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£2.5bn or FTTH?
By jpenston | May 17, 2007 |
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Keith McMahon’s excellent piece this morning, challenging BT’s decision to return £2.5bn to shareholders offers a detailed view of how the deployment of FTTH could be made to work commercially in the UK. It’s enough to make you ask, why not?
Without any inside knowledge of BTs decision making process, I’m guessing, but I suggest that perhaps a combination of competition from embedded technologies, muted demand and regulated returns might explain BTs stace. It also seems unlikley that this stance is going to change any time soon judging by the following statement taken from the summary: “Capital expenditure for the full year amounted to £3.2 billion and is expected to remain at that level for 2007/08 before trending down towards the end of the decade.”
The trending down is clearly expected as investment in 21CN scales back as the roll out nears its goals. If BT were thinking that they would then start channeling their capital budged into further upgrade programmes like FTTx, would they be making such statement to shareholders now?
I doubt it. BT look to be trying to play the straight man, juxtaposing their position with those of their competitors. BT is clearly in the process of consolidating its financial position, building on the recovery from their near-death experience of a few years ago. The company paid £520m to cover a defficiency in its pension contributions in the year just gone and the £2.5bn buyback in this coming two years is clearly a message to investors that the company is not a cash black-hole (unlike some of its challengers…)
The message says that when they do invest, the do so prudently and with a view to investors making a return. This is an old fashioned business strategy, but one that has been proven to work!
So, looking at the specific reasons for the caution, starting with competition from embedded technology. Keith’s post points out that the main upside from FTTH would be the addition of a broadband video pipe - everything else that the fibre can do, could also be done with the existing network without need for any more investment.
As a result, the incremental FTTH investment has to be paid for by additional revenues from video services. The word additional is very important, the total sum paid by consumer has to go up to pay the additional investment. The suggestion Keith makes is that if every home pays £4 a month more, we can all have it.
Which flows nicely into the second point: muted demand. Even the video pipe has an alternative, albeit one that is not quite as fancy: its called broadcast. How many broadband subscribers would pay that £4 more for a souped up version of free to air? For a service with many usability issues that have yet to be resolved? Consumers will have a choice: they don’t need the service. They will only go for it if they want it, so we are not talking about monopoly returns. We are in fact talking about a very, very slow ramp.
A follow up post shows BT with just under 64% of the broadband market through retail + wholesale (the other 36% is Cable & LLU). Spread over 64% of the market instead of 100%, that £4 becomes £6.25, but that assumes all of BTs wholesale + retail punters taking the video pipe and paying the £6.25, which they won’t as not everyone will see the value. That might limit demand even further, so you might be looking at 20% uptake, which would mean a £31.25 premium per month for a distribution service to compete with Freeview. Hmm… you can see the problem.
It’s worth asking; is there any price increase at all that can be supported in this market? How can BT increase prices while ensuring that not only do they keep existing customers, but that they also win back the market share held with Virgin, the WLR and LLU players? In the past, every upgrade has left the consumer paying the same or less and just getting more for their money. There is no precedent for getting investments returned by a straight price increase.
Maybe the business case is made by the cost savings as suggested by Verizon and the 90% gross margin suggested by Iliad? I have a problem with this on a number of levels: financially, the problem is that the headline hides the fact that gross margin is already expected to be 60% on LLU. So, you are only looking at a €10 per month uplift to pay your incremental capex bill of €850 per home. 7 year paybacks on any investment is a hard sell in any industry, let alone in telecoms, by a regulated monopoly, in a market in which so much can change (and become cheaper) in 7 years. 7 years ago spending billions on flat rate dial up infrastructure seemed like a good idea…
The third barrier is the regulated returns of 10%. Remember that the money (because it is owned by the company), is owned by the investors. Those same investors can pretty easily get 10% or better returns elsewhere, much quicker and probably without anywhere near the same level of uncertainty and risk (the risk that consumers will stick to broadcast). If they are taking a risk in the open market, leverage means that their potential returns could be much higher than 10%. For such a big punt, you’ve got to be looking at a potential upside far greater than that.
So in my view we won’t see FTTx in any meaningful scale until some way through the next decade, which means we probably won’t see the benefits (if there are any) until the decade after that. Which is fair enough in my view if you are the one who has to pay for it all.
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Topics: BT, FTTH, next generation networks, share buy back |
May 25th, 2007 at 11:08 am
I wondered if the author actually has an on-demand TV service at his home (which he has been using for some time). I don’t believe that someone who has become used to watching TV on their own timetable would describe on-demand TV as merely “a souped up version of free to air”. When the public learns about the benefits of on-demand, 20% penetration rate forecasts will look as conservative as those old 20% penetration forecasts for mobile do now.
May 25th, 2007 at 12:02 pm
Guilty as charged. I don’t have an on-demand service and there is zero chance of me getting one because of network reach issues.
That’s not the point though. If I could, would I pay £4 a month for it? Would my mum, my gran, my aunts, uncles, cousins…? The lower the penetration, the more Keith’s £4 goes up because it is based on 100% penetration (of BT and Cable areas).
If that is in fact 50% penetration of BT areas, the £4 becomes £12.50 to make his numbers work for BT’s investors. Would you pay £12.50 extra on top of your phone bill? Would your relatives who care little for telecoms and IP technology? So maybe it would then be 20%, but would you then pay the £31.25 it would take to make the numbers work..?
The point is that £4 is a virtuous circle that is really hard and really expensive to make work. It requires a huge loss leader for many years and why should BT pay that under-utilisation cost when there is no competition?
Forget the “souped up…” - read the Precious Hour post for a more balanced view on the attractiveness of on-demand.