Daiwa EuroTelcoblog No. 29, Thursday 11th March, 2004: BT Consumer Broadband presentation (original email blast 3:30 PM Thursday, 11th March, 2004)

BT Consumer Broadband presentation
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BT today held an event (including lunch!) at BT Tower in London which was aimed at the press/industry analysts (Analysys, Gartner, et al), with lowly brokers' analysts relegated to a webcast (note: there was a separate conference call later in the day with an analyst Q&A session). The presentation contained a plethora of interesting information and insights into BT's evolution and its efforts to harness the increasingly chaotic IP revolution to its own business agenda in driving DSL penetration from 2m currently to 5m by 2006. There were repeated references to the proliferation of communications platforms/environments, to the change in the market being customer-driven (familiar themes to those who read our EuroTelcorama No. 5), and to the need for BT to "excite" the market with new services in order to capture the second wave of broadband adotpers and retain a retail DSL market share above 40% (46% currently). In our assessment of the PTTs under our coverage, BT has for some time received top ranking in terms of adaptability, and today provided more evidence of management's market awareness and intention to attempt to co-opt disruptive offerings from newcomers. We will continue to reassess our assumptions around our BT forecasts and valuation, but for now we retain our fair value estimate of 173p and our 3 [NEUTRAL] rating.

Today's event revolved around four key new initiatives in BT's broadband strategy:

The launch of BT Communicator in September, in conjunction with Yahoo! This is effectively a co-branded, modified version of the Yahoo! enhanced voice/video IM platform, but including break-out to the PSTN.

The introduction of flexible bandwidth provisioning and incremental bandwidth purchasing via an online solution, in tandem with the introduction last week of its Broadband Basic product (512Kbps DSL with a 1GB monthly data cap).

The introduction of Rich Media on 6 April (in a separate launch event), which will provide content publication and digital rights management tools to content providers, at a price point which BT believes will stimulate content creation and distribution over its platform, not only from established media players. BT will retain a fee for each transaction effected over this platform.

The introduction of a remote management tool allowing for remote diagnostics and application management of the BT ADSL customer's PC.

BT Communicator

Of primary interest to us here is the BT Communicator, which allows free on-net voice/video calls, and a break-out to the PSTN at "standard call rates," though BT is intending to integrate the service with existing BT Together packages to drive further customer loyalty. At this point the service only supports one-to-one video calls, but a four-way video conferencing feature is in use by over 100 trial user groups at present, and is anticipated to be ready for launch in September. Numbering for the service is still in development, in consultation with the regulator, with a trial number range currently employed. (This is one key area of dissatisfaction we have heard voiced by the independent internet telephony service provider segment in the wake of the OFCOM voice over broadband meeting of 25th February. At this point it would appear that OFCOM is leaning towards "ghetto-izing" voice over broadband services by means of non-geographic numbering [056 is proposed], which we believe may make the market somewhat harder to crack for newcomers. Arguably one of the key areas of appeal for services such as Vonage and voiceglo in the US market has been the ability to sell standard NANPA numbers to consumers - an option they may be denied in the UK. BT is coming at the issue from the opposite direction, as an incremental service offering on its broadband platform, and so presumably it is not particularly disturbed by this development.)

A couple of interesting consumer behavior insights came out in the discussion of the product. According to BT's figures, one in ten instant messaging sessions culminates in a phone call, and in the youth segment where IM use is so prevalent, this is invariably over a mobile phone. BT has often spoken in the past about the need to claw back revenue lost to mobile usage within the home, and this development is consistent with that goal. By allowing a click-through from the IM interaction to a voice/video call, there may indeed be an opportunity to recapture some revenue within the youth segment. The marketing of the BT Communicator will consequently be heavily targeted at the estimated 2m current users of Yahoo! IM in the UK. There was also much made of the unified messaging features (calendar interface for "follow me" functions, etc.) embedded in the product as a differentiator. In notable contrast to the Broadband Voice product, on-net calls are free under BT Communicator, which brings the service more into line with comparable offerings from SIP service providers.

With the BT Communicator, it appears to us that BT is attempting to co-opt service offerings at both the Vonage and Skype ends of the VoIP spectrum (IP to PSTN for a fee and P2P for free), while also attempting to address/harness the threat from enhanced IM in partnership with one of the most accomplished players in this area. As such, it is an impressively aggressive response for an incumbent to make. Retail CEO Pierre Danon remarked that BT would rather cannibalize itself rather than be cannibalized, and that there were also opportunities to stimulate new usage via the product (the mobile claw-back scenario covered above). We agree in principle, but we still expect the market to grow increasingly disorderly, and in actually driving forward change, there is always a risk that change will not occur according to BT's timetable. We think one other risk for any incumbent seeking to drive change is to underestimate the innovative ability and speed-to-market of newcomers. BT crossed this line today, characterizing Skype as comparing "unfavorably" with voice IM platforms, and being "absolutely primitive" in comparison to the BT Communicator. Them's fightin' words, and we would expect a response sooner rather than later.

Two issues not raised by the journalists (there was no Q&A facility for those of us on the webcast) were the potential for: 1) Skype to break out to the PSTN imminently (we know the technical solution exists via an interface with SIP gateways, and we think billing could be achieved via a prepaid model - regulation is probably the more difficult challenge for such a global player) and; 2) for the c.350 DSL service providers in the UK to further accelerate pricing pressure via their own partnerships/white label agreements with VoIP specialists. Yesterday's announcement from deltathree seems to have gone completely unnoticed so far, and indeed there is no sign of it in Wanadoo's website today, but we think it is a pretty clear illustration of the likely response from those in the broadband market looking for product differentiation and incremental revenue streams.

Flexible Bandwidth

In tandem with the GBP19.99 1GB capped DSL service introduced by BT last week under the Broadband Basic name, BT today introduced an online, real-time bandwidth provisioning system for users of the service. This involves both purchase of incremental download capacity, but also variable bandwidth at user-specified times. In the case of the former, users of the capped service who had reached their 1GB limit would be prompted to top-up, or spend the remainder of the month on a 64kbps dial-up service, until their next 1GB data bundle came into effect the following month. In the case of the bandwidth accelerator feature, the user can move from 512kbps up to 2Mbps speed online in real time, and the adjusted speed stays effective until the user resets the bandwidth to the original setting. BT confirmed that it has included parental control features to address any concerns over costs arising from clandestine file-sharing within the family. The service is currently recruiting users for a consumer trial to begin next month. One additional feature included here is ability to upgrade or change DSL packages online in real time.

Our reaction to these innovations is that they are a shrewd marketing tool aimed at accelerating mass market penetration (BT claims that the 1GB capped service would be sufficient for around half of potential DSL users) while generating high margin "overage" charges (allowing higher speeds to capped customers accelerates the rate at which they reach their cap and must purchase more capacity). The price point of GBP19.99 is relatively attractive as an entry point for new broadband converts (though the real cost of ownership is considerably higher when we consider the GBP30 activation charge, GBP50 modem charge, and premium rate call charges for telephone technical support) and the company has provided a seamless way for users to upgrade to more expensive uncapped packages if they determine it is in their interest. As such it may prove both a market accelerator and an incremental ARPU generator at the margin. Our concern is that, in offering a capped service, BT may have opened up scope for other ISPs to exploit this issue in their marketing (NTL tried caps last year and has now backed away, and the geek sites and mailing lists we follow have roundly blasted the Broadband Basic product over the past week). Nevertheless, management today claimed that DSL sales volumes have increased in the nearly two weeks since Broadband Basic was announced, with no evidence of product cannibalization (downward migration) so far.

(Personal anecdote: Shameful though it may be to admit, this author has yet to make the broadband conversion, though we have finally signed up to NTL and should be live next week. The contrast with the BT service gives some evidence as to the ongoing challenges BT faces in the broadband market. When we enquired about BT Broadband we were told that modifications to our access line (replacing the second line with an extension from our primary line to the bedroom, where the computer is) would involve a chargeable engineer visit at an estimated cost in excess of GBP100. Following the upgrade we would be paying GBP28 per month for the standard 512kbps service. In contrast, NTL offers free installation (including modifications to the site), an introductory price of GBP10 per month for the first three months, and GBP25 per month thereafter for 600kps cable modem service. Our order was processed in one minute over the phone.)

BT Rich Media

The third interesting area of today's announcement was the Rich Media service, about which we should hear more on 6th April. The description so far is of a content publication and rights management toolkit available to content producers at a cost of under GBP100 per month, with BT taking an as-yet undisclosed commission on downloads or other purchases transacted on the platform. The comparison with i-mode is one which Pierre Danon himself highlighted, and is valid in our view. Management piqued our interest in discussing the potential for growth from independent content providers, not just "the usual suspects" of the media world, though they did claim to have signed letters of intent with 23 established media companies in the US and UK. One example given of the potential of the independent angle was the Star Trek fan club, which has seen 3m downloads in eight weeks since it began offering content via its own site. The company believes that this model, applied to ethnic groups, sports clubs, hobbyist groups, etc., offers BT the chance to generate revenue both from the syndication and transaction standpoints, and we are keen to know more.

Overall, we thought today's presentation once again highlighted BT's forward-looking approach to the changing dynamic of the market, which we believe is well ahead of many of its peers in Europe, and may serve as a template for announcements by other PTTs later this year. We should get more information on 6th April at the Rich Media launch, and on 29th April, when BT is due to hold another presentation focusing on strategy within the business segment, which we believe will contain more information on enterprise IM/VoIP solutions similar to what we saw today. Impressive as today's presentation was, we still have fundamental concerns over the true scope for all incumbents to control the pace and direction of change within their own businesses/markets. BT, though at the forefront, is no exception. We will continue to re-evaluate our assumptions on the stock, but retain our 173p fair value estimate and 3 [NEUTRAL] rating.