Mexican politics that is failing (and hell, all of capitalism if you will). Carlos Slim doesn't appear to be any worse than other people having been able to collect filthy amounts of money.

As to the second reason for worry over America Movil's involvement with KPN, this seems unjustified. America Movil isn't private equity, but a telecoms company. KPN may be broken up, but that isn't necessarily a bad thing. Especially if fixed and mobile are allowed to compete on the Dutch market. And if the government finds a way to block the takeover, they could still break-up KPN along the passive/active line, and deny America Movil the right to acquire passive network elements in the Netherlands. There will be plenty of interest in owning passive components (NBN, CIF, IPO, ...).

What will America Movil do with KPN's Dutch fixed-line network?

What's next in the battle for KPN/E-Plus, now that America Movil stated that it plans to offer 2.40 EUR/share for the remaining 70.23% of KPN that it doesn't already own (aiming for an acceptance ratio of at least 50%).

First, let's establish that this is all about E-Plus:

• AMXL has an interest in mobile only, as it sees an opportunity in Europe with low 4G penetration.
• Base (Belgium) is too small and KPN Mobile NL is small as well and too much hooked up to the fixed-line network. Hence, it's all about E-Plus.

Next, let's establish that AMXL is not amused with KPN's action to sell E-Plus to Telefonica Germany:

• AMXL's interest in KPN only pertains to E-Plus (see above).
• KPN apparently sold E-Plus without the approval of the AMXL supervisory board members (2 out of 8). Note: AMXL spent billions buying its 30% stake and supported KPN´s rights issue.
• AMXL cancelled the shareholder agreement, paving the way for the intended offer for KPN.

What will happen to E-Plus? A merger with Telefonica Deutschland will unleash synergies valued at EUR 5.0-5.5bn by KPN and Telefonica.

• KPN may still succeed in selling the asset to Telefonica Deutschland, because of the timing of its EGM. AMXL may then withdraw its offer for KPN, but will still be stuck with its 30% KPN stake.
• AMXL may stop the sale of E-Plus to Telefonica Deutschland, either through its intended takeover of KPN or through the KPN EGM (note: AMXL may already be a KPN stock buyer and have its stake increased beyond 30%). The KPN management will likely be replaced. America Movil may hold on to the mobile activities and sell the Dutch fixed-line operation. Next, AMXL may try to buy Telefonica Deutschland.
• Telefonica may launch a higher offer for E-Plus, trying to get approval from America Movil. If it succeeds, America Movil is stuck with the Dutch/Belgian assets of KPN.
• A third party may launch a counter offer for E-Plus. Only Liberty Global seems to be a candidate, as it too will see synergy potential from a takeover. Liberty is expanding into mobile and has a country-by-country approach, ranging from a full MNO in Chile to a 'heavy' MVNO in Belgium (with 2100 spectrum) and other places, to a WiFi focus in the Netherlands (with 2600 spectrum).

What will happen to the Dutch fixed-line activities of KPN?

• If AMXL gets stuck with the Dutch and Belgian units of KPN only, it may try to sell its stake (either 30 or 100%) in due course.
• If AMXL ends up with all of KPN, it may sell the Dutch fixed-line activities. In theory, there are several candidates: the Dutch government (afraid this 'vital' asset to come under foreign ownership), CIF (the Communication Infrastructure Fund managed by Rabobank, whose ideal is to create a national venture controlling all passive network elements in the Netherlands), the public (in an IPO) or a competitor (Vodafone certainly is a candidate, especially now that it is buying Kabel Deutschland).

All in all, it seems likely that AMXL will end up controlling KPN, including E-Plus. The question then is: will it separate the mobile and the fixed-line activities in the Netherlands? And what will then happen to the latter?

What will be the consequences for KPN Fixed? This will obviously depend on who ends up owning it.

• If KPN's Fixed and Mobile activities in the Netherlands are kept together, not much may change.
• If Fixed and Mobile are separated and KPN Fixed is sold, there will be competition between KPN Fixed and KPN Mobile/AMXL, as KPN Fixed may embrace a mobile strategy of some kind.
• KPN Fixed may increase network investments, which will be bad news for Ziggo and UPC.

Finally and in summary, here are the wild cards:

• Liberty Global may make a counter offer for E-Plus.
• Vodafone may buy KPN Fixed NL.

Proof is finally in: FTTH beats cable networks

Never trust the FTTH or the cable lobby for predicting the future. But the recent numbers from Ziggo and UPC NL are starting to show that indeed cable infrastructure is NOT future-proof. There is a clear relation between the rise of FTTH (and even VDSL) and the deterioration of the cable market in the Netherlands.

The point is that the fiber lobby has been stating for years that cable networks have inferior infrastructure. However, one could never tell from looking at the numbers, but that is now changing.

Ziggo and UPC have entered a phase of negative revenue growth (UPC NL Q2: -2.0%), network penetration is dropping (UPC NL: now below 60%), loss of market share on the video market is accelerating, growth on the broadband/VoIP market is slowing and is only sustained by upselling 3P's to 1P and 2P subs.

At the same time, profitability is falling to a structurally lower level: Liberty Global: "... the Netherlands is experiencing significant competition from the incumbent telecommunications operator, who is overbuilding our network in the Netherlands using FTTH and advanced DSL technologies. As a result, the Netherlands is experiencing lower operating cash flow margins during 2013, as compared to 2012, and we believe the Netherlands will be challenged to maintain its current operating cash flow margin during the remainder of 2013 and future periods".

Entering the mobile market, not with a WiFi-based network (as Ziggo has been testing) but with a true MVNO, will boost revenue growth. But there is much less room to maneuver on the Dutch market, compared to Belgium where Telenet shows +12% revenue growth. And worst of all: margins of an MVNO are very small and will first be negative, further reducing profitability.

And it's not only opex that is rising, it is capex as well. At the end of 2009, capex/rev (-12 months) at UPC NL stood at 13.1%, it now stands at 19.2%.

Hence, a merger of Ziggo and UPC makes sense - for the short term. But it will be only a matter of time before Liberty Global decides to abandon the Dutch market. Two losers can't make a winner.

EU single market for telecoms: international roaming major stumbling block

Neelie Kroes is aiming for a single market in the EU for telecoms. Everybody would agree with this concept, but there are several serious issues. Let's look at the main constituents of the single market:

1. Net neutrality
2. International roaming
3. Harmonisation of regulation and spectrum management

All this would add 0.9% to GDP, or EUR 110bn per annum through innovation, new business models and enhanced demand.

1. Net neutrality: adapt or die

NN can be seen as a way to protect the OTT/CSP sector against blocking and throttling by ISPs. Competition at the services level increases, and ISPs (the incumbent) want something in return.

To ease regulation (open access to wholesale customers at layer 2 or 3) doesn't make any sense, however, because regulation covers the relationship between the incumbent and its wholesale customers, not the OTT/CSP sector.

It looks like this is just tough luck for the incumbents: times are changing, managed services are disappearing, adapt or die. They need to focus on broadband (fixed and mobile). And to die isn't all that bad (looking at it from a national security point of view), because infrastructure will always be an attractive asset, even when auctioned off in case of bankruptcy.

2. International roaming: not realistic

While sympathetic, this is as ambitious as leveling the price of bread throughout the EU. Costs (opex) vary dramatically across the EU, so how could wholesale (let alone retail) pricing of an MB be equalised?

3. Harmonisation: lengthy process

Operators would be allowed to do business across the EU - as if that wouldn't be possible today. Next, they could choose which regime to follow - which makes no sense. Harmonising spectrum is ambitious but sympathetic, with current license expiring at vastly different points in time.

LomboXnet: electric cars as storage devices in a solar powered smart grid

LomboXnet, the small-scale ETTH network in the Lombok part of Utrecht, is making an interesting turn. As it awaits a viable IPTV solution, it has decided not to expand the network, for now at least. Instead, it is developing a smart grid, based on the ETTH network, several solar plants and ... storage!

Solar panels are mounted on rooftops of local schools etc. and the smart grid will help to match supply and demand as much as possible. Weather forecasts will be included in the input. This is where storage comes in, and the company has decided to allow electric cars to act as storage devices for the grid and the local community. Charging and home use will alternate, depending on weather conditions.

A few numbers from the solar industry (approximations):

• Existing electric cars (Nissan Leaf) have storage of c. 24 kWh, enough to run a household on for c. 3 days and LomboXnet for c. 8 hours.
• New electric cars (Tesla S) can fully charge at c. 20 kW, which translates in just half an hour. Storage is 85 kWh. Any full day's drive in the Netherlands normally doesn't use more than half of this, leaving the rest for home use. Such cars are currently cheaper than buying comparable storage capacity on a stand-alone basis.

Local (de-centralised) energy production and storage may mean the end of large energy distribution & network companies, although for now they will be needed to make it through the night and through the winter. Solar energy is becoming ever more viable by the day, as a result of increasing efficiency of both production (solar cells are becoming better, faster and cheaper) and storage (driven by the smartphone/tablet/laptop industry).

War of the words continues between fiber and copper

Recently, the Dutch cable sector (i.e. Ziggo, UPC and NLkabel - NOT the smaller cable companies and CIF) decided to step up its lobbying efforts against the fiber lobby (led by Reggefiber/KPN). It all seems to come down to the use of the words 'future-proof' (toekomstvast or toekomstbestendig). Now, unfortunately, Hartwig Tauber of the FTTH Council Europe, decided to enter into this silly discussion, claiming that FTTH is the only future-proof network:

“Fibre to the Home is de enige toekomstbestendige oplossing. Consumenten profiteren nu al van glasvezelverbindingen die 1 Gbps en meer bieden voor het up- én downloaden. Bovendien is Fibre to the Home in staat een niet te kloppen servicekwaliteit te bieden. In plaats van consumenten te misleiden met maximumsnelheden kunnen Fibre to the Home-netwerken aan ieder huishouden een gegarandeerde snelheid leveren. Operators die gegarandeerde snelheden van 100 Mbps en meer aanbieden, bevestigen dat klanten tevreden zijn met die snelle verbindingen.
Er zijn echter nog steeds spelers op de markt die stellen dat hun koperoplossing toekomstbestendig is, omdat consumenten geen hogere snelheden nodig hebben. Het logische gevolg hieruit is dat deze partijen hun klanten voorschrijven wat toekomstbestendigheid inhoudt en de ontwikkeling van innovatieve diensten belemmeren, waaronder diensten met grote socio-economische voordelen.”

Of course, this is total nonsense. No single network is future-proof. Every network needs work: maintenance, repairs, upgrades, etc. And it all starts with the question: is this about the passive or the active components? Fiber appears to be the way forward, but you can never tell; and 100 Mb/s equipment seemed to be enough, until Reggefiber decided to upgrade to 1 Gb/s - with implications for backhaul (i.e. fiber) as well.

And then there is the use of the words future-proof: linguisitically (semantics), it is incorrect to talk about 'more' or 'less' future-proof, in the same way as it is nonsensical to say that something is 'more perfect' or 'less perfect'. Something is either future-proof, or it isn't. And no single technology is future-proof.

We have been proponents of FTTH for many years, but the discussion has to be fair. NLkabel and the FTTH Council are bending the truth (to say the least). And this isn't helping. Of course, fiber is better than HFC: more capacity, easier to upgrade, symmetric, open. But FTTH is on the roadmap of HFC as much as it is on the roadmap of copper networks.

Unfortunately, Hartwig's statement fails on more points:

• He forgets to mention openness.
• He talks about bandwidth guarantees, but networks are all shared at some point in their architecture.
• He doesn't distinguish between GPON ('shared') and WDM-PON and p2p ethernet fiber (dedicated) networks.

We have written on the subject twice recently. In summary, there are three points to be made, two of which are mostly overlooked:

1. FTTH beats HFC in many respects (see above). Cable operators are billing their networks as NGNs, which is total nonsense. One needs to distinguish between the passive and the active networks. Every network can be upgraded. FTTH is on the roadmap of all.
2. There is a sharp distinction between the advantages for users (QoS, real estate value), for operators (capacity, opex, new business models) and for governments (socio-economic and environmental benefits).
• Fact is, that many cable customers still are happy customers.
• Fiber operators are trying to make the network a worry for their customers ('choose the network that is most future-proof'), but the customer shouldn't care. The network is the operator's worry. Fiber operators also claim that cable networks cannot keep up, but again, that is the cableco's worry. Or that they can't afford it - which is probably true, but let John Malone worry about that. If their upgrades start falling behind demand growth, the market will do its work and subscribers will migrate to FTTH. There's one problem though: FTTH penetration. In areas where FTTH will not be deployed for many years, HFC only competes with DSL and hence has no incentive to move to all-fiber, which could create a digital divide.
• The government has no voice, because it decided to leave telecoms to the market (apart from rural areas, where the market fails), and so: either shut up or create a national infrastructure, either the Australia (nationalisation) or the Singapore way (tender).
3. The way the market works, is that capacity is added as demand grows. Business models are based on scarcity. Moving to an all-fiber gigabit network is a big leap and only makes sense when other forms of upgrades make no sense from a return point iof view, or when new business models, based on abundance, are explored.

Dumb-pipe operator or dumb pipe-operator?

Two remarkable releases from the Dutch mobile industry:

• Vodafone NL CEO Rob Shuter on the company blog: "The multiband auction last December brought an unexpectedly large windfall for the Dutch treasury of EUR 3.8 billion. For us, however, this meant a solid bill shock of 1.38 billion! We were obviously fully aware when auction prices for mobile frequencies were established, but all parties agree that the prices were much higher than expected."
• KPN, Vodafone NL and T-Mobile NL are suing the Dutch government over the 2012 multiband auction. Vodafone claim that reserving spectrum for a newcomer created artificial scarcity.

It is rather ironic to have mobile phone companies complain about bill shock and artificial scarcity, because these are at the heart of the industry. In fact, they have sort of invented those terms.

As to bill shocks: mobile operators charge ridiculous prices for international roaming (which next year will end) and for some reason there is still no pan-European pricing (T-Mobile Austria charges €17 while T-Mobile Germany charges €96 for the same smartphone tariff allowances). Further, the companies are using the fact that most people didn't see high prices coming (we did), which created a buzz in the press about overpaying. But in reality, other auctions brought in more on a per MHz per capita per year basis. And the result wasn't impressive in relation to the 2011 UMTS auction. And last but not least: buying a 17 year mobile license creates an enormous entry barrier and comes at the expense of EUR 230 per sub or just over 1 euro per month per sub for Vodafone.

As to artificial scarcity: this is exactly what telecoms operators create, slicing & dicing available bandwidth (i.e. throttling) in order to create a 'business model'. Mind you, this whole throttling of a 24 Mb/s ADSL service to tiers of e.g. 1, 2, 4, 8, 12 and 24 Mb/s (or a 1 Gb/s service to 50, 100, 200, 500 and 1,000 Gb/s) is extremely expensive from a capex/opex point of view (equipment, billing, marketing) and is hardly warranted by the associated costs (a 24 Mb/s sub is probably not much more expensive than a 1 Mb/s sub).

Yahoo!/Tumblr: combining UGC and social networking is where the action is

Yahoo! is acquiring Tumblr. The specs:

• 117m users (growing 120k per day), 108m blogs, 300m monthly active visitors
• 75m posts per day, total 51bn
• Raised $125m
• 2012 revenues $13m
• 175 employees
• Combining with Tumblr will grow Yahoo!'s audience by 50% to 1bn and traffic by 20%.

Tumblr is a combination of user-generated content (UGC) and social networking, like Instagram (Facebook), and in a sense comparable to Pinterest (pictures), Waze (social mapping & traffic info, going to Facebook). Flickr (Yahoo!) could expand its social functions as well, as could YouTube (Google).

Pulse went to LinkedIn and Yammer to Microsoft. Other obvious takeover candidates are those that in a way combine UGC and social networking:

• Pinterest (pictures)
• PhotoRocket (photos)
• SlideRocket, SlideShare (presentations)
• Evernote (notes)
• SoundCloud (music, audio files)
• WordPress (blogs)
• Quora (Q&A)
• Path (mobile social net)
• Dropbox and Box.net (storage)
• Twitter (text-based microblogging)

More on access and services

Telecoms is moving away from its 4 traditional silos: fixed voice, broadband, TV and mobile. A more compelling way of looking at it now is (see previous post):

• Two enablers:
• Devices (portable and non-portable)
• Access (fixed and mobile)
• Two classes of services:
• Communication (voice/video calls, text/IM/chat, M2M)
• Entertainment (TV/catch-up/VOD, gaming)

And thus:

• This could be the basis for new regulation.
• The distinction between managed (traditional voice, SMS, TV) and OTT services is becoming less meaningful. Net neutrality is used to create OTT competition to managed services. The call (mostly from the fiber community) to create new and compelling services ('killer app for FTTH') seems quite ridiculous, considering the innovation going on in the OTT space. And as witnessed by the thousands of apps available on smartphones. Not to mention that it is the world upside down: we are not looking for new services to justify the roll-out of NGA networks; we are rolling-out NGA networks to keep ahead of demand (c.q. commoditise bandwidth, put an end to throttling, remove bandwidth as an artificially scarce resource) and especially because of the implied opex savings.
• A distinction between telco and cableco no longer makes sense.
• Access:
• Each of these markets are very competitive, except access. Unless it no longer makes sense to distinguish between fixed and mobile. LTE allows mobile operators to offer fixed-line replacement services, WiFi allows fixed operators to launch quasi-mobile services. Governments could consider to allocate lots of spectrum for unlincensed use to make sure that technologies such as WiFi increase competition.
• The access market is core for telecom operators. It creates subscriber ownership and generates fat margins (whatever the operators claim). Operators are now throwing in free services to attract/keep broadband subscribers e.g.:
• KPN: free access to Spotify Premium.
• BT: free access to BT Sports.
• Communication is traditionally voice and SMS. A third leg is M2M, e.g. DT's usage-based insurance (mobile) and home automation such as AT&T Digital Life (fixed). The commonality between these services appears to be: sensors.
• The 'entertainment' market is still developing. It consists of video (live TV, catch-up TV, VOD) and gaming. Will there be a third leg?