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Scenario - Pax Telefonica
TRANSCRIPT
Morgan UBS—Telecom 2010
Panel Session
Pax Telefonica: Mega Telcos and the New Balance of Power
Panelists:
- Lloyd G. Trotter – CEO, SBC Echostar (NYSE: SBC )
- Brian L. Roberts – Chairman and CEO, Comcast Corporation (Nasdaq: CMCSA)
- Jonathan M. Nelson – co-founder, CEO, Providence Equity Partners
Moderator: (applause) “Gentlemen, it’s truly a great opportunity to have the heads of two of the major US communications carriers and the world’s most significant private investor in US telecommunications infrastructure represented here today on our industry panel. I’ll try to quickly summarize where we are today, and then try to get your perspectives on why competition unfolded as it did, lessons learned, and where you think the industry is headed.
Just so we can keep our score cards straight, let’s review a short history of the whirlwind, largely consolidation-focused, M&A wave that began a few years ago:
- Cingular, AT&T Wireless, followed by Sprint, Nextel
- SBC, AT&T, followed by Verizon, MCI
- Providence Equity Partners LBO of Qwest, BellSouth
- SBC acquires the Providence/BellSouth stake in Cingular
- Verizon acquires remaining equity in Verizon Wireless from Vodafone
- Cingular acquires T-Mobile USA
- SBC acquires Echostar Communications
“Jonathan, I’d like to start with you – are the big deals over for now, what drove them, where are we headed now?”
Jonathan Nelson: “The first and last parts of your question suggest a little anxiety about where banking fees are headed… (laughter) Yes, I think the big US deals are largely done for two reasons:
“First – and this speaks in part to what drove these deals – consolidation for price stability and more scale economies has largely been accomplished, and these acquisitions require a considerable digestion period.
“Second, let’s face it, at this point there’s not whole lot of significant assets left to buy that can be made more valuable through scale economies. Much of the consolidation you described was the capstone of painfully slow adaptation of the telecom industry since the AT&T divestiture over twenty-five years ago.
“At the big picture level, what drove all these deals was a combination of near-term opportunity created by a few companies like AT&T or MCI being available pretty cheaply, and/or guys like Brian [Roberts] over here scaring the telcos to death about their growth prospects. Or I should say, scaring them even more than they were already. Given eroding core businesses and no visible prospect of organic growth, telcos needed more wireless, more competitive broadband, needed to get seriously into the enterprise, to try their hand at television, etc. The triple-play became the quadruple-play, and so on.
“As we now see a lot more clearly, the telcos never recovered from their late start at broadband…This was the root of all the telcos’ wireline transition problems, whether old voice service or high-definition video-on-demand”
“As we now see a lot more clearly, the telcos never recovered from their late start at broadband. Even though they closed much of the gap in the rate of subscriber growth of DSL vs. cable modem service from time to time, Brian [Roberts] and others managed to keep them at a safe distance even during the richest part of the adoption curve, when broadband became a totally mainstream product. So the two-to-one cable advantage in broadband was never narrowed enough for telcos to break through.
“This was the root of all the telcos’ wireline transition problems, whether old voice service or high-definition video-on-demand. Without being the broadband provider, without your wire being the chosen one, you couldn’t defend properly against VoIP, be effective in displacing cable video, etc. British Telecom realized this years ago. They set very ambitious targets under a master plan they called ‘21CN’, or twenty-first century network. Now, BT Group (NYSE ADS: BT) is shutting down what’s left of the old phone network, having pretty much transitioned to an entirely new network and business model over the last six or seven years.
“Back to the US, we also know the problem with local telcos’ access line disconnect rate got a lot worse after stabilizing for a while – something that, in EBITDA terms at least, was a bit obscured once the wireless consolidation occurred. The access line disconnects in turn worsened the DSL problem. If your wire is disconnected, if you no longer even have an active wire into the home to convert to broadband, then as a telco you’re really behind the eight ball.
“At the same time, to the detriment of wireless, attackers with other business models are chiseling away at wireless margins in ways that are very hard to defend against, and look a lot like the old commoditization of long-distance, so that growth business is looking less interesting now. I might add that several telcos paid enormous premiums to get the wireless businesses they’re now spending a ton of money to defend.
Moderator: “This sounds like a very gloomy outlook for the future – a few players ate the others, but the growth story isn’t there…”
Jonathan Nelson: “Not at all – I mean, we’re far from gloomy, but we set our expectations correctly as well. To the extent there were capital market views that consolidation somehow ‘cleared the way’ for growth they were misplaced, and that wasn’t a trap we fell into. Consolidation cleared the way for some price stabilization and driving out a few remaining ineffective players. And, of course, it triggered a parallel, lagging consolidation on the equipment side.
“To the extent there were capital market views that consolidation somehow ‘cleared the way’ for growth they were misplaced…”
“The difficulty with ‘n-tuple play’ sort of hype is that if everyone has the same bundle, and the bundles are essentially discounts, then that doesn’t sound like net top-line growth, but more like a zero-sum game. Consumers and businesses didn’t all of a sudden start doubling the amount they spent on communications or watching movies, or whatever. These are very mature, fully-penetrated markets, and the battle is all about profitable share, albeit with some room for service innovation, as the cable and satellite industries in particular have shown.
“Our focus has been much less on technology-driven, top-line growth stories , and much more on cash flow. The reason why we led the Qwest, BellSouth LBO syndicate was that we saw excellent continuing cash-flow generation potential. Obviously, we believed there were further de-leveraging and cost reduction opportunities, although a bit more fine-grained and operationally-focused than just wide-spread headcount reduction.
“But given our positive, long-standing experience with CLECs, we’ve known all along that the right density coupled with sensible network capital investment could produce very favorable returns – scale is by no means everything. This, by the way, had been at least implicitly BellSouth’s strategy for some time. And their Cingular minority ownership provided us with an important element of how we financed the entire transaction.”
Moderator: “You’ve explained the private buyout rationale. But as you say in your industry you’ll be measured on the success of your ‘exits’, i.e. selling your portfolio company to someone else, preferably at a significant premium. Are near-term capital markets favorable to this in your view?”
Jonathan Nelson: “It’s nice to wind up my part of the panel discussion where we started – the future of banking fees. (laughter) Our ownership and exit strategy pretty much assumed that an exit would be enabled by financial buyers, that, post-consolidation, strategic buyers were much less likely. Also, our O&E plans assumed that private markets and financial buyers will continue to put a higher value on low-growth, high cash flow assets than public markets. But at the same time, we’re encouraged by public market multiples in our industry recently, encouraged by the track record of dividend-play IPOs in the last few years, and encouraged that the Sprint (NYSE: S) and Verizon (NYSE: VZ) local exchange business spin-outs are bringing more attention to our kind of portfolio. That’s as much as I’ll say.”
Moderator: “Thanks Jonathan – with answers like that, I see a future for you as Fed Chairman. (laughter) Turning next to Lloyd, no sooner had you retired from running a huge, global business unit at General Electric (NYSE: GE), you were catapulted into the top slot at the largest telco in the US, the outcome of a soul-searching transition and succession story at SBC.
“Already you’ve put your stamp on the organization with the Echostar Communications acquisition. In strategic terms, what are the big differences in your role as CEO vs., and your GE experience, and what are your views of the state of the communications industry and its future?”
Lloyd Trotter: “While I’m happy to be here, one of the biggest differences being in telecom and technology-businesses in general seems to be how much time industry CEOs spend at events like this one (laughter).
“I’ve tried to adapt three critical elements of my experience at GE to running SBC. I’d summarize them as ‘global’, ‘growth’, and ‘context’. Let me explain and compare each one.
First, General Electric overall, and my business unit there was no exception, is a global company with over 60% of its revenues and employees overseas. How is this relevant to SBC? Before reporters start rushing out the door, again spinning rumors that we’ll buy Vodafone (NYSE ADS: VOD) (laughter)…right now we actually don’t believe that global scale in telecom, outside of our enterprise business, creates much real value. But what we do believe, and what I’ve had a lot of experience in, is understanding the nature of supply trends globally. So you’ve noticed a major restructuring of our relationships with equipment and software vendors, focused on quality, price, and us defining what our customers want in equipment features, rather than accepting vendor-created features for imaginary services.
“Second, growth: GE remains, despite its size, a growth company delivering double-digit earnings growth, more than half of it organic. GE knows an awful lot about starting with customer problems and working back to practical, technology-based solutions, marketable in the near-term. Recent telecom history is either exactly the reverse, technology fishing for markets, or no innovation whatsoever. At SBC, we’re changing that, as I hope is already pretty evident, and I’ll explain our thinking on that more in a moment.
“Third, is context. One of the things [General Electric CEO] Jeff [Immelt] observed a couple of years after he took over from Jack Welch was that most of his job wasn’t all that different – Jeff had run a huge, successful, growing division, and overseeing more than one of them wasn’t that different.
“The amazing thing to me was that telecom, for all the ‘convergence’ of technologies and so on, was stunningly incremental and non-strategic in its outlook.”
“But what Jeff called ‘context’, constantly thinking about the world around him, developing a clear and focused point of view on where the world is going, and what GE’s role in it should be – what I might call ‘strategy’ – was uniquely his responsibility as CEO. Couple that with GE’s management system which is to really engage in the nuts and bolts of businesses, not look at them merely as elements in a ‘portfolio’, and you have quite an intellectual challenge. The amazing thing to me was that telecom, for all the ‘convergence’ of technologies and so on, was stunningly incremental and non-strategic in its outlook. I guess you could say telcos had some point of view on where the world is going, but it was kind of a General Motors ‘everything’s fine, were still the biggest, next year’s products will be great’ kind of story, very short on specifics and tough trade-offs.
“This focus on ‘context’, having a much broader world awareness, a sharper, clearer strategic point of view, and an honest self-assessment that is fully translated into daily action, is something that I’m changing fundamentally at SBC. SBC is a great company. But, like all big telecom carriers, it really struggled to understand competition, innovation, customer focus.
“The usual industry strategy was what I call ‘incremental resistance’. Especially in the public policy arena, from federal to local, the telecom industry diverted enormous energy and mind share to shaping regulatory and policy outcomes that minimized the amount of change they would have to undergo. The idea was to make uncomfortable outside developments die from exhaustion or threats. A recent example was ILEC threats against municipalities deploying WiFi or even fiber-based networks. Several telcos even provided the text for bills in state legislatures to ban this. We’ll continue to exercise our rights as a participant in public policy debates, but this kind of behavior is unacceptable to me as a crutch or substitute for business strategy.
“So what are we doing differently? We’re bringing innovation and service to telecom, from an entirely different starting point – the customer.
“We will compete and win against an IBM (NYSE: IBM) or Accenture (NYSE: ACN) in telecom-related systems integration services for the largest enterprises. We will pre-integrate and service small business offers, including their websites, email, office phones, and wireless PDAs, and actively promote them through relevant business channels such as Office Depot (NYSE: ODP). We won’t just ‘place’ them there, we will let small business owners and mobile professionals touch, use, and customize entire live systems. Customers won’t just read a brochure or website about our offers and then be given only a glimpse of the glitzy part – a handset sealed in a blister pack, or sitting underneath a glass counter.
“We have given people reasons to use their phone at home again, creating easy-to-use, affordable ‘family phone systems’ where, for the price of a single line, and a two-year contract that pays for the new multi-line handsets and cellphones, each family member can have their own number and a separate voicemail box at home, totally integrated with their cellphone as well. We have created broadband services that lever our huge advantage in upstream bandwidth vs. cable – services that are useful, fun, and affordable for consumers and small businesses as well. This is just the beginning.
“And, finally, we put half-measures behind us and are competing wholeheartedly and aggressively in consumer entertainment, as our Echostar acquisition clearly demonstrates. This give us three large advantages: first, a multi-network mix where we can adapt our offer to the economics of subscriber density – from satellite for rural, to broadband IP video for urban apartment buildings. Second, leapfrogging immediately to a full-service, multi-tiered offer of hundreds of channels, including high-definition and DVR-based services, and international channels we carry exclusively. And third, the ability to mix ‘non-traditional’ web-based video entertainment directly with our core video offers.”
Moderator: “I feel winded just listening to this. (laughter) Your description of SBC’s aggressiveness, particularly in service innovation seems to contrast sharply with Jonathan’s ‘stability and cash flow’ view of the world.
Jonathan Nelson: “If I could just interject here, there’s no question that Lloyd has played an enormous role in awakening a sleeping giant, so to speak. The contrast between SBC and Verizon is a very interesting one. I’m not sure [Verizon CEO] Ivan [Seidenberg] would agree, but what we have here are two distinct business models. When Verizon abandoned their video aspirations or, perhaps more accurately, made it clearer that their real goal was only very high-bandwidth broadband, they retuned the business towards a large-scale utility model that has been very successful. I’d add that Verizon’s stability and profitability is in no small measure because of their balance sheet improvements, such as resolving the Vodafone put, and the asset dispositions like selling off access lines in lower-density markets as well as a good deal of their real estate, and so on.
“The success of the Big Two and the balance of market power they’ve achieved relative to each other and cable – what you’ve called ‘Pax Telefonica’ – is a very interesting and, frankly, somewhat unexpected outcome.”
“But the combination of Lloyd’s growth track record at GE and SBC’s recent success suggests that an innovation-based, higher-growth, lower [than Verizon] profitability model can succeed as well. The success of the Big Two and the balance of market power they’ve achieved relative to each other and cable – what you’ve called ‘Pax Telefonica’ – is a very interesting and, frankly, somewhat unexpected outcome. But we shouldn’t forget the enormous amount of pain inflicted by cable on the telcos that, in part, brought us to this level of détente, to stay with your diplomacy metaphor.”
Moderator: “Indeed not. So, Brian, I apologize for my time management – we’re running a little long, and I’d like to make it up to you during the Q&A portion that follows. But following up on Jonathan’s last point, if you wouldn’t mind, could you focus your remarks on what came to be known as the ‘cable hurricane’, and whether in its aftermath you now agree that we’re in a period of relative stability?”
Brian Roberts: “Sure, I’d be happy to. Before I do, and as delighted as I am to be on a telecom-related panel (laughter), ah, I do feel a need to clarify a little bit of the context here.
“It’s important to understand that at Comcast we think of ourselves first and foremost as a media company. You can look back as far as, say, ’03 or even earlier and see that the way we communicated with investors and analysts emphasized a media business model and a media peer group, such as News Corp. (NYSE: NWS) and Time-Warner (NYSE: TWX). By this I mean look at and compare the mix of O&Os, library ownership, affiliates, advertising revenue, program development, and of course, subscribers. We continue to see ourselves that way and while Lloyd has some video-related assets, there are many he does not have and, in our view, is unlikely to have.
“What happened in that market was emblematic of the rise of cable telephony generally, with incumbent telcos losing as much as 15% of their residential share in key markets over a couple of years – almost double our internal goals.”
“Okay, the so-called ‘cable hurricane’. I found that label a bit irritating when the press came up with that it after our success in the Jacksonville, Florida market. What happened in that market was emblematic of the rise of cable telephony generally, with incumbent telcos losing as much as 15% of their residential share in key markets over a couple of years – almost double our internal goals. Of course, Atlantic coast hurricanes originate way off the western coast of Africa. You know, (unintelligible) I might be warming to this metaphor after all. (laughter)
“For Comcast, the makings of the ‘hurricane’ began years ago when we acquired AT&T Broadband, cleaned up and finished the network, pushed hard on digital cable, and extended our broadband offers. By then, cable modem service had turned out to be a huge success. I mean, to this day, I cannot believe how lucky we were that the telcos spent so much time arguing about the fairness of cost allocations and lobbying on arcane regulatory matters, when it was obvious where this was all going.
“To some extent, we have satellite competition to thank for the timing of our current position. We vastly upgraded our core video business, first to reach parity with all-digital direct broadcast satellite, and then to exceed it with many ancillary video services, like video-on-demand, interactivity, and meshing it with web-based content. The network we built to do this made telephony just another application. We’d already invested almost all the network upgrade money for digital video and were basically done. We’d capped the old circuit-switched telephony offer as soon as we took over the network from AT&T Broadband. So, when voice-over-IP technology was ready for ‘prime time’, we re-launched telephone service at very small incremental network cost. In the eyes of the press, that’s apparently when the so-called hurricane made landfall, but in our view it’s the diversification and upgrading of our revenue streams and their EBITDA margins that was the ‘hurricane’.”
Moderator: “I don’t mean to interrupt, but I think the ‘hurricane’ metaphor was meant more to describe the kind of damage sustained by the telcos…”
Brian Roberts: Well, there’s no question that the telcos were quite vulnerable. Now I see where you’re going with this. Look, people keep asking whether we ‘deliberately’ inflicted that kind of damage. I’m not even sure what that question means. Our customers were interested in telephony at a fair price, we had the ability to offer it to them, our broadband experience made us a trusted supplier. Why wouldn’t we offer it?
“Telcos took their eye off the ball on the one defensive strategy we were really worried about – integrating wireline and wireless services.”
“Frankly, we were a bit surprised by how high our initial win rate was, in part because we thought the wireless part of the telco bundle, which at Comcast we’ve added only in the last couple of years, would make leaving the telco less likely than it turned out to be. The distractions of telco post-merger integration were a blessing in this respect. Telcos took their eye off the ball on the one defensive strategy we were really worried about – integrating wireline and wireless services. Our initial targets called for EBITDA contributions from telephony on the order of a quarter or so of our advertising contributions. We are strongly exceeding that.
“What people really seem to be implying is they expected we would reach a tacit understanding with the telcos: ‘Okay, we’ve had our arms race, now you, Mr. Telco, stay out of video, we at cable stay out of phone, let’s just fight over broadband, this way nobody gets hurt’.
”...there’s no way to fight over ‘just broadband’ – it’s at the root of all the delivery.”
“But there’s no way to fight over ‘just broadband’ – it’s at the root of all the delivery. Plus, from our point of view the competitive landscape was totally skewed in our favor. We’d already built our network, they were in the middle of huge spending and build-out on theirs. We had decades of video experience, programming buying power and tens of millions of video subscribers, they had none. And Verizon withdrew from the video business. So, yes, there is now a sort of ‘Pax Telefonica’ as you call this panel session, but after an appropriate re-alignment of market share and cash flow. (laughter)
“With all due respect to Lloyd and SBC, we’ve competed with digital satellite for over fifteen years now. Over five years ago,we had not just massively upgraded our network, but even more importantly our video offers – big, VoD libraries which we own, much of it provided free to our digital subscribers, and so on – in anticipation of the stakes in video continuing to increase. We keep pouring in more value at the same price, which our profitable presence in many ends of the media value chain makes possible. So we remain very comfortable with our competitive position in our core video business.
“Let me make just one final point, and I know you’re eager to wrap this up. The customer. We know that at most households, video is that consumer marketers call a ‘high-involvement’ category. People spend a lot of time with our services, think about them carefully before they select a supplier, and are informed, discerning judges of the competitive offers out there these days. It’s unlike hand soap or even phone service, for that matter. This is a very sophisticated market which requires a lot of media industry know-how to satisfy.
“Our sense from the beginning of the telco video initiatives was that for all the talk about bandwidth, fiber, compression, multi-casting, and so on, unless they had something really different for the customer, the likelihood they would take share from us in a fully-penetrated market, where our average customer life exceeds five years, was very low.”
Moderator: “Brian, thank you. And thanks to our exceptional panel today. (applause) I’ll now open up the floor for some Q&A…”
* * * * *Disclaimer: This “transcript” is entirely fictitious, created to illustrate simulated strategic outcomes in telecom and other industries. We use the names of actual companies and publicly-known individuals in order to add a measure of realism, detail, and interest to discussions of industry strategy. We are entirely responsible for the views expressed in these simulated scenarios; they are not endorsed, sponsored, or in any way the responsibility of the entities or individuals named herein.
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11 October 05
