29 October, 2019

Worlds collide – 5G and why NZ’s Telco sector faces greater competition and corporate activity


At Jarden, we see potential for greater competition and corporate activity in the Telco sector over the next few years. While it is conceivable that the benign conditions that have prevailed over the last five years could continue, we see scope for change - including change that could influence investment decisions - arising out of some of the following factors on the horizon.

Vodafone NZ’s recent change in ownership will see the recent focus on harvesting cash and exiting the business replaced by a new owner with a clear strategy to drive value uplift through a combination of factors. If this is the only change that occurs over the next few years then the impact on the market won’t be dramatic, as we are clear on Vodafone’s over-arching objective to retain a stable industry structure. Nonetheless, better customer experience, a more competitive cost base, investing for a leadership position in 5G, and entry into Fixed Wireless Access (FWA) will have implications for Spark (SPK) at the margins, over the conditions that have prevailed more recently. 

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Figures 1 and 2 show no meaningful new entry into mobile or dramatic change in connection share since 2015, with slightly more new activity in broadband but big players retaining dominance.

Chorus’ (CNU) UFB communal build is nearing completion and CNU has some interesting choices in front of it – and a new CEO to lead consideration of them. CNU faces a regulatory outcome that won’t shield it from network competition; and it is clear that its focus needs to be on maximising demand and revenue from its substantial fibre investment, while considering what, if any, response it makes to the potential medium- to longer-term threat of mobile network competition. There is a case that CNU could retain a status quo approach (clearly focusing on driving uptake but not on price; retention of reasonably simple product/pricing strategy focused on the anchor 100 Mbps product and premium 1Gbps product; no significant new investment initiatives post UFB). Under this approach we would see the post-UFB communal free cash flow CNU generates utilised in a dividend policy that maximised return of cash to shareholders. The ratings agencies, the board’s view on competitive risk and regulatory settings would act as the constraint on dividends, but an uplift from as early as FY21 seems achievable. Alternatively, CNU could take one of two more aggressive approaches focused on dealing with the network competition risk – these could impact the wider market and would likely impact the shorter-term dividend track. Under approach one, CNU would put its regulatory determination aside, and potentially anchor product pricing, and be willing to use price as a lever to win across all segments in the broadband market (e.g. competitively price a product under the 100 Mbps anchor; look at sharp pricing on 200/500 Mbps products, etc.). This could have an influence on the investment case for 5G network intensification, given the economics associated with that intensification are reasonably reliant on FWA (i.e. it is not convincing at this stage that there is a meaningful premium ARPU opportunity on cellular-led 5G network intensification). Under approach two, CNU could pursue mobile network investment which would be defensively motivated against the FWA threat, as well as diversification into non-regulated infrastructure. This too could significantly impact the market dynamics in mobile, for the two large Mobile Network Operators (MNOs) in particular, given network based investment would be wholesale focused and invite potential retail entry that has been missing from that market.

The number three players in the broadband and mobile sectors, respectively, Vocus and 2degrees have sat somewhat in no-man’s land over the last five years with limited growth. The financial position of 2degrees’ majority shareholder, Trilogy International Partners is interesting. There are a number of potential scenarios which have been looked at over the last five years (new owner, including a merger with Vocus), but we are interested in what CNU might do with regards a play for an existing mobile network. While it would not be without some reasonably high hurdles (regulatory for CNU, which is subject to quite strict line-of-business restrictions), we do wonder whether the conditions are right for CNU to purchase an existing mobile network. We do not see an infrastructure-only spin-off to be nearly as interesting for CNU. 2degrees’ majority shareholder, Trilogy International Partners, has divested mobile infrastructure assets in Bolivia. Divestment of the network would certainly provide some scope to reinvigorate competitive positioning, and might nicely fit alongside the Vocus business. Add Sky (SKT) into the mix (looking to diversify into Telco) and things would be very interesting.

Outside of these considerations there will continue to be other issues that influence the landscape, such as the potential for some Telco-Media convergence. SPK (acquiring content rights) and Vodafone (pushing a platform that integrates third-party content offerings from NZ and internationally) are taking quite a different approach, but the organic opportunity in both businesses seems moderate – particularly after SKT significantly limited the scope of what SPK could do with the retention of rugby rights for the next five years. We expect SKT to enter the broadband market, which will be incrementally negative for SPK and Vodafone given the scale of SKT’s customer base.  An attempted merger between one of the two large Telcos and SKT—a proposition that was quite roundly rejected by the ComCom only quite recently—seems unlikely, but there is more potential SKT could be involved in something with second-tier Telcos (Vocus, 2degrees or TrustPower’s broadband business). We suspect it is most likely that SKT will take an organic approach, looking to get some capability with a much smaller acquisition.

This article reflects the opinions and views at the time of publication, and is not to be relied upon as a basis for making any investment decision. Please seek specific investment advice before making any investment decision. Jarden is an NZX Firm, a broker disclosure statement is available free of charge at www.jarden.co.nz. Jarden is not a registered bank in New Zealand. 

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