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. 

What Next for T-Mobile USA?

AT&T easily will survive any failure of its bid to buy T-Mobile USA. T-Mobile USA, on the other hand, will continue to face strategic problems. A distant fourth in the U.S. mobile market, with no spectrum available to launch a fourth-generation network, T-Mobile USA either has to spend lots more money to try and catch up to AT&T and Verizon Wireless, or must exit the U.S. market. Few think its parent, Deutsche Telekom, has the appetite for investing.


That suggests T-Mobile USA will still be looking to sell, in the event of a failure of the AT&T bid to buy T-Mobile USA. One issue is the pool of potential buyers. But a significant strategic issue is the value of the asset in a mobile market where being "in the middle" is difficult.


AT&T and Verizon Wireless clearly lead the higher end of the market. Many other larger-regional providers lead the lower end of the market, especially the prepaid segment. That leaves firms such as Sprint and T-Mobile USA in an arguably exposed position, vulnerable to lower-cost providers on the lower end and pressure from the market leaders at the top. 


At a practical level, competing with the larger national contestants means heavy advertising and marketing costs. In some cases, the regional providers can be more targeted about such spending. And that's part of the rub. The providers of lower-cost prepaid services succeed in part by controlling their overhead costs, allowing them to offer lower prices. 


The contrast is perhaps not so stark as the positioning of a mass market retailer between Tiffany and Wal-Mart, or between Tiffany and Amazon.com, but it is the same general problem. 

T-Mobile USA has lost 850,000 contract customers in 2011. In the third quarter, sales fell 2.3 percent to $5.23 billion, though earnings rose 3.8 percent to $332 million. One wonders if earnings rose because T-Mobile USA essentially stopped investing as it would have, if it thought it was going to be an on-going business.

T-Mobile gained 826,000 prepaid customers in this year's first nine months of 2011. The problem is that profit margins for such customers are lower than margins for prepaid customers. Also, T-Mobile USA is the only service provide of the top four without the ability to sell the Apple iPhone. Deutsche Telekom's unsolved problem

Spectrum assets are another issue. T-Mobile USA’s CEO, Philipp Humm, made the point at a May 2011 hearing on the merger before the Senate Judiciary Committee. “As data usage continues to explode, spectrum is becoming a constraint to our business, with T-Mobile facing spectrum exhaust over the next couple of years in a number of significant markets,” Humm said. “Moreover, our spectrum holdings will not allow us to launch [Long Term Evolution]. ” No independent future?

CTIA Backs Net Neutrality Rules

CTIA-the Wireless Association, a trade group that represents wireless carriers, filed a motion in federal court supporting the Federal Communications Commission's net neutrality regulations. CTIA backs net neutrality rules: 


Four public interest groups, including Free Press, have sued the FCC, arguing that the agency's net neutrality rules do not go far enough. 

The CTIA filing might strike some as odd, to the extent that the industry group is supporting mandatory "best effort only" broadband access. Sometimes, half a loaf is better than no loaf. The rules allow mobile service providers greater freedom to manage their networks, in principle also preserving the ability to create quality of service mechanisms. 


Even for service providers that operate both fixed and mobile networks, freedom for the strategic mobile business means it is an acceptable compromise to give up the ability to create quality of service mechanisms for fixed line broadband access. 


Of course, there already is a challenge to all of the rules, filed by Verizon Wireless, so fixed-line interests are not completely sacrificed as a result of CTIA support for the net neutrality rules. 


For some, net neutrality is about denying ISPs the legal right to create new revenue-generating products that create quality of service mechanisms, as this is said to create a "two tier" Internet. Sometimes people mistakenly believe it is about "content blocking." 


In the former case, if there are restraint of trade issues, they can be dealt with by the Federal Trade Commission. There is a legitimate concern that ISPs might favor their own services over rival services by applying QoS only to "owned" services, not to all services willing to pay for such QoS. But many would note that other remedies already exist for such situations. 


In the latter case, the FCC and all ISPs already have agreed that consumers have the right to access all lawful content. 


For others it is about both consumer choice and network management, in the former case the right of a consumer to buy services that optimize voice, video or gaming experiences, in the latter case the simple necessity of managing a shared resource. In either case, anti-competitive conduct can be restrained by either effective market competition or the FTC. 

Is "4G Plus DirecTV" a Viable Alternative to FiOS?

Verizon Wireless seems to be cooking up an out of market “video plus broadband” plan, working with DirecTV. During its recent quarterly earnings report, Fran Shammo, Verizon Communications EVP said that the company was working on such an effort.

“You're going to see that come in the fourth quarter with the what we now call the Cantenna, which is not a commercial name obviously, but it's the antenna that we actually trialed with DIRECTV, which was extremely successful,” said Shammo.

Some will legitimately wonder whether that approach might even wind up being used in some Verizon markets where FiOS has not already started to be deployed. LTE plus DirecTV

There are some significant Verizon markets including cities like Boston, Buffalo, N.Y, Baltimore and Alexandria, Va. where FiOS construction has not started.

The obvious new question is the rational approach Verizon should take to upgrading its fixed-line network. There isn’t much doubt about optical access media being more resistant to some weather-related impairments than copper networks, nor is there much doubt that new optical facilities cost less to maintain than older copper networks.

But the business question is how much incremental investment ought to be made in the fixed network,  if video and broadband services can be provided using the wireless network. One might rationally argue that the cost of maintaining the fourth generation wireless network is lower than the cost of maintaining the FiOS network.

Obviously, if that is true then the avoided capital investment in new optical facilities is significant as well. That isn’t to argue that fixed and wireless networks are in any way equivalent in terms of absolute bandwidth. But there is a financial question.

If the expected revenue and operating cost advantage of FiOS, compared to 4G, does not provide the optimal financial return, then a wireless solution might be the most-rational way to invest new capital.

The problem is that voice is a negligible contributor to incremental revenue on a FiOS network, while video, though an important contributor of revenue, is not such a great contributor to profits. That leaves broadband, and revenue upside is tough.

That is not to say fiber to home facilities are unimportant, merely to say that they might not be the best use of capital for a provider that also is investing heavily in mobile broadband.

In fact, there is an interesting bit of data in the latest report from Akamai on global Internet usage. The global average fixed-line connection speed was 2.6 Mbps, and the global average peak connection speed was 11.4 Mbps.

Looking at mobile broadband connections, average connection speeds on known mobile providers ranged from 5.3 Mbps down to 209 kbps, while “average” peak connection speeds ranged from 23.4 Mbps down to 1.2 Mbps.

The interesting observation is that wireless broadband has the higher peak speeds, about double that of fixed line connections, with a variable “average” speed that in some cases also is twice as high as fixed-line connections, though such sessions are highly variable. When mobile broadband is slow, it is an order of magnitude slower than fixed line connections. Global broadband speeds

Wireless Revenue Slowdown?

Both AT&T and Verizon's postpaid average revenue per user growth in the third quarter was slightly lower than consensus estimates.

These trends are prompting analysts to ask whether wireless service, traditionally the telecom industry's most dynamic sector, is headed for a slump. A delay in launching the iPhone 4S probably was a factor.

Nomura Securities analyst Mike McCormack says he is "concerned about the outlook for the economics of the wireless business." McCormack notes that Verizon's wireless service revenues grew 6.1 percent in the third quarter, compared to 6.6 percent in the second quarter.

"We remain concerned about consistent industry deceleration in total service revenue," he added.

Macquarie Capital analyst Kevin Smithen also speculates about whether "some adverse macroeconomic effects [are] beginning to creep through to the carriers."

Wireless Revenue Slowdown?