Editor’s Note: Welcome to our weekly Reality Check column. We’ve gathered a group of visionaries and veterans in the mobile industry to give their insights into the marketplace.
Whenever we talk about the wireline business, about a third of you respond positively, and about a third of you send a note asking when we’ll get back to applications, wireless churn, Facebook/Google spying, etc. The final third are probably wondering why you are reading this column in the first place.
Wireline matters because wireless, especially with the data explosion we have seen in the past three years, cannot survive without a strong fiber-based infrastructure. Across every wireless carrier, the following conversation has occurred in the past six months:
Wireless CFO (to wireless COO): OK, I get the smartphone subsidies. It’s a part of the changing business. But what about my increase in network cash costs per user?
Wireless COO (or network VP): With the smartphones come a lot of data usage. You know, Pandora, Tango, OoVoo, Fring, YouTube, etc.
Wireless CFO (thinking “Fring – really?”): So you need more connections to the towers? How much?
Wireless COOM: A lot more. Like 20 to 30 times more over the next five years as we roll out 4G.
Wireless CFO (gulping): Even along the highways?
Wireless COO: Especially along the highways and in suburbs closest to people’s homes.
Wireless CFO (sweating): Can’t we offload this to Wi-Fi? A femtocell?
Wireless COO: Not unless we want to transfer the relationship to cable or Verizon/AT&T in the home. And Wi-Fi radios can drain battery life.
Wireless CFO (exasperated): Can’t we roam? Partner with the wireless provider? Fund an alternate provider? Anything?
Wireless COO: We’re trying everything we can.
OK, it’s been a few weeks since my last wireless carrier CFO interaction, but I think you get the point. It’s not easy being a nationwide wireless carrier at the moment. Wireless customers get a smartphone, they pay $10 to $30 more per month, and they consume 20 to 100 to 500 times more data than the old flip phone did. They also make fewer voice calls, which impacts wireless average revenue per user (and costs), but voice and text consume little to no network bandwidth.
The connections from the towers to routers and onto coverage even has a dignified name: “special access.” As one who used to sell a lot of this when I was managing what is now Embarq’s part of the CenturyLink Inc. world, it’s “special” because it’s especially profitable. Not a lot of selling expenses, five year terms and scale economies. Next to switched access, which is depleting rapidly due to Voice over Internet Protocol and text messaging proliferation, it’s the easiest buck in telecom.
The closest proxy to this for the industry is the wireline “transport” revenues line in AT&T Inc.’s quarterly numbers (yes, it’s an $11 billion revenue stream each year).
Again, not all transport revenues described here are carry wholesale sales and distribution costs, but I think you get the point: transport is an annuity to AT&T and every other local exchange carrier. Even with pricing “resets” that happen annually as new circuits are ordered and terms expire, the stream is steady and profitable. In fact, I have argued that with the sharing of fiber costs with U-Verse, the actual percentage of total operating profits is likely higher than the 25% shown. Bottom line, it’s $4 to $5 billion of annual non-regulated free cash flow to fund a healthy portion of the $11 billion in wireline capital expenditures AT&T had last year.
The cable providers do not have this cash flow foundation, although they have tried to make strides in this area. Time Warner Cable now has a $1 billion per year commercial services market, largely due to the growth of its commercial high-speed Internet and data sales channel. Comcast Corp. has made some progress, as has Charter Communications. But they lack the contiguous footprint of AT&T (California, Texas) and Verizon Communications Inc. (Boston to Washington, D.C., corridor). Until they band together (call it an “access buying club”) with a consolidated set of provisioning, network management service level agreements and prices it’s going to continue to be tough to compete against the incumbents in this area.
The good news is that the cable companies do not have to care about special access because they have continued growth in high-speed Internet services to residences and businesses. And if you thought the business was good for special access, have a look at the gross margins for high-speed Internet for Time Warner Cable as reported in their trending schedules (note the high-speed data lines for residence, commercial, and cost of revenue) :
Yes, that’s one sweet gross margin (97.3% for the first quarter to be exact). Between Q1 2010 and Q1 2011, revenues from high-speed data grew $135 million. Cost of revenues grew $2 million. Said another way, the first quarter gross margin from high-speed internet could cover all of the employee costs plus the video franchise and other direct operating costs and leave $300-plus million for customer service, marketing and other selling expenses. Bottom line: High-speed data is the only thing that matters to cable. Video is legacy (still profitable, but harder to sustain and grow), and voice is growing, but, to use an example that one of my analyst friends uses to describe markets like this “the voice pool is quickly draining. Mastering your residential voice swim stroke at this point is pointless.”
Can cable sustain this growth? They seem to be holding their own against the telco fiber and the wireless plays:
As this table shows, cable continues to add twice as many subscribers as the telcos. At a $40 monthly revenue per user, the Q1 growth alone funds about $400 million in annualized revenue growth for the cable segment (remember the gross margin figures above – this flows to the bottom line). And, if cable decides to move to metered usage, the picture gets even better. Further, as we have discussed many times in the column, every iPad 2 sold without the 3G radio represents an unsubsidized cable high-speed Internet device addition. How much sweeter can it get?
This is why wireline matters to wireless. While threatened by the residential voice cannibalization that wireless presents, cable (and fiber-based telco) hold the house keys to wireless long-term costs and profitability. With metered pricing for data becoming mainstream as carriers introduce 4G, the role of on-premise (in building, in home) data offloading becomes more important to the wireless carrier – preserve the spectrum and backhaul costs for the “out of doors” experience. This integration, if it has occurred, is just beginning.
Jim Patterson is CEO and co-founder of Mobile Symmetry, a start-up created for carriers to solve the problems of an increasingly mobile-only society. Patterson was most recently President – Wholesale Services for Sprint and has a career that spans over eighteen years in telecom and technology. Patterson welcomes your comments at: [email protected].
