On May 27, at an investor strategy briefing in Sydney, Telecom laid out its financial and operational outlook for the next two years. It was a sombre picture — and one that has implications for the rest of the industry.
There is no short-term growth fix; the economic downturn has permanently reset fixed telecommunication prices. Telecom is facing declining revenues and its flat earnings (EBITDA) forecast will be achieved primarily by cost-out programmes that will help minimise the erosion, but not drive new growth.
Revenue hopes are primarily pinned on Gen-i’s IT services and XT mobile growth (despite the ‘speed bump’ attributable to the XT outages). But can these do more than offset pressure on voice and data revenues?
Gen-i needs to deliver an additional $90 million in revenues to offset the 9.5 percent decline in its fixed telecommunication business by FY11. It is also aiming for $70 million cost out.
But the IT services business, by its nature, carries higher operating costs than the traditional telco business. Gen-i is currently delivering IT solutions at a margin of 6.5 percent, with a goal of 7.8 percent by 2011 – that means it will need to both streamline its cost base, whilst also trying to deliver IT solutions (particularly the cloud and managed services) that are more scaleable. It is a tough call.
XT mobile is the other revenue centrepiece, with Telecom Retail forecasting 17.9 percent year-on-year growth to $105 million (FY11). Much was made of the fact that XT customers have higher average revenues per user (ARPU) than CDMA customers. Given that Telecom’s CDMA customer ARPU is roughly half that of Vodafone, there is clearly ground to be made up, particularly in roaming traffic, mobile broadband and new data services. IDC’s market tracker puts Telecom’s revenue market share at 39 percent in December 2009. Telecom is aiming for 43 percent revenue share by FY13.
But ARPU growth will be tough to sustain. Increasing mobile competition and lower mobile termination rates will inevitably drive down voice prices and voice yield per minute. Telecom could counteract this by disruptively pricing voice, to drive up voice usage, but this would erode its profitable fixed calling base. And whilst mobile data is a true growth sector, it is currently 30 percent of Telecom’s total mobile revenues – it will need truly stellar growth to significantly offset the voice squeeze.
So in the absence of a strong revenue story, the focus is on cost out. Telecom forecasts $622 million of cost out to FY13, through restructuring, simplification and better systems. However, experience suggests that whilst headline cost cutting can deliver short-term wins, restructuring to a sustainably lower cost base takes time to deliver, and often carries additional transition costs.
Amidst these pressures, Telecom continues to experience ongoing and substantial capital expenditure commitments. Between FY08 and FY11, Telecom’s capital expenditure will be $4.6 billion in capital expenditure. This means Telecom’s capex-to-sales ratio has been over 20 percent, compared to an industry average of 14 percent to 16 percent. Much of it is driven by regulatory requirements and undertakings via operational separation – undertakings that incur significant financial penalties if they are not complied with.
Given that these undertakings were established to address Telecom’s control over the access network into people’s homes, it is fair to say that at least a portion of this investment will be marginalised as a consequence of the Government’s ultra-fast broadband initiative. This effectively drives cost in a slow to no-growth market with little or no prospect of return.
Little wonder then that Telecom is considering structurally separating its business: a clean split between its regulated and non-regulated businesses and associated regulatory rollback may significantly shift its operational outlook.
Should Telecom’s increasing (dis)stress concern the industry? After all, it might be argued that new investment and competition is exactly what operational separation sought to achieve – and the dilution of Telecom’s market power should be a signifier of success.
But herein lies the challenge: this is a low to no-growth market. Last year, IDC estimated that over 5 years to 2013, there would be $5.3 billion industry investment into a market that is worth just $5.6 billion annually with flat topline annual growth. Today that figure may well be higher. Telecom is most exposed, but so also are Vodafone, Telstraclear, 2Degrees, FX, Compass and Kordia and the existing regional fibre investors. And this doesn’t even factor in the $3 billion plus public/private investment required for the ultra-fast broadband initiative.
What this shows is a market in a state of fundamental flux, exacerbated by the proposed separation of the industry. Much of this change is inevitable and necessary. Alongside risk will come opportunity.
Nonetheless, IDC believes this is also a red flag to policymakers and regulators, who need to be cognisant of the wider commercial and financial impacts of new initiatives. Otherwise, we risk shifting the sector from a state of positive competitive stress into financial distress, undermining investment, stranding assets and forcing consolidation.
Nelson is telecommunications research manager at IDC New Zealand