Wednesday, December 7, 2011

Do Service Providers Earn Back Their Cost of Capital?

To the extent that all U.S. broadband networks rely on private capital to invest in new broadband facilities, the question of financial return for such investments is fundamental. After all, telcos, cable companies, satellite and wireless providers go to private markets for the funding to build their broadband networks, and those investors have lots of choices.

If the financial return, and the risk, of broadband facilities investment do not roughly match or exceed what is available from alternative investments, those investments will not be made, and it won't matter much how much people scream about what they can't get.

In that regard, it is fair to note that many investors no longer consider telecom an especially desirable investment. It is rare these days to find a venture capitalist willing to consider backing a new telecom equipment supplier, for example. To the extent that interest remains, it is centered on mobile and mobile applications.

And there are reasons for that investor caution. Any perusal of industry statistics or quarterly or annual financial reports, at least in developed markets, will show stress around the traditional revenue sources most communications or video suppliers rely on. 

Growth rates are down, subscriber trends are negative in many cases, profit margins are lower than has been the case historically, and there is more competition and a shift of value elsewhere in the Internet, broadband and wireless ecosystems. 

In fact, Bernstein analyst Craig Moffett argues that, over the last decade, the returns on invested capital in communications networks in U.S. markets have been anemic, at best. He argues that economic value creation has been, in aggregate, barely positive.

Wireline networks have the weakest returns on invested capital with a 1.5 percent gain over the last decade. Wireless networks had a meager return of 0.3 percent. Cable garnered a 2.5 percent return. Satellite networks had the best return on invested capital at 5.5 percent. Others, including AT&T, Comcast, Dish,Sprint and Verizon, have negative returns, Moffett argues.

It probably goes without saying that potential end user shifts in the direction of over the top video entertainment do represent a threat to subscription video revenues now earned by telcos, cable and satellite companies.

A new study by Edelman suggests U.S. consumers are are disenchanted with their entertainment choices. Only about 17 percent of respondents think entertainment sources today provide “very good” or “excellent value.” That should send up a warning flag about the latent potential demand for different video and other entertainment options. 

Declining entertainment value obviously creates a gap that competing providers might be able to exploit. Unlike many other businesses, though, the video entertainment business is unusually controlled by content creators and distributors, rather than distributors. DirecTV, for example, recently had unusual success with its “Sunday Ticket” service delivering National Football League games, says Michael White, DirecTV Chairman, Chief Executive Officer and President.

Those sorts of issues mean there is potential for alternative distribution methods, so long as content providers are willing to cooperate. For fixed-line access providers, there are other issues, beyond a threat to existing video service revenues, though. Some would argue that fixed networks already have trouble earning a return on invested capital that justifies deploying that capital.

Whether or not a provider of goods and services can remain in business is not a consumer's problem, of course. But the apparent difficulty of making money in the fixed-line service provider business is a key concern for service providers, naturally. 

Beyond that, to the extent fixed access networks are seen as a key underpinning of economic growth, and a "national resource," there are key public policy issues. Specifically, if robust and high-speed broadband access is a "public good," inability to earn a return on invested capital is a broader problem. 

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