Thursday, March 14, 2013


One of the greatest sources of disappointment in life is our own unrealistic expectations. If you found yourself stuck at sea on a lifeboat with a tiger, you wouldn't expect it to suddenly adopt a vegan lifestyle just because doing so would save your ass. You wouldn't expect a bureaucrat to ever advocate less red tape. Turkeys don't vote for Christmas, and incumbent telco shareholders don't advocate cannibalising the assets they generously received through privatisation - assets which, through their eyes, have decades of life still left in them. People and institutions (which are made of people, well most of them anyway, with the possible exception of Goldman Sachs) will almost never give you what you want, apart from occasions when their self-interest coincides with yours.

But some people never learn. You can't swing a dead router these days without hitting someone who thinks it's down to the government to solve the broadband problem. Without wanting to make this an overtly political post, does anyone really believe the government is best-placed to do that, when it seems to struggle to optimize the things it already does? I guess there could be a financial incentive, in the form of taxing under-utilized bandwidth on "ultrafast" broadband connections, but I hate to think of the implementation schedule. Whereas Singapore, Australia and New Zealand have all taken radical approaches to stimulating fibre deployment, the UK government's approach has been incrementalist, and based on its recent form in providing public funding for NGA, I'm not hugely encouraged, to say the least, though I would stop short of saying that the entire venture has failed to stimulate the economy - a not inconsiderable number of lawyers and consultants will no doubt be paying someone to dig swimming pools at their second homes this spring. Every little helps.

So, inevitably, the focus of everyone's ire turns to BT. A few weeks back, at the FTTH Council Europe event in London, one panel I attended contained a great sound bite from a BT apparatchik, which was, "We think that if the really compelling applications which require fibre are still 10 years away, then we should wait until then to build the networks." He said this with a straight face, but his was the only one in the room, apart from his public affairs colleague, who seemed to quietly spit blood any time anyone else on the panel spoke.

Waiting 10 years to start building networks which take 10 years to build means that we get the "networks of tomorrow" 10 years later than they are required. Okay, you and I know it's silly, and he probably knows it's silly too, but everyone's got to feed their kids, and we all end up spouting someone else's dogma at some point, gritting our teeth as we think about paying off credit cards, taking the family away somewhere nice, or building a loft extension.

Then again, it's not silly at all, in light of my opening paragraph. I'll spare you a repeat of all the constraints on BT from a balance sheet perspective, but they are material, and the company has to manage the complex demands of shareholders, lenders, customers, and the regulator. Moreover, from its own perspective, and those of its shareholders, it would be cannibalising existing assets and crushing its own cash flows if it were much more aggressive in deploying true FTTP (how it could possibly be less aggressive, is an imponderable question).

To borrow Mr. Livingston's analogy from several years back, would Ford shareholders back a £20bn investment program to upgrade all its plants to produce Ferraris, when people are still buying Fords? Probably not, unless north of 30% of the market started buying Ferraris instead of Fords, however, that would require someone to sell Ferraris in volume, and at the moment, there is no one on the UK broadband scene able to pose that sort of threat, yet. As a result, viewed through the lens of BT, why fix it if it ain't broke?

But surely the "B" stands for British, and good old BT genuinely cares about the long-term competitiveness of UK plc, right? I'm sure that's true (apart from competitiveness as in "competition in infrastructure"), and in my experience the company never misses a chance at NextGen Roadshows to trumpet its contribution to regional and national employment (which I've always read more as a veiled threat to government, but I'm probably just paranoid). And surely its shareholders, in investing in a British company, are implicitly backing UK plc, right? After all, a stronger and more innovative economy in the UK ultimately means better demand for BT products, and greater spending capacity on the part of customers. So, BT shareholders should surely be aligned with the national agenda there, right?

Well, actually, probably not.

My friend Benoit (who very kindly posted something nice on my return), recently pointed to an interesting article by our friend Stefan, who has derived an average holding period of less than one year for investors in incumbent telcos. This underlines his view (which I have shared for many years) that the investor base of these companies is fundamentally unsuited to backing long-term transformational investment programs such as FTTH.

For those unaccustomed to the investment banking or asset management worlds, I would stress that this is nothing unique to telecoms, by any means. Traditional "long-only" fund managers are routinely (monthly, quarterly, annually, as befits their firms' policies) appraised on the basis of their performance relative to a defined benchmark, for example the MSCI or the STOXX. Whatever the relevant benchmark, the fund manager and his team will have a stance on which sectors they are more or less confident about, and this is reflected in the weightings of sectors within the portfolio, which are constantly reappraised and tweaked.

For example, if telecoms accounted for 10% of the total European market by capitalisation, and the fund manager were confident of the sector's prospective performance, he might put 11 - 15% of his portfolio into the sector (otherwise known as an "overweight" position), at the expense of some other sector. Conversely, a pessimistic view might take him "underweight" by the same sort of margin. It is extremely unusual, in my experience, for a traditional fund to have a "zero weighting" in a particular sector, apart from perhaps short periods surrounding cataclysmic market disruptions, such as 9/11 or the Lehman collapse.

The risk of being seriously underweight, or zero-weight, in a given sector is that, obviously, if something unforeseen or technically-driven occurs, it can be very damaging to performance - for example, the technical dislocations of the market in the immediate wake of 9/11 drove investors out of airlines and insurance companies, and into telecom, providing a brief and dramatic reversal of fortunes in a sector which had been bottom-of-the-barrel consistently for over a year. Anyone seriously underweight telecom at that point would have been racing to catch the pack.

In any event, given that most traditional funds can only deal with the market in such a fairly conservative fashion at the sector level, the secret to success thus lies in stock selection. Even here, there are technical factors at work - the likes of Vodafone and Telefonica have traditionally been such large constituents of the sector, that most funds would own one or both as core holdings, and then selectively augment their portfolio with some smaller names.

All the constituent telecom stocks of the portfolio are typically subject to regular adjustments in size. Positions in stocks which have done well, but are now pushing the envelope on valuation grounds, might be pared back in favour of those which have lagged. For some smaller holdings, it isn't at all uncommon for the fund manager to switch completely out of one name (Telenor, for example) and into another (KPN, for example), subject to his criteria around valuation, macro environment, technical indicators, or adverse developments in corporate strategy or policy.

Typically, any corporate policy likely to threaten dividend income for the investor, or to risk seriously constraining company cash flow in the short term will be punished by shareholder flight. For example, a major capex program - for a graphic reminder, look back at Verizon's torrid share price performance post its commitment to FiOS. No matter that Verizon's decision would appear to be, by most accounts, resoundingly vindicated as we look back at it today. At the time, people freaked out.

This is, sadly, just the nature of institutional asset management, which is a highly competitive industry in its own right, forever measuring its performance over the last quarter against peers and rivals. If you want aggressive, bold, long-term directional commitment to sometimes unconventional strategies, invest in Berkshire Hathaway, because the mainstream industry is considerably more fickle and short-termist. That's what it has to be in order to remain what it is, so to speak.

And just like BT, the pension fund or insurance company fund manager has a duty to maximise returns and minimise downside risks for his investors and beneficiaries, even if they live in the UK and would benefit in the long term from an improved macroeconomic environment enhanced by fibre. If BT made an aggressive plunge into FTTP, which saw the share price crater and dividends reduced, trust me, Mr. UK Fund Manager would soon find better value in a Hungarian cable company, and he'd be gone with the wind, only to return once the model had either been proven, or abandoned.

Which, to Stefan's point, is precisely why Mr. UK Fund Manager is not the right source of long-term, patient money with which to fund the huge investment required for FTTH, at least not via incumbents, because funds invest in incumbents for cash flow and stability, on the whole, not as long-tail investments which burn a lot of cash in the early years. The very investment thesis is thus completely inconsistent and unpalatable for both the investor and the incumbent, so there's no logical reason for either to go there, in terms of the ways they view the world.

On top of this fundamental problem in the market, I see one other source of misalignment, and that is the national domicile of some of the institutions which invest in incumbents. A colleague once told me that this was a red herring, and I'm not trying to go "all nationalistic and shit," but it is a fact that the age of globalization means that there is no longer a clear correlation between the home market of a telco and its shareholder base, which I believe reduces the level of alignment between the national economic agenda and the behaviour of the incumbent in making new investments.

For example, going back to the "B" in BT, a good friend and former colleague still in the financial markets pulled down the shareholder register for BT (as compiled by Bloomberg) a couple of days ago, as a favour to me. Given that it's a list compiled by a third party, it may not be considered authoritative, but it certainly makes interesting reading. If the data is correct, then of the 63 institutional shareholdings identified as being 0.5% of the company or more, 23 are held by funds classified as being non-British. However, the non-British positions are more concentrated, with six of the top ten holdings being non-British, and the aggregate of all holdings above 0.5% shows a split of 42% of the company in non-British funds, and 49% in British funds.

So, to recap, not only is Mr. UK Fund Manager not likely to back a bold digression from the current strategy in the interest of helping transform the country, but something like half the company is in the hands of people who have no skin in the game at all. That sounds harsh, but let's be realistic - what real interest does a Dutch public sector pension fund, the Norwegian sovereign wealth fund, or the People's Republic of China really have in seeing an improvement in the competitiveness of the British economy, let alone future-proof connectivity for Coventry, Newport or Falkirk?

I use the names of relatively obscure British towns by design, because these are the sorts of places that feel the greatest need for fibre, as a differentiator which aids new business formation, business retention, and improves the quality of life for residents. However, institutional investors don't see things down to this level, not even within the UK, let alone outside it. It's not what they do. It's not what they're paid to do. Telco shares are assets in a thoroughly globalized game of Monopoly, where, when one tires of Fleet Street, it's easily sold, and Picadilly is bought. The fact that real people's lives and livelihoods, and the future of the economy, may hang in the balance, doesn't enter into it. Thus the national telco is, in the eyes of the shareholders who drive it, abstracted from the future of the economy it serves, despite having potentially such a huge influence on what that future looks like. It's a strange state of affairs, but not at all uncommon, and it's just the way the world works today.

So, where does all this leave us? Well, when it comes to FTTH, to paraphrase David Cameron, we're all in this together. All of us, that is, apart from the government, institutional investors in BT, and BT itself, none of which are remotely aligned to an agenda which says that the country needs ubiquitous fibre provided by the incumbent. Therefore, I think we should all stop expecting any of them to form any meaningful part of the solution.

Tuesday, March 12, 2013

Value perceptions

To the discerning blog-watcher, it's a pretty much tried and true generalisation that when a long-dormant blog suddenly springs back to life, there must be some sort of career or life hiccup underlying somewhere. I am far too discrete to say, but, let's put it this way - you're going to be hearing a lot more from me now, and I am in search of new opportunities and adventures, so don't hesitate to let me hear from you if you have anything interesting in mind.

During my two years at CityFibre, one of the recurring assertions I heard from sceptics was that the UK is somehow an exceptional market, in which there is no scope for a competitive fibre-based infrastructure. I always vehemently disagreed with this view, which seemed invariably to be based on two perceptions:

1) that the UK consumer has been ground down by decades of underinvestment in every category of infrastructure, and is now de-sensitized to such an extent that the barely acceptable passes as the norm. A logical extension of this argument is that, whatever is on offer from the two infrastructure incumbents is good enough, and anyway, where is the proof that there's a market out there for anything different, or, God forbid, even better? And if there is a market, where is the proof that consumers would pay more?;

2) that the structure of pricing in the market is a natural barrier to entry, as consumers are willing to spend far more on a few pints in a ghastly West End pub on a night out than on an entire month's worth of broadband.

I have some sympathy with Argument 2, which relates to the reality distortion field created by LLU economics, under which consumers have come to expect that "broadband" costs tuppence (with the first six months free!), yet blithely accept increases in POTS line rental charges at rates several times the level of consumer inflation, year in, year out. Perversely, the legacy service which has a precipitously declining perceived value, is the cost of entry to the broadband product, which is increasingly perceived as being indispensable to modern life, but still expected to be dirt cheap.

I explained this situation to some Dutch friends recently, who shook their heads uncomprehendingly, and though I'm not a lawyer (I'd rather nail my privates to the floor), I believe such blatantly coercive product bundling is illegal in at least one EU country. Still, if it works and the majority don't complain, why tamper with the status quo?

I've long believed that one way around this conundrum would be a consumer education campaign to encourage a "total cost of ownership" (TCO) view of the world. From conversations I've had with non-industry folk in the UK, it strikes me that most people in my non-scientific sample seem to disregard POTS line rental as some sort of necessary evil about which nothing can be done (if they even notice that they're paying it), and prefer to focus on what a great price they got on their broadband product, often complaining about the quality and reliability of it in almost the same breath.

So, perhaps there are elements of both Arguments 1 and 2 at work here, after all, and the consumer has been thoroughly conditioned by the pricing policies of the Big 4 service providers, who have absolutely no incentive to change their marketing strategies. Hell, even disruptive newcomers Hyperoptic have latched onto this formula, building a mandatory telephony package into their products (or a £10 supplement for broadband only), presumably in order to keep their broadband pricing optically in line with market ranges. Frankly, if it's an established precedent in the market there for the taking, they'd be stupid not to do so.

Therefore, if we take it as read that the UK consumer has been thoroughly conditioned to believe that broadband is a low-value commodity product, then the dilemma for the newcomer deploying superior infrastructure lies in differentiating the product to break the cycle and promote (or perhaps "provoke" is a better word) a reappraisal of the value of broadband in the consumer's mind.

The pricing prevalent in the market today is what it is, and it will always be a constraint to some considerable extent, but it is only an absolute block to progress if fibre is sold simply as "a better form of broadband." So why not sell it as something different, with a (I'm now going to use a term I hate) "value proposition" based on different parameters? If the industry can create a perception of value in the mind of the consumer which sets "true" fibre apart, and then quantify its specific benefits over legacy hybrid copper/coax fibre products, then I believe there may be some mechanism for breaking the "lowest common denominator" mentality which dominates the market at the moment.

Consider for a moment the development of the subset of food products now claiming to be some combination of organic/free range/sustainable/ethically produced/all-natural, in response to a change in consumer attitudes towards health, the environment, and animal ethics. Have they entirely replaced legacy products? No, but they didn't really exist in the mainstream a little more than 10 years ago, and they're not going away. They command a premium among the audience which buys them, because they deliver a perceived benefit - sometimes something quite tangible (better flavour, lower fat content, lower risk of chemical contamination), and conversely, sometimes highly abstract (a feeling of making a difference, saving the planet, not being part of the problem, etc.).

Compared to the complexity of changing the food chain, fibre would seem to have a relatively simple task in selling itself as something with a higher perceived value to the consumer, if only on the basis of crude economic self-interest.

Greater productivity, particularly as it relates to the time compression allowed by higher upload speeds, is an easy one (which Verizon FiOS has cleverly exploited as a key marketing message versus cable). Everyone has some idea of the monetary value of their time (especially lawyers, psychiatrists and management consultants), and being able to quantify the potential time savings in monetary terms is a potentially powerful message in support of premium pricing. "How much would it be worth to you to get a day of your life back every year?"

This recent piece of research from ICM provokes some interesting questions in my mind. ICM found that 22% of respondents to its survey claimed they would be willing to pay between 4% and 10% more for a home with good broadband. The definition of "good" is always highly subjective in the UK, and presumably "true" fibre would command a premium even above "good." Nevertheless, even if we take this 4 - 10% range at face value, it is a not-inconsiderable amount of money.

On a house worth, say £250,000 (people in Greater London are laughing now, but let's just keep the maths simple, eh?), 4 - 10% would imply £10 - 25k, which over 20 years works out at £42 - 104 per month in additional perceived value. Interestingly, the bottom of this range (£42), is pretty much the top of the range for TCO (including the accursed line rental) on a monthly basis in the mainstream broadband market. Am I alone in seeing a disconnect here? By which I mean, a disconnect which can be developed and exploited to challenge consumers' perceptions of the true value of broadband, and nudge them away from thinking that this essential enabler of modern life should cost the same as a packet of crisps?