Microsoft & Google pressure Amazon’s prime spot in the cloud; Apple may be prepping for entry

After a decade of dominance in the public cloud market, Amazon’s top spot came under immense strain in 2017. Years of investment in networks & cloud services began to pay off for Microsoft’s Azure and the Google Cloud Platform (GCP). Apple is also making noises in the cloud.

Tides shifting in 2017

At year-end 2016, Amazon’s Amazon Web Services (AWS) was the public cloud’s market leader, as it had been for many years. Per the Cloud Security Alliance, in 2016, AWS had a 42% share of the public cloud application installed base, Azure had 29%, and GCP had 3% (as did IBM’s SoftLayer).

Capex spend has been strong at Amazon’s rivals for many years, though, and it appeared to pay off in 2017.

As shown in the figure below, capex has grown at all three since 2012, but faster at Google and Microsoft. Each of these “webscale network operators” (WNOs) spend capex on items unrelated to the cloud, for instance Amazon’s fulfillment centers, or Microsoft’s retail outlets. But the big driver in the last few years has been cloud capex, concentrated around construction (or expansion, or retrofitting) of data centers, and supporting infrastructure such as data center interconnect.

MTN Consulting - cloud capex WNO

All this cloud investment has created an intense rivalry, with the new entrants pushing hard on Amazon’s top spot. Large and medium enterprise customers (such as Target, Apple, Dropbox, and Spotify) are now looking at alternatives, including a partial shift from Amazon to other leading cloud service providers. Amazon’s loss of such enterprises from the AWS fold has hurt operating margins, not just topline growth.

Microsoft’s “not so soft” approach appears to be hurting Amazon’s AWS margins

Amazon’s AWS unit has continued to grow fast in 2017, but at declining rates: year-over-year (YoY) revenue growth for AWS was 42% in 3Q17, down substantially from 3Q16. By contrast, Microsoft’s Azure revenues have grown at an average of more than 90% in recent quarters (chart, below).

MTN Consulting AWS-Azure rev grate

More important, after margin declines in 2016, Azure saw improvement in the last two quarters. As the chart below shows, Microsoft’s “Intelligent Cloud” (Azure) margins have improved YoY for the last two quarters, while AWS margins did the opposite. The two companies’ margins converged somewhat in both 3Q16 and 3Q17, but Microsoft’s overall level is safely higher. 

MTN Consulting AWS-Azure margins

To support Azure’s growth, Microsoft has invested on multiple fronts, including acquisitions. For instance, the company recently acquired Cycle Computing, a startup software developer that allows businesses to run apps in the cloud, a lucrative business for cloud vendors. As Cycle Computing has been a long-time partner with AWS and Google, Microsoft gets some new customers out of this acquisition: the existing Cycle Computing customers on AWS and Google Cloud will be asked to migrate to Azure, along with the future customers.

Microsoft has also invested heavily in network capex, partnering with such vendor suppliers as ADVA (100G optical for DCI); Cisco (Cisco Cloud Services Router 1000V); Ericsson (IoT accelerator); Huawei (a jointly engineered server product for hybrid cloud apps on the Azure Stack); Mellanox (40G Ethernet switches); Qualcomm (evaluating the new Qualcomm Centriq 2400 processor for cloud applications); and, many others.

Cloud is one of Google’s three big bets

Google Cloud Platform, the tech giant’s cloud division, currently lags far behind AWS but is trying to catch up. The renewed focus on cloud is a result of Google exploring growth outside its core advertising business. This continues to grow nicely, but remains highly vulnerable to economic headwinds.

Google’s CEO Sundar Pichai says “Cloud” is among the top three bets of the firm going forward. Unlike Microsoft, Google does not break out revenues (or report margins) for its cloud business separately. However, we know that GCP is a big part the company’s growing “Google Other” segment, which was 12.3% of total revenues in 3Q17 (3Q16: 10.8%). Google’s CFO Ruth Porat confirms that GCP is a main driver for growth in this segment. One metric of GCP’s growth is the number of big (>$0.5M) cloud deals signed per quarter; the total in 2Q17 was 3x the total for 2Q16.

To support this growth, cloud-specific investments have increased significantly in 2017; overall capex was $3.5B in 3Q17, up 39% YoY, benefiting server manufacturing partners Inventec & Quanta Computer. Cloud opex is rising as well, due to new cloud technical & sales staff hires.

Google racks PRY_20

Google’s push into the cloud market is only a few quarters old

The moderate gains made so far by Google in the cloud market are impressive, considering they just started in 4Q15, with the appointment of VMware co-founder Diane Greene to head its cloud business.

Prior to Greene’s appointment, Google was mostly perceived as the Internet search and advertising giant, which struggled to market cloud solutions to enterprises. The perception has since changed a bit, with GCP’s aggressive pricing strategy and incremental market gains. The GCP got a big boost in September 2017 with a win at Salesforce. Earlier this month, Google made another important hire: Diane Bryant, Intel’s former datacenter unit head, is becoming the COO of Google Cloud.

With this impressive team, Google is now looking to outperform AWS by 2022. Five years is ambitious, but not impossible. To succeed, Google is looking to position itself as a cloud solutions provider for AI- and Big Data-based applications, as these two technologies are considered as next big key adopters to cloud. Google is starting to reap some results from this new positioning. For instance, it recently struck a deal with Zebra Medical Vision to host its AI algorithms on Google’s cloud.

However, Google has to do much more than enticing big-ticket enterprise customers to switch. For rapid growth, and to support an AWS-like breadth of offerings, Google would need a sizable acquisition. Google’s biggest acquisition so far has been Motorola for US$12.5 billion. It would be looking to make a similar-sized acquisition in the medium term to help catch up to Amazon. Per the rumor mill, Salesforce and Workday are options, among many others.

 In the long run, Apple’s project “Pie” could eat into Amazon’s “share of pie”

While Amazon is focused on Microsoft and Google in the short to medium run, Apple may be secretly beefing up its own cloud capabilities to battle Amazon in the long run.

Currently, Apple’s role in the cloud has been mostly in the SaaS space through its iCloud service. However, a number of indicators point to Apple pursuing its own cloud computing strategy beyond SaaS; for example:

  1. Secret restructuring of its cloud computing operations under a project code named “Pie”: This includes moving the infrastructure for Siri, iTunes, Apple Music and Apple News onto a single proprietary cloud platform called “Pie”.
  2. Reduced reliance on other cloud operators to run its iCloud and other services: Apple is having issues relying on other cloud providers, as slow networks and outages disrupt Apple’s services. In late 2015, Apple started exploring how to build its own cloud infrastructure and end dependence on other cloud players completely, through “Project McQueen”.
  3. Increased investments around data centers: in 2017, the company announced two massive data centers in Iowa and Nevada, with construction costs of US$1.3B and US$1.0B respectively.

All the above specifics clearly suggest Apple aims to make a foray into the cloud market. But by no means guarantee it. Apple does not enjoy being predictable.

Amazon fights back

Amazon is not sitting back in face of these threats. The company is adopting a three-pronged strategy of “Innovate-Invest-Collaborate” in the cloud.

As the cloud pioneer, AWS continues to “Innovate”: expanding cloud platform functionalities from 280 new features in 2013 to 1,000 new features in 2016; launching a joint innovation center in Qingdao, China in 2017; rolling out a the AWS Snowmobile, Snowmobile.6824c527b221bfcd0fc284a04576b23d0d5edc1fwhich is a physical data transfer service using a 45-foot long container on a truck. That’s for transport to and/or between AWS data centers. Amazon also continues to “Invest” in (or acquire) cloud-related companies, including cyber security company Harvest.ai in January 2017, Thinkbox Software in March 2017, and GameSparks in July 2017.

The “collaborate” aspect of Amazon’s strategy involves collaboration with rivals where Amazon is weak. For instance, Amazon announced a surprise partnership with Microsoft in October 2017, to launch a free software tool for developers, Gluon, which allows them to build AI and cognitive systems. The alliance is seen as countering Google’s TensorFlow tool, which is already popular among developers. In 1Q17, Amazon teamed up with rival VMware to develop software to help companies move on-premises applications to the public cloud. These moves are significant for Amazon, as it looks to counter its peers in specific product segments in order to maintain its #1 position and lift margins.

(Photo sources: Google & AWS)

 

 

 

Telco-OTT battle is looming in India as net neutrality policy is reviewed

Globally, operators are experiencing a rough patch, with sliding core revenues combined with an ongoing need to invest and maintain their networks. The wide usage of apps and services provided by OTTs, purchased easily from a smartphone or other device (e.g. Apple TV, Roku player), are drawing attention & dollars away from the more-expensive traditional telco platforms. With the success of OTT services, telecom operators globally are re-strategizing their traditional offerings. That’s true in India as well; recent service innovations include Vodafone India’s app Vodafone Play, and Jio and Airtel’s partnership with Hotstar and SonyLiv, respectively.

India’s telco-OTT tensions and net neutrality

Like their counterparts in the US, Indian telcos have found multiple ways to complicate life for OTTs and their users.

Telecom network operators (TNOs, or telcos) in the past have either blocked OTTs or throttled internet speed for selective apps on their networks. Notably, in 2014 Airtel introduced differential pricing for VoIP services, such as Skype and Viber. The mobile operator then launched Airtel Zero in mid-2015, which gave preferential treatment to a few select OTTs. Airtel is India’s largest mobile operator, so these were controversial moves – and they helped to spur the current debate on net neutrality in India.

Just recently, in November 2017 the Indian regulator TRAI announced a net neutrality recommendation, concluding that telcos cannot unfairly prioritize content. This was a win for OTTs. India’s telecom regulators are now pursuing more open, pro-consumer policies than the US FCC, which today voted to end America’s version of net neutrality. However, the TRAI’s recommendation still needs to be formally adopted by the government, and India’s telcos are lobbying hard for relief. In fairness, this comes at a tough time for them, as they’re facing high debt and weak revenues, made worse recently by the rapid growth of new entrant Jio. The figure below shows how stark the revenue declines have been for many in recent quarters.

mtnconsulting india revenues

Smartphones are the platform of choice for OTTs in India

While India’s fixed broadband networks are underdeveloped, it has an enormous base of smartphones. As shown below, by 2023, Ericsson expects India to have 970 million smartphone users, after growing at a 17% CAGR from 2017 . That’s the same as the entire region of Europe.

mtnconsulting ericsson forecast

Given India’s smartphone-centric broadband market, smartphones play a huge role in launching new OTT services and partnerships. For new revenues, telcos are looking at apps and content. A common approach is to bundle traditional offerings with OTT services such as media/cloud storage/video/music, to drive data usage and help migrate users to higher-priced plans.

For instance, video-streaming. Vodafone India has won deals with Eros Now, HOOQ, and Amazon’s Prime Video. Vodafone has also partnered with Netflix in a deal which includes carrier-billing, and free Netflix service for a year under a few of the post-paid plans. Netflix plans to strike similar deals with India’s Airtel DTH and Videocon d2h. Starting from scratch, Jio is carving out a niche for itself with app-based services such as JioPlay, Jio Beats, Jio VoD and Jio Security.

As a result of India’s rising smartphone penetration and OTT service adoption, data traffic is booming. Ericsson expects data traffic per smartphone in India to reach 18 GB/month by 2023, from the current 3.9 GB/month. Telcos, of course, claim to worry they’ll be stuck carrying all this traffic, while OTT providers function as free riders of telco network assets. So far, that argument hasn’t held up with regulators.

(Photo credit: Mpho Mojapelo)

Understanding the carrier-neutral market (and why revenues will pass $40B this year)

MTN Consulting has just published a “Market Review” of the carrier-neutral network operator (CNNO) sector. The report assesses the key role that these tower, data center, and bandwidth specialists are playing in the downsizing of the telecom sector. While many telcos are shrinking, the CNNO sector is growing >10% per year. Revenues for the 25 CNNOs we track should surpass $40B this year, and approach $60B by 2020 (Figure 1).

mtnc-cnno revs through 2020

Takeaways from the study include:

  • CNNO revenue growth has been steady around 10-15% YoY for several years, in line with the growing telco (& other provider) need for low cost, carrier-neutral network resources. 3Q17 revenue growth for CNNOs was 13.1% (Telco Network Operators: 1.0%; Webscale Network Operators: 23%).
  • CNNO capex rose 11% YoY in 3Q17, to $3.6B. Tower specialists spent 24% of their revenues on capex, data center specialists over 43% due to higher (and lumpy) investments in developing new sites. Tower providers’ incremental capex in new sites is primarily for small cells. Bandwidth specialists’ capital intensity has been over 50% for the last 5 quarters, due to the influence of new builds (NBN in particular).
  • CNNO capex hit $15B on an annualized basis in 3Q17; the biggest spenders were Equinix, Level 3, Australia’s NBN, Crown Castle, Digital Realty, American Tower, and Zayo.
  • M&A is a big factor in the sector’s growth, but just one. CNNOs are growing organically too, and expanding their business models to require a broader mix of equipment (Crown Castle is looking at edge computing, for instance). Technology-related operating expenses can be quite high, for repairs & maintenance of old plant, and energy costs in particular.
  • Total capex across telecom, Webscale, & CNNO was $355B in 4Q16-3Q17 (Figure 2).

mtnconsulting 3Q17 capex-summ5

The report also assesses CNNOs’ network holdings across four main categories: fiber, data centers, towers, and small cells. Most big operators have assets in multiple areas, and that will increase over time. Tower companies are building small cells, for instance, while bandwidth specialists are extending their fiber routes to small cell sites.

Table 1 provides a snapshot of the infrastructure assets for a sample of the CNNOs covered in this report.

Table 1: CNNO network assets (excerpt)

mtnc cnno1

If you would like more information about this report, please send us an email, or complete the below contact form.

(Photo credit: Tony Stoddard)

 

 

 

 

 

 

 

 

Telco capex in 3Q17 up 4% YoY (preliminary); what’s in store for 2018?

Not all telcos have reported, but a large sample (of 60 companies) has spent US$50.2B on capex in 3Q17. That’s up 4% year-over-year (YoY), after adjustments for acquisitions.

A 4% growth rate for telco capex is relatively high by recent standards (Fig. 1). LTE spending declines have plagued YoY capex comparisons since 2015. In this same time frame, the Webscale sector – led by Alphabet (Google), Amazon, Apple, Facebook, & Microsoft – has increased capex by double digit percentages in most quarters.

mtnconsulting telco-webscale3q17.png

Looking forward, Webscale sector capex will continue to grow much faster than telcos, by 5-15% per year. The outlook for telco capex remains challenged, however.

Weak top-line growth not just a short-term problem

In 3Q17, telco revenues grew just 0.8% for the sum of the 60 companies we’ve captured to date. That pushed down the annualized growth rate to under 1% (Fig. 2).

mtnconsulting telco revs3q17.png

Telecom operator revenues have been challenged for several years, and it’s not a regional problem, or one that will go away soon. Many telcos are facing margin squeeze as subscriptions decline in key areas (e.g. consumer broadband), & mobile churn remains too high. Telcos like KDDI and (many) others are investing in new service areas based, for instance, on IoT. Seeing a return from these investments has been slow, though.

3Q17 results & operator plans

Capex for our group of 60 was $50.2B in 3Q17, up 3.6% YoY. That pushed annualized capital intensity for the group to 15.3% in 3Q17, up slightly from 15.2% a year ago. (Note that the sample of 60 excludes China).

As telcos move to more software-based networks, most aim to keep a lid on network spending – at least, the capex component of network spend. That was clear from 3Q17 earnings calls, for instance:

  • Telefonica says its “radical network virtualization” helps to optimize capex, enable faster deployments, and incorporate big data into network planning. Its capex has been in the 16-17% of revenue range steadily since 2014, though, without a noticeable decline. Looking ahead, Telefonica suggests a “distinctive declining capex trend” will be needed to drive growth in free cash flow and reductions in net debt.
  • NTT projects capex of 1,700 Billion Yen for the fiscal year ended March 2018. That’s flat year-over-year. But the last 6 months of the year (4Q17-1Q18) will fall YoY, from 1,034B Yen to 942B Yen.
  • Deutsche Telekom’s 9.24B Euros in capex so far this year is up nicely (+12%), but the company projects capex in its core market of Germany to be flat through 2021 at around 4.3B/year; only regulatory relief would bring any upside.
  • Comcast’s capital intensity was 15.6% in 3Q17, but will average 15.0% for the full year. The company is under pressure from rising content costs (despite ownership of NBCUniversal; AT&T, take note!).
  • Orange is spending €7.2 billion on capex this year, from 7.0B in 2016, with a practical focus on raising 4G & FTTx coverage. Fiber investments helped Orange grow its base of “very high-speed broadband” customers to 24.6M households in September, up 46% YoY.

Not all bad news for vendors

The telco shift to more virtualized, software-driven, open sourced networks is real, and it will bring many benefits, but it doesn’t guarantee lower capex. That’s in part because it’s a very gradual shift for most. Big telcos with millions of subscribers & thousands of employees do not change processes that quickly. Many big operators are raising capex, or at least keeping levels flat despite revenue declines. At the global level, though, a 5-10% drop in telco capex is likely next year. The changes by technology area & region will be more extreme; more on this topic soon.

A side note on this week’s news: AT&T-Time Warner and net neutrality

Two major events took place in the US this week: the US Department of Justice (DoJ) announced it would file suit to block AT&T’s purchase of Time Warner, and the FCC made clear it would soon be gutting net neutrality provisions. What’s the impact on capex?

The AT&T situation is too complex & politicized to assess yet. I was never a big believer in the merger, in part because of Comcast’s troubles, within an (already) integrated content-cable group. It seemed a big gamble, given AT&T’s lack of history in content, and limited experience with large cross-sector acquisitions. It also would clearly distract the company during a time of industry upheaval. So, if the merger falls apart, it wouldn’t be the worst thing for AT&T. In the meantime, I would not be surprised if it targeted a bit more of its total capex overseas, in Latin America, pending more certainty.

Regarding net neutrality, my two cents: the FCC’s new rules will have approximately zero impact on US telecom capex. They may change the distribution by company slightly, and you can be sure Verizon, AT&T and others advertise loudly any investment that can be positioned as “new,” and incented by the FCC rule change. But that’s marketing, not reality.

(Photo credit: Jason Blackeye)

 

Indian operators divesting tower assets to raise cash

Faced with tough competition and high debt, Indian telecom operators are spinning off their tower assets to investors or independent tower companies to improve their financial situation. The 2016 sale of Tata Teleservices’ tower business (Viom) to ATC, and RCom’s planned sale of its tower unit (Reliance Infratel) to Brookfield are just two examples.

Operators in many other regions have divested towers to raise cash, not just India. This is part of an ongoing trend, enabled by the maturity of independent asset management companies. Such divestments in India, though, come against a backdrop of urgent debt reduction needs. Funding network capex while navigating this transition will be a challenge.

Do operators really gain from tower divestments?

Though operators benefit from a cash influx after an infrastructure sale, the devil is in the details. Tower sales typically come with long-term leaseback arrangements, with pre-determined pricing levels locked in. Operators need to set aside sufficient funds for recurring rental costs.

There have been instances where tower companies have shutdown service to operators following rental defaults; RCom is one case. Since the details of the outgoing rental costs incurred by operators are not revealed, it does question the merit of the tower sale. On the other hand, many towers remain underutilized, and operators see benefits not only from the initial sale but in lower ongoing costs as tower space is shared. It also helps them avoid new tower construction, hence avoiding some capex (all else equal).

In India, mobile operators increasingly are focused on their main telecom business, relying for tower assets on a mix of dedicated private equity firms and pure tower infrastructure companies. Deals continue to happen. For instance, now that Vodafone’s acquisition of Idea Cellular has been approved by the antitrust regulator, Bharti Infratel will likely try to buy Vodafone’s 42% stake in Indus Towers. It’s also possible that, post-merger, Vodafone/Idea’s combined 20,000 towers will be acquired by ATC.

Below are a few cases of Indian operators selling towers, or their holdings in tower subsidiaries. Two are completed deals, one is in progress, and two are still under discussion. 

indiatowers-mtnconsulting.png

Tower asset transfers are affected directly by the broader services market, and M&A changes at that level. We’re seeing this now in India. Vodafone’s merger with Idea, for instance, set to complete in 1H18, is forcing a realignment of ownership in Indus Towers. RCOM’s hoped-for big payout from its tower sale to Brookfield is now in question, since the RCOM-Aircel merger collapsed. Meanwhile, Jio continues to push aggressively to expand, keeping margin pressure high on rivals.

Mobile market consolidation might free up capital for network expansion

In the wake of heavy competition and high debt, Indian operators are exploring various financial deals, not just asset spinoffs.

The recent Tata Teleservices (TTSL) sale of its mobile arm to Airtel, and Vodafone-Idea merger, may just be a silver lining for the Indian telecom mobile market. Over the next five years, we might see a drop in the number of mobile players from 9 to 5. Such consolidation should be beneficial for operators, which can merge network and spectrum holdings. That would free up more capital to invest in network expansions and upgrades; recently Indian operator capex has dipped. Tata Communications’ capital intensity (capex/revenues) averaged just 9.5% for the last three fiscal years, for instance.

With growing demand for a complex range of new mobile services (including in the IoT space), there is a strong argument that operators shift tower management to independent, specialized companies, and focus on providing better quality of service and coverage. India may soon provide a test for that argument.

Weak network spending climate becoming more apparent

Fidelity’s “Communications Equipment” index is up nearly 11% so far this year, tracking just a few points behind the S&P 500’s YTD gain of about 15%. Looking ahead, though, the communications equipment sector remains challenged, something 3Q17 earnings are making clear.

Ericsson, Nokia and ZTE in a similar boat

Vendors selling mainly to communications markets are reporting sluggish demand. In 3Q17, revenues declined by 4% and 9% YoY at the networks divisions of Ericsson and Nokia, respectively (for Nokia’s trend, see figure below).

Multiple regions are seeing the same issue: weak telco revenue growth is constraining more rapid investment. LTE networks are in place, ready for growth & upgrade via software (mainly). Fixed broadband networks remain expensive to construct, and the video revenue upside is proving to be a challenge for many operators, including AT&T.

ZTE doesn’t break out carrier revenues on a quarterly basis. Corporate revenues fell 5% YoY in 3Q17, and ZTE says carrier demand is stronger than average. We’ve estimated 1% YoY growth for ZTE’s carrier group in 3Q17, in local currency. The China capex outlook is cloudy, though, something which both ZTE and Huawei will have to face next year. They also, I suspect, will reinvigorate their vendor financing programs, as has already come up in Brazil with a potential buyout of Oi with involvement from the China Development Bank.

The figure below confirms, though, that it’s not just ZTE, Ericsson and Nokia facing issues. Many suppliers reported YoY revenue declines in 3Q17.

3q17v2

Accenture’s result is modest evidence that telcos continue to increase spending on services & software, but not definitive as Accenture includes telecom in a larger Communications, Media & Technology (CM&T) vertical.

Adtran’s growth is due largely to an acquisition, namely of CommScope’s active fiber access product line, in late 2016.

Corning’s growth is more interesting. Many vendors are reporting a shortage in actual fiber optic cable supply over the last year or two. New factories or expansions have been announced by Corning, Furukawa, and most recently Prysmian. These tend to tie in to specific large telco (or national government) fiber builds, as with Verizon’s FiOS and the NBN in Australia. The economics of these builds require video service profitability, in general, and that has been mixed lately.

Telco capex datapoints not reassuring, but it’s early

Many telcos have reported already, including Rogers & Verizon, Telefonica, Orange, America Movil, AT&T, Telenor, and DoCoMo. Occasionally a big operator reports capex growth, unapologetically – referring to the revenue opportunities that might come with that. DoCoMo comes closest to this model so far. Its capex for the last two quarters is up 9% YoY, in part to support new services in the “Smart Life” business. Most, though, are talking down capex, emphasizing that the bulk of 4G work is done, fiber capex is more targeted & tactical than 2 years ago, etc.

On Telefonica’s 3Q17 earnings call, for instance, COO Angel Vila noted that:

“CapEx is on a declining trend in Spain. We have already 97% LTE coverage. I think it’s close to 70% fiber-to-the-home coverage. We will continue deploying fiber, but reduce speed and focusing on connecting… the CapEx trend in Spain is already declining in terms of CapEx to revenues.”

Many operators have similar stories. Vendors will have to seek out the ones with more budget flexibility. Even with some success, though, it’s likely we will see a pickup in M&A activity around the communications equipment sector over the next 1-2 years.

First few 3Q17 telecom vendor reports: YTD revenues down 3.4%

If you’re looking for a capex bump in the telecom sector, results for 3Q17 so far won’t reassure you.

The vendors that have reported are not seeing much growth. For six vendors (or divisions) with high exposure to telecom, annualized revenues continued their decline in 3Q17 (figure).

vendor-1

On a nine month (year to date) basis, revenues for this same group were $33.2B, down 3.4% from $34.4B in 1-3Q16.

This is not a random sample, just a view on the early reporters. Many more significant vendors in the sector have yet to report. However, the weak spending trend is consistent with what many vendors have been reporting for several quarters. It’s also consistent with operators cutting their capex targets.

The figure below shows YoY % change in revenues for each of the 6 companies/divisions, for the last five quarters.

vendor-2

The steady negatives at Ericsson are concerning, as is the 3Q17 decline at ZTE. That could signal weakness in China, where operators were already guiding down capex projections. Juniper’s telecom/cable revenues declined, but that was one point of the vendor’s recent segmentation, to highlight growth differences: its “Cloud” segment is up 16% YTD.

Adtran’s growth is due partly to its CommScope acquisition, so hard to decipher. Wipro is a small services/software player in telecom, and hasn’t been helped by a weak Indian spending climate. Corning, though, is reporting steady YoY growth in optical communications segment revenues, noting yesterday “especially strong demand” for its carrier products, where Verizon is an important customer.

More to come soon, as more vendors report.

(Photo credit: Maarten van den Heuvel)

Cisco buys BroadSoft for $1.9B in a cloud & collaboration-driven deal

Cisco Systems is one of the largest suppliers to network operators worldwide, including telcos. Its growth strategy from the start has been reliant heavily on acquisitions, and 2017 has been no exception.

Today the vendor announced it would buy Gaithersburg, Maryland-based BroadSoft for $1.9B. BroadSoft’s software & services help telcos deliver hosted, cloud-based Unified Communications to their enterprise customers. This plays into Cisco’s collaboration offerings.

A mature target for Cisco

BroadSoft’s revenues for the last 4 quarters were $355M. That’s less than 1% of Cisco’s corporate revenues, or about 8% of the division it will be rolled into (see first figure, below). But Cisco often buys companies with no revenues, just a promising technology and/or team. BroadSoft is a relatively mature target for Cisco: it was founded in 1998, and reached its 100th customer milestone over a decade ago (May 2005). The deal size is also manageable for Cisco. Totaling $1.9B, the offer is $55/share, all-cash. Cisco had over $70B in cash & short-term investments at the end of July, so the company’s coffers will be just fine after this transaction.

This is Cisco’s eighth acquisition in 2017. That sounds like a lot, and is, but integrating acquired products & teams effectively is one of Cisco’s core strengths.

revs-mtnconsulting

Cisco’s margins still high, but revenues are falling

Cisco remains loaded with cash, but growth is another issue. Despite heavy R&D spending ($6.1B in FY2017) and an aggressive M&A strategy, Cisco’s revenues have declined for 7 straight quarters, on a year-over-year (YoY) basis. The company’s saving grace are its reliably high margins. Gross margin dropped below 60% in FY2013, but it has averaged over 62% for the last three years. It generates healthy free cash flow each quarter, over $22B for the first two quarters of 2017.

During the late 1990s tech bubble, Cisco was one of the hot stocks in the new “Internet” market – and the company billed itself as “empowering the Internet generation”. That tagline has changed multiple times, but Cisco still sits in a sweet spot of the  infrastructure market: its routers & switches retain high market share with some of the largest network builders around. The market is more competitive now, though, and much “softer” in its technology demands.

Established companies with high share have to scurry to adapt to these shifts: they need to be ready for the next big thing, but also want to leverage their established markets – and extend technology life cycles when possible. With the growth of the cloud, vendors like Cisco have a larger role to play in enabling services, not just building networks. That’s one reason why some key Cisco rivals, e.g. IBM, HPE, SAP, and now Huawei, are investing heavily in cloud networks. It also is a factor in Cisco’s interest in BroadSoft’s capabilities.

What does this deal bring to Cisco?

BroadSoft’s focus is helping telcos roll out & manage new “unified communications” services for their enterprise customers. With 1,720 employees worldwide, BroadSoft claims 25 of the top 30 global “telecommunications service providers” (telcos) as customers. That doesn’t imply global coverage for each of the 25, just 1 (at a minimum) country deployment, but it is impressive scope.

Collectively the vendor is in a total of 80 countries, and its (service provider) customers have deployed 13 million UC subscriber lines over its software. Verizon & Telstra are both major customers, accounting for over 10% of BroadSoft’s revenues recently (Verizon in 2016; Telstra in 2014). Other announced customers include AT&T, BT, Orange Business Services, and Vonage. Overall, revenue from customers outside the US accounted for 48% of sales in 2016, so it has good geographic diversity for a small supplier.

Upon close of this deal in around 1Q18, Broadsoft’s employees will join Cisco’s Unified Communications Technology group, which appears in the vendor’s “Collaboration” segment in financial reporting. Cisco’s collaboration revenues were $4.3B for the FY ended July 2017, down 2% YoY.  The BroadSoft deal should help that segment’s near term prospects, mildly. If BroadSoft’s revenues are added to Cisco’s for both the FY17 and FY16 periods, though, Cisco’s Collaboration revenues would still have fallen last year, by a slighter 0.7%. Clearly the hope is that Cisco’s corporate umbrella (and sales organization) will accelerate combined growth.

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There’s likely to be some benefit on the cost side. BroadSoft’s gross margins are actually higher than Cisco, but the former has high selling costs. BroadSoft sells through its own sales force in part, not just distributors, VARs, and other partners – as some similar sized companies do rely more heavily on. BroadSoft’s SG&A expenses have averaged over 45% of revenues for the last two years. Cisco’s comparable ratio is about 23% (figure, above). Scale clearly has some benefits.

(Photo credit: James Padolsey)

 

Early telco reporters Verizon & Rogers provide mixed signals for vendors

The first sizable telcos reported 3Q17 earnings this morning: Verizon and Rogers. Both can point to reassuring bottom line results. For the 9 months ended September, operating & net margins improved year-over-year, as did earnings per share. Rogers’ EPS through September was C$2.66, up 24% YoY, while Verizon’s $2.80 EPS for the same period was up 32% YoY. The results contain some negatives, too; some company-specific, but some illustrative of broader market challenges.

Wireless not always a growth driver

Rogers was an early mover in Canada’s LTE market, and continues to grow its postpaid subscriber base: 8.8M in September 2017, up 3.3% from 3Q16. That 8.8M amounts to roughly 25% of Canada’s population. Wireless revenue growth this year has averaged 5% YoY. The company’s operating margins are reliably in the 40-50% range; in 3Q17, the figure of 47.9% was up a bit from 47.1% in 3Q16. What helps keep the margins high are stable ARPUs and fairly low churn. Rogers’ blended (postpaid + prepaid) wireless ARPU for the year so far is C$61.94, up just under 3% from the 2016 period. Churn in retail postpaid is 1.11% so far this year, down a bit from 1.19% YoY.

Verizon, also a first mover in the US’ LTE market, retains high operating margins in its wireless division: 46.2% for 3Q17, from 44.9% in 3Q16. However, core service revenues are falling: $47.2B in wireless service revenues for 1-3Q17, down 6% YoY. Total wireless division revenues also fell, by a more modest 3.1%. The difference is equipment. Verizon regularly charges more in “cost of equipment” than it books in equipment revenues; that’s not changing. However, Verizon closed the gap significantly in 2017. The implicit loss (or subsidy) from its wireless device sales was $2.4B YTD17, down from $3.1B in 1-3Q16. This narrowing may not be sustainable. New device releases and sales/distribution strategies can often lead to spikes in equipment subsidies.

On the plus side, nearly 95% of Verizon’s subscribers are on smartphones (from 93% a year ago). Churn also remains low at Verizon: for the high value retail postpaid segment, Verizon’s churn was 1.02% so far this year, essentially unchanged from the 0.98% in 1-3Q16.

Cord cutters and OTT

Wireline accounts for about 30% of revenues at Verizon, and 25% at Rogers (over a cable network). Like most big incumbents with fixed access networks (PSTN or cable TV), both offer video platforms combining voice, data & video over an operator-provided CPE. To do this, they’ve invested heavily in network upgrades, workforce training, and sales & marketing over the last 5+ years.

Despite this investment and overall subscriber growth, both operators are reporting net losses in video/TV subscribers. Consumers have far more OTT video options now. Performance over mobile networks often isn’t good (or economical) enough for heavy video users. The incentive to keep your telco/cable-provided Internet service but cancel video is growing stronger.

Rogers’ reported sub losses have been ongoing; its TV subscribers are now 1.75M, down 4% from the prior year. This was worsened due to Rogers’ growing pains with platform development. It spent nearly half a billion C$ trying to develop a proprietary IPTV platform, similar to BCE’s “Fibe TV” platform, before having to write it off. It’s changed strategy, and will now license the Comcast-developed X1 platform.

Verizon’s had more luck with its custom FiOS box. However, it also lost video subscribers in 3Q17. Overall net adds for FiOS in 3Q17 were 59,000: +66K for Internet, +11K for voice, and -18K for video. Margins remain low in wireline, despite some YoY improvement; EBITDA/revenues so far this year in wireline is 21.2% from 17.1% in 1-3Q16. Further, to sustain its wireline business Verizon’s capital spending is higher as a % of revenues: 14.6% so far this year, from 10.9% YTD16.

Overall revenue trends point to caution

The figure below shows recent YoY revenue trends for the two operators. Rogers’ trend is relatively steady; its early lead in LTE and market-leading broadband position has helped with this consistency. The growth rate is just 2-4% per year though.

Verizon’s growth has been negative until recently, held back by weak mobile service revenues. A modest improvement helped push Verizon’s YoY growth to Rogers’ level in 3Q17, +2.5%. Another factor benefiting Verizon’s measured growth recovery is mobile device equipment revenues, up 5.4% so far this year, to 13.5% of corporate revenues.

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Even with slow top-line growth, both Rogers & Verizon generate healthy free cash flow in typical quarters, including $3B for Verizon in 3Q17 and C$372M for Rogers in the same period. They have high debt typical of telcos, but interest costs are on the low end.

Verizon capex 13-14% of revenues, selective M&A activity likely to continue

On the capex front, Verizon is big but not hard to predict: its annualized capital intensity has been in the narrow 13-14% of revenues range for several years now. Variations in the past have come from quick buildouts to gain market position. As Verizon and other telcos move to more software-centric networks, these variations will be less common and less extreme. It’s unlikely that we’ll see Verizon’s capital intensity rise above the 15% mark anytime soon. For 4Q17, Verizon will likely spend about the same as 4Q16, plus maybe 1-2%.

Verizon’s capex is constrained not just by revenue growth & software-based expansion, but also the need to reserve capital for spectrum and acquisitions. Earlier this year, Verizon purchased Straight Path and its spectrum holdings for $3.1B; in early 2015, Verizon spent $9.9B for AWS-3 spectrum in FCC auctions. On the company’s balance sheet, in fact, the value of spectrum assets (“wireless licenses”) is now slightly higher than net property, plant & equipment (PP&E, net): $88B v. $87B.

And Verizon has a healthy track record of acquisitions. That includes a recent deal to purchase fiber optic assets in Chicago from WOW. That deal was just $225M and for one metro area, but it’s a reminder that Verizon and other deep-pocketed telcos are constantly considering build v. buy alternatives. That’s more the case now, as a sector of neutral network operators (NNO) has matured.

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Rogers’ capex levels are looking up

As part of its 3Q17 earnings release, Rogers added C$100M to its 2017 target capex (now C$2.35B-C$2.45B). That modest change is, Rogers says, due to “strong growth in our wireless segment and the intended investment of those incremental profits to further enhance the quality of our networks”.

Even with that, Rogers’ full year 2017 capex/revenues is likely to settle around 16%, low by its historic standards. That’s down, in small part, because of a slowdown in its “NextBox” service while a new platform is being developed: Rogers is set to launch its white label partnership with Comcast sometime in 2018. An X1 success would mean more capex at Rogers. Comcast and it supplier partners, though, may be the main beneficiaries of this growth. At least initially. If the platform takes off and helps reverse Rogers’ video sub declines – and lift ARPUs – you can expect more investment in the core of the network to keep the cord cutters at bay.

(Photo credit: Bernd Schulz)

Communications sector M&A dominated by infrastructure in 3Q17

October’s seen a few mergers already, including Airtel-TTSL, a tower sale by Zain and the long-rumored Sprint-T-Mobile transaction (confirmed yesterday). Some interesting deals came out of 3Q17 too, especially in infrastructure markets.

63 M&A transactions announced, including OTT/cloud deals

The communications services sector saw 63 merger and acquisition (M&A) transactions announced in 3Q17. These deals accounted for a total $17.4B in deal value. Infrastructure targets accounted for 56% of deal value across 13 deals. Crown Castle’s $7.1B purchase of Lightower was the biggest by far, and exemplifies the quarter’s focus on towers, data centers, and fiber networks.

Other infrastructure deals announced last quarter include:

  • Equinix: $295M for Spanish data center provider Itconic;
  • Verizon: $225M for WOW’s fiber optic network in metro Chicago;
  • Iron Mountain: $128M for Colorado-based MAG Data Centers;
  • Keppel DC REIT: $78M for a colocation data center in Ireland, from Dataplex;
  • Zayo: $3.5M for a data center in Colorado.

Several small deals involving fiber optic and related assets were announced without valuation: FirstLight Fiber’s acquisition of 186 Communications; Neural Path-Infinity Fiber; Ufinet-IFX Networks; and EQT Infrastructure-Spirit Communications. Also, South Africa’s Dimension Data Holdings decided to sell its fiber & wireless business to Vulatel; Dimension’s view on the network assets is that they are no longer core to its “value proposition”.

Fixed-mobile-integrated services: 28 deals totaling a modest $5.2B

3Q17 also saw 28 deals targeting fixed and/or mobile service operations: 18 fixed, 7 mobile, and 3 for integrated (fixed & mobile) assets. There were no very large (>$10B) telco deals announced in 3Q17, though several earlier ones are still pending (including AT&T-Time Warner and Vodafone-Idea Cellular).

Two sizable deals in 3Q17 were international in scope: Vodacom South Africa’s $2.6B purchase of a 35% stake in Kenya’s Safaricom, and Omantel’s $846M acquisition of a 10% stake in Kuwait-based Zain. Most other significant deals were domestic in nature, including:

  • USA: Cincinnati Bell-Hawaiian Telecom ($650M, July 10); T-Mobile US-Iowa Wireless (value unknown; Sept. 26)
  • South Africa: Blue Label Telecoms-45% stake in Cell C ($424M, July 27)
  • Hungary: DIGI-Invitel ($164M, July 11)
  • Russia: Renova Group-AKADO ($120M, July 11)
  • Austria: Hutchison Drei Austria-Tele2 Austria ($112M, July 30)
  • Thailand: AIS-CS Loxinfo ($79M, September 14)
  • Australia: Superloop-NuSkope ($12M, Sept. 10)

Lowering network & selling costs (relative to size) are common dominators across most transactions. Some transactions markedly improve competitiveness through more scale or better access to a customer segment; for instance, Hutchison Drei bought Tele2’s Austria operation to jump into a strong #2 overall position in the market, behind America Movil’s Telekom Austria.

OTT/Cloud network operators also buying companies

Notably, Alphabet/Google made five notable acquisitions in 3Q17, Facebook 3, and Alibaba 2. Their targets are spread across a range of sectors, in line with their business scope. Lots of action centered around Artificial Intelligence in 3Q17, something OTT/cloud operators anticipate having a role in their networks. Alphabet acquired two firms in this space: Bangalore-based Halli Labs, and Belarus-based AIMatter. Baidu acquired Seattle-based Kitt.ai, and Facebook bought conversational AI startup Ozlo.

Infrastructure demand rising, or unstable?

With all the infrastructure deal activity in 3Q17, some wonder if this indicates rising demand for basic network assets. Does it suggest a strong growth outlook for the “neutral network operators” (NNOs) focused on neutral operations of towers, data centers and fiber networks?

The sector is growing, to be sure, especially member companies like Equinix with aggressive M&A strategies. Private equity (PE) is driving much of the deal activity in this sector. That was the case with 3Q17’s biggest deal: Crown Castle bought Lightower from PE owners including Berkshire Partners and Pamlico Capital. This quarter, there’s an even more audacious deal underway in the sector, with a PE consortium looking into an $11B Indian cell tower deal. That is motivated, at least in part, by high debt among many Indian operators & tower companies.

Which brings us back to the market outlook. In telecom, PE firms tend to buy, reorganize, and sell assets – they’re generally not in it for the (very) long-haul. Publicly traded NNOs like Crown Castle provide exit opportunities for the PE investors – as it did for Lightower last quarter. The fact that several PE firms are raising big infrastructure funds now is a positive for telecom dealmaking.  Telecom network operators seem almost certain to continue slimming down their asset base in light of weak top-line growth. PE firms will surely be around to pick up some assets when the price is right.

(Photo credit: Rawpixel)