Even for a sector as dynamic as telecoms this year promises to be a time of major change driven by unprecedented levels of M&A. Meanwhile, the early success of 4G and the ongoing move to cloud environments offers both opportunities and challenges, writes Philip Carse, Analyst at Megabuyte.com.
The big news of 2014 was undoubtedly the proposed £12.5bn acquisition of EE by BT announced just before Christmas, with EE preferred over Telefonica's O2. The deal would boost BT's revenues and EBITDA by £6.2bn and £1.6bn, or a third and quarter respectively, and almost double its consumer and business retail revenues. With BT having already announced an aggressive move back into mobile through an EE MVNO, and basically moving the UK towards the already converged structure of most European markets, BT's competitors have had to rapidly reconsider their strategic options.
Life for the mobile-only players is likely to get tougher, hence both Telefonica and EE offering (or even throwing) themselves at BT. Assuming BT agrees a deal with EE, Telefonica O2 could sell itself to Three owner Hutchison (as it has done in Ireland). For the latter such a deal would quadruple its UK presence for less than the £12bn it has invested to date in the UK. It would also represent consolidation down to three mobile network players. Vodafone, Sky, Virgin Media and TalkTalk will also be considering their options.
EE's and O2's desperation to sell is in some ways untimely given that the outlook for mobile is improving. First, 4G has proven to be more successful than expected globally, driving up ARPUs and persuading subscribers to switch from prepaid to postpaid services. Secondly, regulatory-driven reductions in mobile termination rates have now almost worked their way through the system (though meaning fewer arbitrage opportunities for fixed line players). However, lower roaming rates continue to have an impact. Overall, UK mobile free cash flow (FCF) is stable to trending upwards. One likely impact of the BT/EE deal is that it may well significantly boost EE's positioning in the B2B comms market, hitherto dominated by Vodafone and O2.
M&A picks up
While all the headlines will be about consumer telco M&A, we expect B2B comms M&A to also pick up in 2015, not least due to the take-private of Daisy and a new backer for XLN. While XLN will be aiming to consolidate its position in the smaller end of the business market (a possible bid for Vitruvian-backed Universal Utilities?), Daisy and potentially other larger players such as Alternative Networks will be looking to broaden their product sets and technical capabilities through M&A, particularly adding IT capabilities. It remains to be seen whether Gamma will leverage its new found status as a public listed company, following its successful AIM IPO, to undertake M&A.
The rush of private equity investments into data centre and hosting companies in 2010 and 2011 could lead to several exits in 2015, with Pulsant having already changed owners in 2014 in a £200m deal. Contenders for new owners in 2015 (either private equity or trade) include broader network and data player Six Degrees and the more hosting focused Adapt Group and Onyx, with UK2 and Attenda possibly eyeing 2016. Public-listed Iomart could be a target given recent trading wobbles following the unsuccessful approach from Host Europe in Summer 2014.
Other areas of corporate activity could include, as in 2014, networks, differentiated ISPs and companies with a strong hosted/cloud strategy, which are all benefiting from the move to the cloud. The last year has seen several network-based deals, including Zayo buying Geo Networks, Interoute/Vtesse and COLT/KVH. Zayo particularly remains on the lookout for deals across Europe. A take-private of EuNetworks could also herald corporate activity. Examples of private equity interest in differentiated ISPs in 2013/14 included Entanet, Metronet, ASK4 and Cablecomm, while Living Bridge's late 2014 investment into IP Solutions taps into growth in hosted voice and unified comms.
UC will continue to gain ground, aided by the adoption of hosted and cloud solutions, as evidenced by strong growth from companies such as 8x8 and RingCentral. It is also driving corporate activity, for example with Mitel bidding (but subsequently withdrawing) $574m for ShoreTel. We recently surveyed UK service providers on the actual and expected demand for UC services and the major challenges involved. The main message is that hosted UC revenues are expected to double over the next one to two years, albeit off a low base, though many service providers are unclear of the impacts on their finances.
The survey asked service providers what they felt to be the main buying decisions for hosted solutions, and the good news is that flexibility comes out on top, with an average score of 2.5 out of 3.0. The bad news, and inescapable in the world of telecoms, is that price and making an opex rather than capex buying decision come out in second and third place, followed closely by mobility and business continuity. Least important, and not quite attaining an 'Important' score of 2.0, were productivity and collaboration.
We also asked about the main challenges faced in selling hosted services, and these can be broken down into three broad categories. The first mirrors the cashflow impact in that selling hosted solutions on an opex rather than capex basis requires someone (the service provider) to pay for the capex. The second broad challenge is operation, making sure that businesses can support the service and quality requirements
of hosted services, as well as the technical challenges. Finally, customers still need to be educated on the pros and cons of hosted rather than on-premise solutions.
The move off-premise is a strong theme across most Megabuyte peer groups, and our survey shows that it is now definitely happening in the world of voice and unified comms. While industry revenues are still relatively small, one can point to companies where it is having a material impact. For example, the strong growth being achieved by pure-play UCaaS providers such as 8x8, RingCentral and Telesphere (recently acquired by Vonage) in the US, while hosted voice is a strong driver behind Gamma's 16 per cent first half revenue growth.
The broad message is that all existing voice service providers should have a hosted voice and UC strategy, albeit that it will not necessarily improve their financial performance. For existing on-premise providers, they also need new technical skills and a strategy for managing the inevitable shift away from legacy on-premise solutions. For relatively pure-play hosted voice or UCaaS providers, particularly those developing their own platforms, deep pockets are needed to fund infrastructure, invest in R&D, as well as finance start up losses given still unpredictable demand (as evidenced by Outsourcery). The bad news for the latter camp is that, in the event of business failure, customers on a sub-optimal hosted platform will hold little value given the difficulties involved in migrating hosted customers.
More generally, the outlook for industry revenues remains tough, notwithstanding the improving outlook for mobile revenues. Fixed line prices and volumes continue to decline, though rebalancing towards line rental helps soften the blow. Industry growth areas (reflected in the private equity interest) include activities that supports the new off-premise cloud economy, ranging from data centre colocation, through managed and cloud hosting, to providing the underlying connectivity either for the last mile or on a broader WAN basis.