6 degrees of Kevin Bacon, 5 ways to catch a subscriber – consolidation in cable

I’d been feeling pretty pleased with myself since last Saturday – I managed to get Sky TV, broadband and a landline installed in my flat. That was until earlier today, when after discussing some of the recent activity in this sector with our telecoms and media analyst, I was left feeling something of a technology dinosaur.

These three services sold as a single package is called a “triple play” offer. However, I have since discovered that this is so 2010. These days it’s increasingly about “quad play”, whereby consumers access video, broadband and voice services both inside and outside the home. Inside the home is provided by your cable, copper telephone line and/or satellite dish whilst outside connectivity is provided by a mobile network. The most visible example of this business model in the UK comes from Everything Everywhere (EE), mostly due to their……um……interesting adverts featuring Kevin Bacon. EE allows a subscriber to make voice calls, surf the internet and watch video content either at home or on the move via a combined mobile and fixed line broadband connection. Advances in mobile technology (4G) now mean that seamlessly streaming a film in your house on your iPad as you eat breakfast and then on your journey to work should be possible. This is the direction the industry is moving in the UK, with Vodafone, 3 and O2 expected to launch later in the year once they secure the necessary 4G spectrum that is currently being auctioned. In the US and portions of Western Europe it is already there.

So quad-play has a clear consumer proposition, i.e. ubiquitous and fast media consumption and connectivity from a single service provider. But what benefit do the telecom operators derive from this service? Firstly, they hope to stem the revenue declines and customer churn they have experienced over the past few years as a combination of competition and regulation have ground down prices. Secondly, quad play offers them a cost saving opportunity by shifting data traffic off their mobile networks and on to their fixed line infrastructure as fast as possible, either via an in-home WiFi point or a fibre optic link to the network towers outdoors.

Generally speaking, in each country there is an incumbent telecom operator offering both mobile and fixed line services (the UK is an almost unique exception after BT spun off O2). However, there is also a swathe of mobile-only and fixed line-only operators in each market and hence consolidation in the face of this strong industrial logic seems inevitable.

Last Wednesday, press reports suggested that Vodafone is considering acquiring cable operator assets. Two firms seem to be in their crosshairs for now; Kabel Deutschland and ONO (which operate in Germany and Spain, respectively). Both companies’ bonds rallied on the news that they could be taken over by a company with a much stronger balance sheet – they are both high yield whilst Vodafone is solidly investment grade. We think that Kabel Deutschland would be a better fit but either way Vodafone is clearly interested in fixed line assets across Europe. Last year it bought Cable & Wireless Worldwide in the UK and its interest could also stretch to alternative fixed line network operators like Jazztel (Spain), Versatel (Germany) and Fastweb (Italy).

Similarly, Liberty Global, an international cable operator, recently made a bid for UK cable operator Virgin Media. Virgin’s bonds were weaker on the news as LGI is a lower rated entity than Virgin and plans to leverage the business to a level commensurate with its other European cable investments (UnityMedia, UPC, Telenet). LGI already offers triple play services across its extensive European cable footprint but, along with the usual scale and tax synergies, Virgin brings with it significant experience in mobile as well as providing fibre optic connections to other UK operators’ mobile towers.

What can possibly come after quad-play? Internally we refer to what we believe is the next step as “penta-play”. This involves business models where service providers offer quad play delivery and services complemented by ownership of the content being consumed over those networks. The importance of control over content to a network provider was underlined by the US’s largest cable operator Comcast, with its $17bn purchase of the remaining 49% of NBC Universal it did not already own. If you think this is a US aberration, just think what would happen to Sky if it lost the Premiership contract and why BT has recently decided to park its tanks on Sky’s lawn with its recent expansion into Premiership football and rugby.

And after that? Well the regulators will probably demand these vertically integrated behemoths are broken up but that’s another story…. From a consumer’s point of view we think that consolidation and competition, to provide us with all our communication, entertainment and informational needs under one subscription, will eventually lead to lower prices for services previously purchased separately now being provided as a single service bundle. From a bond holder’s point of view the recent activity suggest M&A risk is on the rise with negative and positive impacts depending own whether you sit in the acquirer or the target, the better rated credit or the company with the weaker balance sheet, and your specific bond covenant protections.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Matthew Russell

Job Title: Fund Manager

Specialist Subjects: Corporate bonds and ABS

Likes: Travelling, gym, reading & pool parties

Heroes: John Nash, John Stuart Mill, Ari Gold

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