Saturday, June 25, 2011

MPJC: no visionaries

Last Thursday was the annual Mediapark Jaarcongres (MPJC) of the public broadcasting sector in the Netherlands. Not quite as interesting as last year's edition, but well worthwhile. No real visionaries, apart from the 4K contribution, but that was done last year as well. Here are a few common themes.

It was all about:
- Smartphones, tablets, touch screen, swiping
- Connected TV, TV everywhere, second screen
- Social media and social TV
- Consumer is in control
i.e. nothing really new.

Hybrid TV
UPC and others pointed out that there still is very little true integration of broadcast and broadband, despite all the connected TVs. We have come to the same conclusion (report available at 50% discount for readers of this blog), which is well worth stating explicitly, because the term 'interactivity' is used much to easily for functions that aren't really worth it. Such as pausing live TV - nothing more than a very basic feature exploring the two-way connection of an 'interactive' TV. There is still a lot to be done.

Kevin Slavin
Excellent talk from Kevin Slavin of Starling TV and Area/Code about the role of the audience. From the laffbox (LFN: laugh from nowhere - check out this) to Facebook/Twitter, parasocial relationships, the audience becoming a character (see Brand Fiction Factory), a character as the audience and finally Everyware (... is where the laughter comes from): social media replace the laugh track.
Twitters problems: hashtags are not unified; there are simply too many tweets.

RTL, Sanoma
Both are pusuing a strategy of 'follow the consumer' - not surprising.
Sanoma NL (revenues: EUR 500m) took some effort defending its takeover of SBS (3 TV channels, program guide) for EUR 1.2bn (shared with Talpa). The problem is not so much SBS's current underperformance (that's simply due to a 'cycle'), the real problem is that this is essentially a change of control where the acquirer has no clue how to run a TV company. Talpa (TV productions) is included in the deal, taking a 33% share, but they don't know how to run a company like SBS either. Which is why they will have a very hard time realising synergies.

Solid statements: Google lacks a unifying UI across all devices; social TV is still embryonic. No news on the Horizon box (see page 5 of this journal: trial coming to the Netherlands in July, commercial launch September).

Glashart Media (Reggefiber)
Reggefiber has ~700k homes passed and ~200k homes activated (for more details on the Dutch FTTH market: our FTTH NL 2011 report will be out next week - here is last years' edition). Glashart Media services 130k TV homes, of which 45k use interactive services.
Its claimed USPs: picture and sound quality; number of channels; EPG (providing access to apps); 3-D ready; content (local TV, VOD, catch-up TV, Eredivisie Live). OTT services are drawn into the managed services domain, while providing open access to all content parties (0900-TV).
2010 Was the year of 'fix the basics', 2011 is the year of 'boost the base'. A new box will be launched, allowing 3 TV sets to be connected and with a 250 GB hard disk optional. They also want to experiment with a kind of prepaid card, giving access to certain content for a limited time. Intriguing plan: an off-footprint break-out is coming, i.e. Glashart Media providing TV services outside the Reggefiber footprint.

Launch of the new site

Some stats on Eredivisie Live: 550k subscribers, 1m unique visitors/month, 1.5m views/month, 300k live streams/year. A new site will be launched at the end of June 2011, relying completely on adaptive streaming. It will offer a single-sign-on (across devices). They see an interest in niche content, such a (just 30k active sportsmen, but no fewer than 28-30k views per video).

TNO/Waag Society
Wonderful demo of 4K, which is predicted to come to market in 2011. What it claims to be is an even sharper image, creating the illusion of 'really being part of it'. But 4K also offer a more dynamic picture and a much better opportunity to zoom in. Japan expects 8K by 2020. SD (720x576) implies 0.4 megapixels, HD (1920/1080) implies 2 mp, 4K (4096x2160) goes to 8.8 mp and 8K to 33 mp. And then you can combine 4K (or 8K) with 3-D. Bandwidth consequences are apparent.

Public Broadcasting
The day started off with the PO (public broadcasting) commenting on government plans to reduce support by EUR 127m. This number is supported by a recent BCG report. Broadcasters (essentially production companies) will be forced to merge to reduce the field to 8 players, from 21 currently. (According to the PO, this will supply only 30% of the targeted savings and the plans will force 20% lay-offs.)

Ericsson: File-sharing is a symptom of a problem, rather than a problem in itself

Considerarti recently published a study on piracy in the Netherlands. With expert advice coming from Warner, Universal, Buma/Stemra and other contnet parties, the outcome is predictable.

Fortunately, we have the Ericsson Business Review. In the latest edition (#2 2011), Rene Summer very eloquently explains what is wrong with the content industry:
ISPs are being forced to act as digital security agents on behalf of economic rights holders by listening in, screening, surveying and filtering the exchange of information between consumers. Such strict enforcement further damages the prospects of legal digital alternatives by introducing the principle of innovation by permission. It also carries unwelcome echoes of the old Eastern-bloc surveillance societies that modern Europe has decisively rejected.

File-sharing is a symptom of a problem, rather than a problem in itself. This problem is the inadequate availability of legal, timely, competitively priced and wide-ranging choices of affordable digital-content offerings. Consumers also expect to be able to make decisions freely regarding when and how to consume the content of their choice. By clinging to outdated business methods such as windowing and territoriality, economic-rights holders are in fact creating the consumer behavior against which they so violently protest.

How can we, as good Europeans, accept this state of affairs? The success of our European project is founded upon freedom of movement – for persons, goods, services and capital. Why should digital content be an exception? How can policymakers continue to endorse the vested interests of economicrights holders at the expense of the promises of the single market and our fundamental freedoms?

Ericsson is calling for full consumer access to legal, timely, competitively priced and wide-ranging compelling content offerings, and a free choice of when, where and how this legal digital content can be consumed. We call for an end to regulatory barriers and deliberate non-availability through windowing and territoriality. We call – a full 60 years after the Treaty of Paris – for a digital single market that not only meets the requirements of today’s and future European consumers, but also the requirements of European history.

Sunday, June 19, 2011

Can you discuss internet freedom with morons and barbarians?

My colleague, who is a member of the D66 LibDem party in the Netherlands, asked me to host a debate on internet freedom and net neutrality at the upcoming D-cafe meeting. They are trying to get government officials for the discussion. I'm not sure if the topic still warrants such a debate, because there appears to be broad consensus about the validity of net neutrality.

Internet freedom may prove to be a whole different kind of animal. But how do you discuss freedom with parties such as we have in our minority government (VVD, CDA), supported by the neo-fascist PVV party? How do you discuss basic values with people who are showing democracy's dark side: a minority, with support from dubious morons, imposing their will, having no eye for the democratoc rights of minorities. Or social cohesion and cross-party loyalty for that matter. VVD and PVV have the V for freedom (vrijheid) in their names, but we all know where their conception of freedom ends: when people start wearing funny things on their heads.

The latest disgrace coming out of them is cutting the cultural budget. Classical music especially is falling victim to their cultural barbarism.
  • The Radio Kamer Filharmonie will disappear. A few years back, the national radio 0rchestra infrastructure was severely cut back and now it will happen all over again. We have an internationally acclaimed set of orchestras (Radio Filharmonisch, Radio Kamer, Metropole) and a unique choir (Groot Omroep Koor).
  • All institutions will receive less state subsidy and will need to be more commercial to find new income sources. A US model around patrons paying big bucks is seen a role model for our country.
The government wants to make our cultural life less dependent on subsidies. But this comes at a very bad time, when culture is completely undervalued and the economy isn't picking up. But what do you expect from a governement that honours mediocrity? They have appointed the embodiment of mediocrity as their minister of arts & sciences: Marja van Bijsterveldt. Her state secratary Halbe Zijlstra is probably even worse. His cultural background reaches no further than rock band Metallica. And a system of patronage cannot simply be imposed to a nation that is alien to the concept. You can't change a national character just because you want it. And look at what it brought to the US: culture is for the very happy few only and the range of music on offer at live concerts (esp. outside a handful of large cities) is horribly poor.

In our country, another complete moron, Joop van den Ende, king of musicals and soap operas, is looked at as a patron of the arts, because he is building a 'musical hall' for his horrible and mediocre 'art'. It is mediocrity that is at the heart of today's cultural barbarism. I come from a place where mediocrity = bad. But the people ruling our nation today live by the opposite of this rule.

Here is what Reinbert de Leeuw, who needs no introduction, has to say on the matter in today's newspaper:
"I feel defeated and dispirited. It is as if all if did during the last 50 years was without value. I am bewildered by the resentment against the arts. It's one big frontal assault. As if you are sitting at the table and somebody gets up to slap you in the face. That makes it so hard to formulate a response."
Indeed, how to discuss matters such as art, or freedom, with mediocre morons like the people he refers to? Come to Utrecht on June 29.

If they will still have me.

Friday, June 17, 2011

Are operators going to hit a wall?

Mobile operators like to complain to regulators over the threats posed by net neutrality and over-the-top service providers. Some even go as far as to say: if you go down this road, mobile service revenues will decline by 33% over the next five years relative to 2010.

What they are essentially saying is this: We are in a car, going really fast, but down the road is a wall and we're going to hit it.

It's easy to suggest what can save them: you have a driving wheel, you can easily drive around the wall. And what's more: walls on roads are characteristic of any market. It's part of doing business. Get used to it. Or as Bob Lefsetz puts it in his latest newsletter: Android shows Apple is vulnerable. And if it stays in place, Google search is vulnerable. You've got to reinvent yourself every day. Or get left behind.

Wednesday, June 15, 2011

Operator points of view on net neutrality

We have made an analysis of net neutrality here, but a closer look at the operator's point of views may add some insights. There are (at least) four arguments put forward by operators who wish to be more flexible in managing their networks, to which we respond below:

1. It's my network, I can do what I like with it.
Fundamentally a good point, but at odds with Net Neutrality. Legislation and regulation are the price of doing business in the telecoms sector. Internet access is a fundamental human right. When anyone buys internet access, he has the right to access the entire internet, not just some sort of walled garden. Access to the entire internet cannot be restricted to more expensive bundles/packages, because that would create a digital divide. It's also about innovation: not only do we want consumers to access the entire internet, we also want innovative companies to be able to access the entire internet population. Without that, they wouldn't be able to come off the ground and fly.

2. We must be protected from those disruptive OTT forces.
Not a very good point. Companies don't live forever, it's a survival of the fittest. Companies need to adapt constantly, or else they will go out of business sooner or later.

3. Our profits are not excessive and we need to invest a lot.
The first part is a good point. Even if tariffs are high, it must be kept in mind that other elements of the service are sometimes free, such as the handset and customer support. On the second part, implying that costs will rise above revenues, we believe that there is not really a problem:
  • Tellabs: 'End of profit' (study, 2011), assuming that flat fees are kept in place.
  • Ericsson: 'Busting the myth of the scissor effect' (Business Review #2 2010).
  • NSN: '... it is possible to provide up to 5 GB of data per month for every existing voice subscriber by using HSPA and LTE radios in existing sites. (...) Monthly network capex + opex can be kept below 3 EUR per subscriber ...' (Mobile broadband with HSPA and LTE, 2010)
4. We will raise our prices.
We fail to see why this is a problem in the first place. Go right ahead - competition will hopefully limit price increases. More generally, the market seems to be moving to a pricing structure that is very much like the way we pay for fixed broadband: tiered pricing based on speed, volume (caps), QoE, VAS.

3-D and mobile data offloading can use some 'standardisation'

Some new technologies or applications need standardisation before mass market adoption can take off. Apple is a famous example of an exception: it uses its own proprietary technologies and walled gardens and gets away with it. For such diverse things as 3-D and mobile data offloading, some form of standardisation seems to be necessary.

3-D: Prospective buyers are probably well informed and early on in their decision making are confronted with three different solutions:
Innovators may move in, but even early adopters may remain on the sidelines until the dust settles.

Mobile data offloading. Options are manyfold and operators the world over are making different decisions, but many appear to be on the sidelines - while data traffic explodes. Is there any operator that really knows which option is best? This is not about standardisation, strictly speaking, but consensus on what the best network architecture is, would be nice. The options:
  • WiFi: either free from restaurants/hotels; free for mobile and/or broadband subs; for-pay (e.g. Boing); free/shared (FON).
  • Femtocells, picocells.
  • Rely on 4G and the right spectrum (Real Wireless for Ofcom: 230-450% efficiency gain; TeliaSonera at Investor Day: 8x more efficient). LTE-Advanced is poised to offer speeds up to 1 Gb/s.
  • All new wireless architectures from Alcatel-Lucent (lightRadio), Ericsson (Antenna Integrated Radio), NSN (Liquid Radio).
  • TD-LTE to roll out a cheap data network.
  • Network sharing, possibly even with a wholesale-only partner (such as LightSquared in the US, or perhaps UK Broadband in the UK).

Thursday, June 09, 2011

France Telecom offers little to support growth forecasts

France Telecom has presented its targets for the period 2011-15 at an Investor Day in Paris. This follows its 'Conquests 2015' plan presented in July 2010 and subsequent announcements such as plans for Orange Business Services (September 2010) and the FTTH roll-out in France (February 2011).

Some elements of the strategy already announced:

  • Focus on emerging markets, where revenues should double within three years (18 June 2010);
  • Further cooperation with Deutsche Telekom on network sharing, Wi-Fi roaming, M2M, R&D and joint procurement (11 February 2011); sharing agreements are already in place in Austria and Poland, as well as the joint venture Everything Everywhere in UK; the procurement project has also started (18 April 2011);
  • Working towards network sharing in Austria, Romania en Slovakia (27 April 2011); in Belgium (Base) and Spain (Vodafone) it’s already working with partners;
  • A review of assets for possible sale, outside France, Poland and Spain (3 May 2011).

'Adapt' and 'Conquer'

The new plans add to the above. The period 2011-2015 is split in two phases:

  • 2011-2013: the ‘Adaptation Phase’. The company will invest and expand in new markets, such as apps. The company will also be strengthened. Sales growth is expected at an average 0.6 percent per year (CAGR), and EBITDA is estimated at a cumulative EUR 45 billion. Capex will total EUR 18.5 billion. Operating cash flow, defined by FT as EBITDA minus capex, is put at EUR 27 billion. Capex will be 12.6 percent of revenues, excluding FTTH in France, with a peak of 14 percent in 2012.
  • 2014-2015: the ‘Conquest Phase’. A return to sustainable growth, with a revenue CAGR of 2.7 percent and EBITDA CAGR of 3.4 percent. Cumulatieve capex is forecast at EUR 11 billion, and operating cash flow will grow at a CAGR of 9 percent. Capex will drop to 10 percent of revenues.

The company also targets cost savings from network sharing and IT. These are expected to reach EUR 3 billion per year by 2015. For the FTTH plans in France, the company will invest as earlier announced EUR 2 billion. France Telecom will also sell minority stakes in companies where it has no operational control, such as in Austria (35 percent in Orange Austria) and Portugal (20 percent in Sonaecom). The dividend was set at EUR 1.40 per share for 2011 and 2012.

A look back, and forward

First we compare the targets to the company’s recent results (2009, 2010 ) and the market expectations to 2015 (see table).

EUR bln2009A2010A2011E2012E2013E2014E2015E

We see that the targets for the first phase are in line with market expectations, although capex will probably be higher than is currently expected. However, the aim to accelerate growth in the second phase is not in line with current market estimates, which predict a continued erosion in results. Estimates for 2014 and 2015 should be taken with a grain of salt, as most analysts do not provide estimates beyond 2-3 years. The coming days will show whether the market was impressed by the plans and the presentation from CEO Stephane Richard. If so, the estimates should move up.

France: difficult market

The first reaction from investors was slightly negative, with a small drop in the share price. This reflects the fact that the targets for 2014 and 2015 are a bit of a shot in the dark. Furthermore, France (in 2010 good for 49% of sales and 59% of EBITDA) is no easy market:

  • A fourth mobile operator (Iliad/Free) will enter the market in 2012.
  • A bit of a half-hearted FTTH strategy, where the target of 10 million homes passed in 2015 (see our commentary ‘If KPN wants to match the French FTTH plans, it should buy out Reggefiber’) is difficult to square with the capex budget of just EUR 2 billion. Furthermore, there is significant competition in FTTH, from Iliad/Free, Numericable, SFR and numerous local initiatives.
  • Possibilities à la KPN to cut jobs are more limited, due to the public status of many of the 170,000 employees. FT did recently estimate that in the period to 2020, around 30,400 employees should be eligible for retirement.

Positive effects include an end to sharp cuts in termination rates and expected economic recovery. Outside France, much will depend on good portfolio management. This includes the sale of minority stakes as well as takeovers, such as Meditel (Morocco, September 2010) and Korek Telecom (Iraq, March 2011). At the same time, the level of risk is growing, due to the political developments in the Middle East and North Africa region. Cost savings, though network sharing and the cooperation with DT, are also important.


At the moment it’s not totally clear what FT expects to support the growth targets for after 2013, apart from economic recovery and an easier comparison (the big cuts in MTA end in 2012 and Free Mobile is expected to start in early 2012). In addition to acquisitions, investments from the preceding years should make a contribution, but then it’s curious that the investment level (capex as a percentage of sales) for the period from 2014 is projected to quickly drop back to 10 percent. This puts growth in the period after 2015 at risk. In short, after years of contraction through both competition and regulation, the question for France Telecom and the telecom sector general is can it return to the status of growth sector? Or do we need to settle for the low growth seen in the utilities sector?

This post originally was published here on May 31, 2011 as a translation of this Background article (subscription required)

Wednesday, June 08, 2011

Consumer clouds and lockers: implications for operators

What is cloud computing?
  • Internet-based computing, remote computing
  • Often subscription-based or free
  • On demand
  • Managed by third-party
  • Optional: automatic updates/back-ups, synchronisation across devices
OTT players (B2C):
  • Apple: iCloud, iTunes, iPhone, iPod, iPad.
  • Google: Android, Chrome, Chrome OS, Chromebook, Google Music, Gmail, Google Docs, Google Apps, YouTube, Picasa, Google Fiber, cloud connect for Microsoft Office.
  • Microsoft: Office 365, Lync, SkyDrive, Azure.
  • Amazon: Cloud Drive, Cloud Player, Kindle, Amazon Web Services.
  • Yahoo!: Yahoo! Mail, Flickr.
Services (B2C):
  • Any file: Amazon Cloud Drive,
  • Music: Spotify, Google Music (beta), Apple iCloud
  • Photos: Flickr
  • Video: Netflix, YouTube, Uitzendinggemist, BBC iPlayer, UltraViolet
  • Presentations: SlideShare, SlideRocket
  • Social networking: Facebook, LinkedIn, Hyves
  • OS (turn iPad or Chromebook into fully-fledged computer): Chrome OS
  • Office: Microsoft Office 365, Google Docs/Apps, Zoho
  • Individual file storage (for sharing): RapidShare, MegaUpload, zShare
  • Back-up, remote access: Dropbox, Mozy, Carbonite
Telco acquisitions (B2B), bringing data centers and services to the table:
  • NTT Com: Dimension Data, Frontline Systems
  • Verizon: Terremark
  • CenturyLink: Savvis
  • Windstream: Hosted Solutions
  • TDS: Visi
  • Cincinatti Bell: CyrusOne
  • Time Warner Cable: NaviSite
  • Telefonica: Acens Technologies
Operator initiatives (B2B):
  • Netflix is a big AWS (Amazon) customer for its Watch Instantly streaming service.
  • KPN launches SME Workspace: software and services from KPN CyberCenters at 40 EUR/employee/month (May 31 2011).
  • Telstra to invest AUD 800m over 5 years; 1 new datacenter, modernising existing, building new apps and a management portal (June 16 2011).
Developer platforms (B2B):
  • VMware: Cloud Foundry
  • Microsoft: Azure
  • Amazon: BeanStalk
  • Google: App Engine
Computer vs. cloud:
  • As the computer/files/hard disks are cut out of the ecosystem and the cloud replaces them: a. connectivity becomes more important, and b. the computer ecosystem (Microsoft, Intel) stands to lose.
Infrastructure and connectivity:
  • Syncing/back-ups/updates will be done over WiFi, so wireless will not be burdened (for now). WiFi becomes even more important. Ultimately, WiFi implies fiber.
  • Other network elements (CDN's, data centers, servers) may also become more important. However, Apple (and Google) are using their own private networks.
  • Operators have control over the last mile, but Apple (and Google) may control all the other network elements. Next battlegrounds: WiFi, FTTH (as in Google Fiber).
  • Amazon Web Services provides cloud services to smaller players.
  • Hosting, co-location, housing.
  • Enormous lock-in for Apple (and Google) will work in their favour. They control the subscriber's data. Will operators have an answer and provide these services: put all your data in our cloud, with automatic back-up and syncing?
  • Apple's system is closed: plays on iOS devices only.
  • Apple and Google are going OTT, while operators have their own managed and secure infrastructure.
  • Is email (Hotmail, Yahoo! Mail, Gmail) the basis of developing a cloud strategy?
Other players:
  • Do cloud-based players such as Facebook, Dropbox, Zoho, Flickr, SlideRocket, Netflix, Evernote have a future?
  • Ericsson is in a way the biggest operator in the world, through its managed services. They can be a partner for telcos, which can then focus on sales & marketing.
  • Is UltraViolet still relevant? It's open, runs anywhere.
  • Cloud negatives: security (privacy), reliability (access), latency. Also: digital media fragmentation across multiple clouds and devices.
  • Cloud positives: better functionality and flexibility, faster and automatic updates (everything as a service), cost savings (lower capex/opex), shift from capex (hardware) to opex (subscription).
Benefits for consumers:
  • Lower cost (SaaS, Slim PC)
  • Buy once, play anywhere (streaming)
  • Sync across devices
  • Share among family members
What is the future role of a telco?
  • Infrastructure? Last mile (fixed and wireless) is too expensive to replicate
  • Cloud computing? Local and managed datacenters offer better security.
  • Services, sales & marketing? OTT players are building direct-to-consumer relationships, with credit card billing.
  • Telcos are squeezed: competition, regulation, device manufacturers, OTT players.
Apple iCloud limitations:
  • iOS devices only.
  • No TV/video.
  • WiFi only.
  • Video calls (FaceTime) limited to on-net over WiFi.

Tuesday, June 07, 2011

Apple iCloud: perfect for laundering all your 'acquired' music

Here are the main takeaways from Apple's WWDC 2011 (so far), related to iCloud, iOS 5, and OSX Lion.
  • iCloud: auto sync over WiFi to all devices (up to 10); scan & match to convert all your tracks to AAC; photo stream to push 1,000 most recent photos to each device; daily back-up over WiFi; 5 GB free storage for mail, docs, back-up.
  • iOS 5: iMessage for free on-net SMS/MMS among iOS users; Twitter integration.
And some numbers:
  • 200m iOS devices sold so far, of which 25m iPads.
  • 54m active Mac users.
  • App Store holds 425k apps, of which 90k for iPad only; 14bn apps have been downloaded.
  • iBookstore holds 200k titles; 130m iBooks have been downloaded.
  • iTunes Store: 225m accounts, 15bn tracks were downloaded.
  • Game Center: 50m users.
  • Bad news for SMS/MMS and possibly for BlackBerry/Ping. However, Apple is still a top-end brand, limiting its network effect. But the lock-in appears to be vast.
  • Cloud computing, data centers and connectivity increasingly important; WiFi in particular.
  • Same for developers. Who are the champions? Apple, Google, Microsoft, Amazon, ...
  • Sacrificing: the Mac computer; no longer needed for syncing.
  • There seem to be no limits to their developing powers. Each is building its own version of the internet. And if Google should ever launch a bank, they would be building their own version of ... the economy.
  • Conspicuously missing so far: streaming media, broadcast/video and VoIP.
  • Scan & match appears to be a laundering tool for all so far cobbled together music from various sources. Not sure if the music majors are involved. Is there a revenue sharing deal? Or have they been as clever as one can expect, taking just $150m?

Friday, June 03, 2011

Groupon IPO (2): $30bn seems to be more like 10 Groupons

According to the New York Times, Groupon could be going for $30bn valuation. Two more reasons (see also previous post) why this looks like a stretch.

First, simply check out the losses in this graph.

Second, let's take a look at the EV/sales ratio. Google's ratio stands at 4.94, Amazon's at 1.71 and Ahold's at 0.37. To arrive at Groupon's 2011 revenues, we assume no further acquisitions. Here bis how we calculate the current organic growth rate:
  • 11Q1: revenue $645m, of which $298m in North-America.
  • In 09Q2, Groupon's revenue (North-America only) came down to $660,000 per market. We really want the 'same store sales' to filter out the effect of acquisitions. We take the revenue per North-American market as a proxy. In 11Q1, this number was $1.70m.
  • This works out to be an annual growth rate of 72 percent. Still quite high, but not as astronomical as the total revenue growth numbers. We assume that this drops off quickly to more normal levels, dus to competition and market saturisation.
If we apply these multiples to the estmimated 2011 revenues, Groupon would be valued anywhere between $1.6bn (a la Ahold) and $21.9bn (a la Google).

We would argue that Groupon's value could be between the Ahold reference and the Amazon reference ($7.6bn). Groupon's organic growth is higher now, but we assume that it is dropping off quickly. The $30bn valuation seems to be more appropriate for 10 Groupons. In other words, when Google offered $6bn they should have taken the money and run.

Thursday, June 02, 2011

Groupon IPO: not all that rosy beneath the extreme growth rates

Groupon, the daily deals site, has now filed to go public to raise $750m. Here is the section 'Business' from the SEC-filing:
Groupon is a local e-commerce marketplace that connects merchants to consumers by offering goods and services at a discount. Traditionally, local merchants have tried to reach consumers and generate sales through a variety of methods, including the yellow pages, direct mail, newspaper, radio, television and online advertisements, promotions and the occasional guy dancing on a street corner in a gorilla suit. By bringing the brick and mortar world of local commerce onto the internet, Groupon is creating a new way for local merchants to attract customers and sell goods and services. We provide consumers with savings and help them discover what to do, eat, see and buy in the places where they live and work.

We started Groupon in November 2008 and believe the growth of our business demonstrates the power of our solution and the size of our market opportunity:

    We increased our revenue from $3.3 million in the second quarter of 2009 to $644.7 million in the first quarter of 2011.
    We expanded from five North American markets as of June 30, 2009 to 175 North American markets and 43 countries as of March 31, 2011.
    We increased our subscriber base from 152,203 as of June 30, 2009 to 83.1 million as of March 31, 2011.
    We increased the number of merchants featured in our marketplace from 212 in the second quarter of 2009 to 56,781 in the first quarter of 2011.
    We sold 116,231 Groupons in the second quarter of 2009 compared to 28.1 million Groupons in the first quarter of 2011.
    We grew from 37 employees as of June 30, 2009 to 7,107 employees as of March 31, 2011.

Each day we email our subscribers discounted offers for goods and services that are targeted by location and personal preferences. Consumers also access our deals directly through our websites and mobile applications. A typical deal might offer a $20 Groupon that can be redeemed for $40 in value at a restaurant, spa, yoga studio, car wash or other local merchant. Customers purchase Groupons from us and redeem them with our merchants. Our revenue is the purchase price paid by the customer for the Groupon. Our gross profit is the amount of revenue we retain after paying an agreed upon percentage of the purchase price to the featured merchant.

Groupon primarily addresses the worldwide local commerce markets in the leisure, recreation, foodservice and retail sectors. According to Euromonitor, the leisure, recreation and foodservice market is expected to be $1.4 trillion in the U.S. and $5.3 trillion internationally in 2011. The retail market is expected to be $2.9 trillion in the U.S. and $12.2 trillion internationally in 2011. We believe a substantial portion of these expenditures on leisure, recreation, foodservice and retail will be spent with local merchants. Groupon also addresses the online advertising market serving these merchants. The size of the U.S. online advertising market is estimated to be $51.9 billion in 2011, of which $16.1 billion is estimated to be spent by local merchants according to Borrell Associates. The size of the global online advertising market is estimated to be approximately $79 billion in 2011, according to IDC.

First of all, two very important issues have to be kept in mind:
  • Groupon grows mainly by acquisition (but it is unclear how much organic growth is). What we really need is a 'same stores sales' number.
  • The entry barrier is very low. Loads of competition is coming, from a wide range of companies: LivingSocial, DailyCandy (Comcast), (Amazon), Thrillist, ChoozOn, Google Offers, Facebook Deals, Spreets (Yahoo! in Australia), even AT&T/ and lots of newspapers such as Treat Me in New Zealand and Times Limited from the NYT.
And here are some thoughts on the numbers:
  • Growth by acquisition is hard to value. We have done a similar thing for Skype (for which Microsoft ended up paying much more than we anticipated) and LinkedIn (which was sharply undervalued at its IPO). For Groupon, we do not look at R&D (there is none), but marketing as an essential source of growth.
  • In 11Q1, revenues were up 14x, gross result 14x, earnings after marketing 27x.
  • Gross margin appears to be roughly stabilising at the 40-45% level. The earnings-after-marketing margin is not yet stabilising.
  • In 11Q1, operating cash flow was up 39% and free cash flow was down 42% (possibly as a result of buying office space?). So, cash flow growth is not nearly keeping up with topline growth.
  • In 11Q1, subscribers were up 24x, customers 18x, merchants 20x, groupons sold 16x.
  • The activity rate (customers as a percentage of subscribers) seems to be sort of stabilising at around 20%. The number of groupons per customer is down to 1.78 from 2.01 last year. The number of groupons per merchant is also down, from 606 to 495.
  • Conclusion #1: subscribers are growing faster than revenues, so are becoming less valuable.
  • Conclusion #2: buying groupons per customer is down, so either competition is kicking in or the excitement of buying is wearing off.
  • Conclusion #3: selling groupons per merchant is down, so either Groupon is adding less interesting (and interested) merchants, or they are less willing to offer their wares at steep discounts.
  • Conclusion #4: operating cash flow as a percentage of revenues is not as impressive as one might expect; there was a peak level of 27% in 10Q1, but all of 2010 was just 10%. It is early days, but the business doesn't appear to be that profitable.
Now how about valuation? Again, we compare to Google, which currently has a $138bn enterprise value. Google's PEG-proxy (price/earnings to growth, hre: value/gross result to growth or value/earnings-after-R&D to growth) is somewhere between 0.30 and 0.50. Groupon has been rumoured to go for a valuation of $20-25bn, but that is hard to get at, using the Google multiples. See for yourself.