Last week Megabuyte Forum hosted a dinner for Telecoms and Networks CEOs and private equity investors ahead of the publication of our latest, 77-page, Insight report into the sector (*). The focus was the business telecoms market, a contradictory market if ever there was one; in revenue decline but with improving profitability, and with a clear mismatch between risk and reward. On the whole, CEOs in this part of the market have more to smile about than their mobile network counterparts.
The dinner was attended by a broad cross section of telecoms companies and investors; from mass market consumer-focussed businesses, through business telecoms resellers, network operators, companies with substantial data centre and hosting activities alongside telecoms, through to new, small companies specialising in hosted voice and unified communications.
The companies operate in a UK business telecoms market that has been falling since 2008, with an estimated 3% decline last year taking it to 8% off its peak. Fixed voice has been in structural decline for many years whilst mobile, which accounts for nearly half the market, is now also in revenue decline. There are bright spots – notably hosting and Ethernet – with data just about growing, but there are also legacy data services such as ATM and Frame Relay. Perhaps the most telling statistic is that total business fixed and mobile voice minutes, as measured by Ofcom, started falling in 2012, with communications shifting towards IP-based services; unified comms, over the top messaging, email etc.
Despite declining revenues, most of the companies that we track, including BT, have grown their EBITDA margins by 3-5pp on average over the last three years, begging the question as to how. An obvious source for some highlighted at the dinner is MTR arbitrage; basically not passing on reduced mobile termination rate reductions in full or straight away in terms of lower retail prices for fixed to mobile calls. Note that this is in stark contrast to the mobile network operators, where falling MTRs (and EU roaming rates) are knocking 4-5% off revenues, which goes straight down to the bottom line. Just like the companies they serve, telcos are also benefitting from cost efficiencies arising from new technology, whilst falls in telecoms hardware costs makes it a deflationary environment for costs as well as prices.
What is also apparent is the wide range of opportunity for business telecom providers, and the relatively low barriers to entry for new service providers, though with such a dynamic market comes risks from picking the wrong markets, services or technologies. The ten or so telcos represented at the dinner have noticeably different elements to their business models, whether service offerings, target customer segments, routes to market, network ownership or resale, and so on. Most are profitable and reasonably or very cash generative, and some are even achieving organic growth. There is plenty of scope for M&A which, in contrast say to software businesses, tends to generate immediate and significant cost synergies. The big irony in the market is that, whilst the asset rich networks take the risks in investing in new technologies and products, the resellers generally enjoy the best FCF returns. Depending on product mix, they enjoy decent EBITDA margins from having reasonably competitive wholesale supply, have very minimal capex requirements, and enjoy better operating cash conversion.
Before we get too carried away, few of the companies that we track over £100m revenues are generating organic growth, mainly because such companies tend to generate reasonable chunks of their revenue from fixed voice calls and lines and equipment supply, and it is hard to see where growth is going to come from. 4G may in time return mobile to growth, while investment in data centre and hosting services makes sense for some, but involves time and cost in acquiring new skills. At the end of the day, BT’s market share continues to be the obvious target, with just 5% of BT’s estimated business telecoms EBITDA equal to the combined EBITDA of Alternative Networks, Gamma, XLN and Unicom!
(*) The latest Megabuyte Insight report into the UK business telecoms market contains analysis of market trends, major players, business models, and corporate activity, as well as one page profiles on 43 leading UK headquartered players. The report is available to purchase; please see here for details.
