Wholesaling isn't a dirty word
Not many topics stir more fundamental debate within the sector than whether operators should voluntarily open up their networks to wholesale business or not. At New Street, we have ongoing debates between us in the office about whether operators really are better off doing it or not. There are so many variables at play: the opportunity of new high margin revenue streams - but what about the threat of losing retail customers, or causing damage to overall market pricing structure. Which one is bigger?
And we aren’t the only people debating this. In the past we believe this has been a hot topic at Vodafone, where the previous CEO, Vittorio Colao was a vocal advocate of not opening his networks up to wholesale business, unless done so at a suitably high rate. He also felt that by refusing access to MVNOs at low rates, this would lead to a behavioural change at the other MNOs and MVNOs might get shut out of the market, leading to broader market repair. Sadly, this turned out to be wishful thinking as other MNOs gladly saw more upside from our earlier equation. They didn’t see any incremental market damage and they picked up valuable high margin wholesale revenue from a competitor. Pure upside. As a sign of the controversy that this debate can cause, the new CEO now seems to be partially reversing this strategy and is now open to more wholesale opportunities. Better sweated assets should mean a better return for Vodafone, if retail markets don’t deteriorate as a result - see HERE for more details on this. In Europe, we certainly do think most of the retail damage has already been done.
This week, we explored HERE in this theme piece whether cable operators should now follow the MNOs and also offer their networks up to wholesale voluntarily. While for MNOs, we have always struggled with the angle that any network had clear differentiation which deserved a price premium and shouldn’t open itself up to competitors, this is more clear cut in cable where they clearly have network differentiation against the incumbents and have therefore been concerned about the potential damage to their retail franchise. At least for now.
With incumbents like BT and DT gradually beginning the upgrade path to FTTH, cable network speed is likely to become less of a differentiator. Furthermore, with sector ROCEs low and therefore less pressure likely from market wide retail broadband price cuts, the equation for a cable operator can now look more favourable - especially if they set the wholesale rate appropriately. Take Virgin Media - their current ARPU is £51 and we estimate their incremental cash conversion per average subscriber might be c.45% implying incremental cash profits of c.£22/ month. We assumed Virgin could offer a wholesale product at c.£20/ month, slightly undercutting BT’s rate to unbundlers and over a far wider area. So if all Virgin’s customers migrate over to wholesale, they would lose out (but not by much) – but then more importantly, if some of the other resellers can use their different brand messages to bring customers over to Virgin, it doesn’t take many migrations across before the model can be nicely profitable. We assumed 15% of the available competitor subscribers could migrate over, and Liberty can add 10% to their current equity value. Not bad for sweating the asset more aggressively. Vodafone should be able to achieve the same in Germany – so offers to United Internet and Sky could follow on from their initial offer to O2D.
This is all about voluntarily opening up the network. Where investors really have shown concern is when there is regulatory intervention – however, even this concern can often be overblown. As we saw in the US back in 2016 (see HERE), investors were concerned about cable networks being forced open by Democrat lawmakers, and there were similar concerns in Belgium that cost-plus regulation could lead to aggressive cuts in wholesale rates (see HERE). However, peak fear on these issues also proved to be greater buying opportunities. So, although forced wholesale can still bring with it risks – even those might be overstated, and where it is done voluntarily, assuming the appropriate rate is set, we believe European cable wholesale is something than investors should no longer shy away from.