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.


Somerset said...

Many years ago BT proposed to 'fibre' the UK but this was stopped by the government to protect the new cable TV industry as BT could have used it for video. It was only a few years ago that BT was permitted to install FTTP although business products such as ISDN, private circuits and internet access have been provided over fibre for years.

Where is the return on investment for installing FTTP in a Virgin Media area?

Clearly the FTTH Council are just a suppliers organisation, keen to sell their products, and are confused by FTTC which is being installed across the UK. With FOD being introduced how does that fit in?

Benoît Felten said...

It's like you were barred from writing and the floodgates have just opened! Hope to read more in this vein!

And of course, you are correct. In the UK maybe more than anywhere else in Europe, the regulator is also deeply not interested in disruption. Ultimately, the only governments that will affect change are those who care, have money and don't care about being reelected too much. Not many of those around.

chris said...

Keep writing! you'll get the odd troll but like Ben says you are correct, and history will prove you right if nothing else. I think the secret to changing things and still having happy BT shareholders is if funding went to altnets to provide much needed competition and connectivity to underserved areas. This will make us a digital nation if we can get a connection to everyone. The new fibre networks will be far superior to anything delivered over copper and will stimulate the telcos to upgrade, the ROI will be faster cos take up would be better. The networks once built will be far cheaper to run thus bringing even more cash in for the pension funds. win win.