Monday 27 February 2017

Do Telco Investors Need to Fear the Fourth Telco?

Ever since the Government announced that they would allow the entry of a fourth telco, share prices of the 3 existing telcos have been on a down trend. In Dec 2016, the name of the fourth telco was made known; it would be TPG Telecom. Do investors of the 3 telcos need to fear the fourth telco?

Firstly, some background information about TPG. TPG is the second largest internet service provider and the largest mobile virtual network operator (MVNO) in Australia. As a MVNO, it is able to offer the full suite of mobile telco services such as voice, SMS and data. However, there are important differences between a MVNO and a full-scale telco operator such as the 3 local telcos. MVNOs buy network capacity from full-scale telcos and resell them to retail customers. In the case of TPG, it buys network capacity from Vodafone. Thus, when customers use TPG's services, they are actually using Vodafone's network. Hence, compared to full-scale telcos, MVNOs do not need to and probably do not have the experience of setting up their own telco network infrastructure. Therefore, when TPG sets up shop in Singapore, they will have to learn this and do it quickly. TPG can start rolling out their services in Apr 2017 and is required to achieve nation-wide street-level coverage by Oct 2018, in-building coverage by Oct 2019 and underground MRT coverage by Oct 2021.

How easy is it to roll out a 4G network infrastructure? I am not an expert. I believe TPG can engage network equipment vendors to design and implement a standard network infrastructure. However, for an optimal network, knowledge of the ground is important. For example, how many people usually congregate in a building, how many voice calls they usually make, what is the typical duration of each voice call, etc., etc. All these factors affect how many base stations are required to serve an area. Not only that, the usage is dynamic throughout the day, with more voice calls during day-time and mobile data usage during night-time. Unless TPG employs network engineers from the existing telcos, they will not have intimate knowledge of the ground for an optimal network infrastructure.

Interestingly, in TPG's annual results presentation in Sep 2013, they mentioned that they had secured the rights for 2 x 10MHz spectrum to build a 4G network in Australia from Oct 2014 onwards. I am not sure what happened subsequently, but the latest I check is that TPG is using Vodafone's network, so I guess they did not proceed to build their own 4G network in Australia. 

Last week, I mentioned that the mobile telco services and broadband markets in Singapore are highly saturated. See The Telco Landscape in Singapore for more details. When the markets are highly saturated, there are only 2 ways of gaining market share -- price competition or innovative offerings.

Price competition will hurt the 3 existing telcos badly. However, for price competition to be viable, TPG must be able to offer a comparable service in the first place. As discussed above, TPG does not have experience in rolling out a 4G network infrastructure. Its coverage, at least in the initial period, will be poor. Subscribers are unlikely to switch to it in droves even if it offers the most competitive plans. If it struggles to attract subscribers, it will not be able to generate the revenue required to further build up its network, which in turn leads to being unable to attract new subscribers, which ends up essentially as a chicken-and-egg situation. 

In the area of innovative offerings, TPG offers monthly pre-paid plans. Although of the same name, they are different from the pre-paid plans that we commonly know. In Singapore, pre-paid subscribers only need to top-up their pre-paid balance whenever the balance drops to zero or whenever the balance expires, which is usually 6 months. TPG's pre-paid plans in Australia require subscribers to pre-pay via direct debit or credit card every month. Thus, although called pre-paid plans, TPG's pre-paid plans have more in common with the post-paid plans that the existing telcos offer. They are unlikely to entice pre-paid subscribers to switch to TPG, because firstly, pre-paid subscribers do not like the monthly payment scheme of post-paid plans. Secondly, when pre-paid subscribers switch telcos, they lose the remaining value in their pre-paid balance.

TPG also offers SIM-only plans in Australia, but all 3 existing telcos have offered them since Jul 2015, so it is not innovative.

One offering that TPG might introduce is unlimited mobile data. This idea was suggested by MyRepublic, the other bidder for the fourth telco licence, as it drummed up support for its bid. Currently, the largest mobile data plan offered by the 3 existing telcos is 11GB. Thus, this is one area that TPG could exploit. Nevertheless, the 3 existing telcos will not sit back and do nothing. They are very good at matching the competition. For example, when Singtel launched Data X2 upsize plans in Mar 2016, the other 2 telcos followed suit within a day. And when Singtel launched Data X3 upsize plans in Sep 2016, M1 went one step further and launched not only Data X3 but also Data X4 plans 2 months later! 

One area that the existing telcos might not be able to match fully is TPG does not have its own physical stores. It sell services online, via sales hotlines and third-party distributors. In this aspect, TPG saves on rental and sales staff costs, but incurs distribution costs. Distribution costs will likely be higher than rental and staff costs, as distributors add their own profit margins to the costs. Overall, this is not likely to offer TPG any competitive advantage. If it does, the 3 telcos will likely follow closely.

In conclusion, although TPG offers mobile telco services in Australia, it does not have experience in setting up a 4G network infrastructure in Singapore. Coverage is unlikely to match that of the 3 existing telcos, at least in the initial period. And whatever new services TPG can offer, the 3 existing telcos will likely match. 

P.S. I am vested in M1 and Singtel.

Sunday 19 February 2017

The Telco Landscape in Singapore

The telco regulator in Singapore, Infocomm Media Development Authority (IMDA), regularly publishes a list of facts & figures about the telco industry. It is interesting to look at the figures occasionally to understand the trends affecting telcos and review whether telcos worth investing.

Mobile Services

To investors of the 3 local telcos, the most important figure must be the no. of mobile subscriptions. Fig. 1 below shows the no. of subscribers according to type of network (3G/4G) and payment mode (pre-paid/ post-paid) for 2016 up to Nov.

Fig. 1: Mobile Subscriptions

From the figure, it should come as no surprise that 4G subscriptions are rising as more subscribers switch from 3G to 4G. However, what is surprising is that the 3G pre-paid segment (red line in Fig. 1 above) is fairly resilient, dropping only by 3.4% over the 11 months of 2016 even as the 3G post-paid segment shrank by 22.1%. The 3G pre-paid segment remains the second largest market segment, commanding a market share of 32% of the mobile services market.

Why do 3G pre-paid subscribers choose not to upgrade to the 4G pre-paid network? To mobile subscribers, the main difference between the 3G and 4G networks is faster data throughput on the 4G network. Thus, subscribers who use mobile data will be keen to upgrade to the new network. However, for subscribers who use only voice and SMS but no data, there is very little difference between the 3G and 4G networks. Given that pre-paid subscriptions do not come with much data (you need to buy a data add-on), there are little incentives for 3G pre-paid subscribers to move on to the 4G network.

Internet Broadband

Besides mobile services, telcos also sell internet broadband services, in the form of fibre, cable and xDSL broadband. Fig. 2 below shows the no. of broadband subscribers for the 11 months of 2016.

Fig. 2: Broadband Subscriptions

Again, it should come as no surprise that fibre broadband subscriptions are rising as they offer faster speeds of 300Mbps or more. This growth is at the expense of cable and xDSL broadband, which Starhub and Singtel operate respectively. Thus, Starhub and Singtel should be wary of declining revenue from their respective cable/ xDSL broadband business. Although both will gain from increased fibre broadband business, the fibre broadband segment is a competitive one with many operators such as the 3 telcos and MyRepublic. Telcos have found it necessary to bundle mobile broadband and home digital lines to improve their offerings.

Finally, there is 1 particular chart that all wired broadband operators should worry about, which is that the no. of residential wired broadband subscriptions have peaked in 3Q 2015 (see Fig. 3 below)!

Fig. 3: Residential Wired Broadband Subscriptions

Where did broadband subscribers go to for their internet consumption? Fig. 4 below provides the answer.

Fig. 4: Wireless Broadband Subscriptions

Fig. 4 shows that even as broadband subscribers begin to terminate their wired broadband subscriptions, they have continued to subscribe to mobile broadband. This reflects changing internet consumption habits of consumers, who access internet and watch online videos on the go instead of being tied to accessing them at home. 

The penetration rate of mobile broadband as at Nov 2016 is 196.7%, even higher than that of mobile services at 149.2%! There are more mobile broadband subscriptions than mobile service subscriptions! Again, this reflects more people having more mobile devices such as phones, tablets, smartwatches, etc.

Entry Points for 4th Telco

A key reason for the analysis above is to understand whether there are any market segments for TPG, the fourth telco, to exploit and enter the Singapore market in a big way. When MyRepublic made its way into the fibre broadband market, it did so at a time when the fibre broadband market was still nascent and the telcos were reluctant to reduce prices so as not to cannibalise their existing broadband businesses. This provided MyRepublic a chance to slash prices aggressively, gain widespread publicity and lead the competition. 

Looking at the figures above, the 3G pre-paid market segment is a potential market that TPG could exploit. It is 32% of the mobile services market. Currently, none of the existing telcos could entice 3G pre-paid subscribers to move to 4G in a big way. If TPG could offer a compelling reason to 3G pre-paid subscribers, it could capture large market share from the 3 existing telcos and entrench itself in the mobile services market.

In the fibre broadband market, competition is already very intense. While TPG will enter this market and provide fibre broadband services, I do not expect any innovative offerings. 

In the mobile broadband market, the penetration rate is already very high at 196.7%, which is equivalent to each person having 2 mobile broadband subscriptions. Having said the above, the next big bang will be the Internet of Things, whereby everything is connected to and streaming data to the internet. When this happens, the market for mobile broadband will expand significantly and all telcos, including TPG, will stand to gain.

P.S. I am vested in M1 and Singtel.

See related blog posts:

Sunday 12 February 2017

Can Telcos Stop the Decline in Profitability?

All 3 telcos have reported their financial results for the quarter ending Dec 2016. Both M1 and Starhub reported a significant drop in net profit of 27.1% and 33.2% respectively while Singtel reported a slight 1.8% rise in net profit. Starhub even dropped a bombshell by announcing that dividends for 2017 will be cut by 20% to 16 cents. Can telcos stop the decline in profits, or will profits continue to decline? As M1 is closest to a pure mobile telco company, this analysis is carried out using M1's results.

Fig. 1 below shows the overall service revenue and costs excluding handset sales, which are very volatile. As shown below, the service revenue is fairly stable, hovering around $200M per quarter in FY2015 and FY2016. Service costs, however, are on the rise, especially in the last 2 quarters, leading to a decline in quarterly profits.

Fig. 1: M1's Service Revenue & Cost

Service Revenue

Fig. 2 below shows the breakdown of the service revenue. The bulk of the revenue comes from mobile services, which constitute 79% of the total service revenue. The rest of the service revenue comes from IDD calls and fixed services (i.e. fibre broadband).

Fig. 2: Breakdown of Service Revenue

As shown in the figure above, mobile services revenue is on the decline, which explains why the telco profits are declining. Some of the reasons for the decline are discussed in Impact of SIM-Only Plans on Telcos and Impact of Data Upsize Plans on Telcos. Since this business segment has the largest impact on telco profitability, I will come back again to discuss the trends affecting this segment.

IDD revenue is on the decline, which is not surprising given the popularity of over-the-top (OTT) services such as Whatsapp, which allows any Whatsapp user to make a phone call to fellow Whatsapp users anywhere in the world using WiFi or mobile data instead of voice. Very likely, this downward trend in IDD revenue will continue.

On the other hand, revenue from fixed services is growing strongly as more people subscribe to fibre broadband. In the short term, this segment is still expected to grow, but perhaps not as strongly as before as it faces many competition from other telcos as well as broadband service providers like MyRepublic. Already, M1 has to bundle mobile broadband and home digital voice to improve its offering among the competition.

Service Costs

Fig. 3 below shows some of M1's largest cost components necessary to earn the service revenue discussed above.

Fig. 3: M1 Service Costs (Extracts)

As shown in Fig. 3, depreciation and amortisation costs, which is the largest cost component, is on the rise, as M1 continues to invest in building its network. In fact, in the latest financial results, M1 reported that the estimated capital expenditure (capex) for FY2017 is around $170M. For FY2016, the capex was $141.2M, excluding a spectrum rights payment of $64.1M. Depreciation is definitely on the rise moving forward. 

The next largest cost component, staff cost, is fairly stable. In my opinion, this cost component is unlikely to rise, because TPG, the fourth telco, would likely not have any physical stores and would rely on third-party dealers to sell its services. The 3 current telcos, which have their own physical stores and sales staff, would be under pressure to contain staff cost.

The third largest cost component, facilities expenses, is also on the rise. I am not sure if facilities refer to physical stores or telco network facilities. If it is referring to physical stores, this cost will be contained for the same reason as discussed above for staff cost. However, if it is referring to telco network facilities, this cost will be on the rise in tandem with capex. To be conservative, I assume that it is referring to telco network facilities and will continue to rise.

The last major cost component, fixed services cost, is rising as well. However, this is of no concern, as the rise is in tandem with the rising revenue from fixed services shown in Fig. 2. Deducting the cost of $11.2M from the revenue of $27.2M, this segment earned a gross profit (excluding all sales-related costs like staff costs, rental leases, etc.) of $16.0M for 4Q2016. This is a rise from $10.8M in 1Q2015.

Revenue Drivers

Based on the discussion so far, service costs are likely to continue rising due to expansion of the network infrastructure. Thus, if M1 is unable to halt the decline in service revenue in its main mobile services segment, it is likely face declining profits and dividends, even before the fourth telco opens for business.

2 of the factors affecting the mobile services revenue have been discussed in previous blog posts, namely, Impact of SIM-Only Plans on Telcos and Impact of Data Upsize Plans on Telcos. Both these factors are negative on revenue and profitability. The impact of SIM-only plans will be spread out over 2 years, as subscribers can only switch from regular plans to SIM-only plans when their contracts expire, and the typical contract period is 2 years. On the other hand, the impact of data upsize plans is fairly immediate, as subscribers need not wait for their contracts to expire before subscribing to the upsize plans. Having said that, when comparing results on a year-on-year (YOY) basis, it will take 1 more year for the effect to fully disappear from the financial statements.

Although there are headwinds from SIM-only plans and data upsize plans, there are, nevertheless, silver linings. As previously discussed in Impact of Data Upsize Plans on Telcos, the larger data allowance is encouraging subscribers to use more data, as shown in Fig. 4 below (note: M1 changed the way it measures the percentage of subscribers who exceed their original data allowance in FY2016. The figures for 2015 and 2016 are not directly comparable).

Fig. 4: M1's Subscriber Data Usage

Perhaps as a result of the introduction of SIM-only plans, the number of post-paid subscribers has also jumped. The blue line in Fig. 5 below shows the YOY growth in number of post-paid subscribers, which jumped from 1.8% in 2Q2015 to 3.0% in 3Q2015, the quarter when M1 introduced SIM-only plans. The growth has continued to rise and recently stablised at around 4.5%. This rise in post-paid subscribers will counteract the fall in revenue due to conversion from regular plans to SIM-only plans by existing subscribers and data upsize plans.

Fig. 5: Trends in Post-Paid Customer Revenue

Also on the rise is the percentage of post-paid subscribers on tiered data plans (see red line in Fig. 5 above). Prior to the introduction of tiered data plans (and smartphones), some subscribers had very large data allowances under their very old mobile subscription plans. Tiered data plans cap the mobile data allowance according to the monthly price plans and subscribers have to pay more for having more data.

In conclusion, there are both headwinds and tailwinds for the mobile services operations. 

Finally, please note that although all 3 telcos have mobile services operations, Starhub has other business segments and Singtel has overseas operations and investments. 

P.S. I am vested in M1 and Singtel.

See related blog posts:

Sunday 5 February 2017

Impact of Data Upsize Plans on Telcos

Competition among the 3 local telcos used to be fairly stale, until things started to heat up in Mar 2016 when all 3 telcos launched data upsize plans as a way to pre-empt competition from a potential fourth telco. The upsize plans provide subscribers with more data with the payment of an extra monthly fee. How does that impact the revenue and profitability of telcos? As M1 is closest to a pure mobile telco company, with 79% of its service revenue derived from mobile telco services, this analysis is carried out using M1's results.

Data X2

The table below shows the monthly cost and data allowance of M1's regular plans without data upsize and with Data X2 upsize (Note: each telco calls its plans differently and has different data sizes. I am using Singtel's naming convention for ease of reference). M1's Data X2 upsize costs an additional $5.90 monthly for all regular plans.

Plan Lite Lite+ Reg Reg+ Max Max+
Monthly Cost $28.00 $42.00 $62.00 $82.00 $102.00 $228.00
Original Data (GB) 0.3 3 4 5 7 13
Data X2 Cost
$47.90 $67.90 $87.90 $107.90 $233.90
Data X2 (GB)
5 7 9 13 25

Prior to the launch of data upsize plans, M1 charged $10.70/GB for excess data usage beyond the data allowance. Thus, a subscriber who previously had to pay $10.70/GB for excess data usage now only has to pay $5.90 to upsize his data allowance. He saves at least $4.80 per month on excess data usage. This has a direct impact on M1's revenue and gross profit, since the network infrastructure is already set up and the marginal cost of providing the additional data is likely to be small.

Using M1's financial results for 4Q2015, which is just before the 3 telcos launched their data upsize plans in Mar 2016, the percentage of subscribers who exceeded their data allowance was 21%. I assume conservatively that these subscribers exceed their data allowance by not more than 1GB, because those who exceed their data allowance by between 1-2GB would have to pay $21.40 more in excess data usage and are better off subscribing to the next tier regular plan, which costs $20 more only. Thus, M1 potentially loses $4.80 per month for every subscriber who chooses to upsize their data allowance. As at 4Q2015, the number of post-paid subscribers was 1.195M. The number of subscribers who exceeded their data allowance was 251K (21% of 1.195M). The potential revenue loss is 251K x $4.80 x 12 months or $14.5M. This works out to be 2.4% of FY2015's revenue of $591M. It is also equivalent to 6.6% of FY2015's pre-tax profit of $218.4M.

Unlike the SIM-only plans, which subscribers could only switch when their 2-year contracts expire, subscribers could choose to upsize their data allowance at any time. Thus, while the impact of SIM-only plans are spread out over 2 years, the impact from data upsize plans is fairly immediate. 

Fig. 1 below shows the year-on-year changes in M1's revenue and post-paid ARPU, with timeline of the launches of the SIM-only plans and Data X2/X3/X4 plans superimposed on the chart. To understand the impact of SIM-only plans, please refer to Impact of SIM-Only Plans on Telcos.

Changes In M1's Revenue & ARPU

From Fig. 1, M1's revenue and ARPU have actually started falling in 2Q2015, but the decline accelerated from 3Q2015 onwards, which was when M1 launched the SIM-only plans. Things got worse in 1Q2016, which coincided with the launch of data upsize plans. 

Given that the impact of data upsize plans is fairly immediate, I am unable to explain why M1's revenue continued to fall at a rapid pace after 2Q2016. The reasons M1 gave for the decline in net profit were lower IDD and roaming revenue, higher handset subsidy and higher depreciation and amortisation. Thus, there are other factors at play besides SIM-only plans and data upsize plans.

Data X3/X4

As if Data X2 plans are not good (or bad) enough, Singtel launched Data X3 plans in Sep 2016, just after TPG, MyRepublic and airYotta submitted bids to be the fourth telco. M1 followed suit in Nov 2016 with not just Data X3 but also Data X4 plans!

As M1 did not disclose the number of subscribers who exceed their Data X2 allowance, it is difficult to assess what is the impact to revenue and profitability of Data X3/X4 plans. My personal opinion is the number of such subscribers is likely to be small and thus, the impact on revenue and profitability is likely to be small as well. Data X3/X4 plans are likely to be marketing gimmicks.

What's Next

Data upsize plans may be bad for telcos, but there is a silver lining. The higher data allowance of the upsize plans are enticing some subscribers to use more data. Fig. 2 below shows the average data usage and percentage of subscribers who exceed their original data allowance.

Fig. 2: M1's Subscriber Data Usage

As shown in Fig. 2, there is an uptick in average data usage after 2Q2016, which is after the launch of data upsize plans in Mar 2016. The percentage of subscribers who exceed their original data allowance is also on the rise (note: M1 changed the way it measures this metric in FY2016. The figures for 2015 and 2016 are not directly comparable). This will eventually translate to increased revenue and profitability as subscribers who now exceed their original data allowance and upsize have to pay at least $5.90 extra per month.


Data upsize plans have a direct and immediate negative impact on telco's revenue and profitability. However, they are also enticing subscribers to use more data, which will gradually translate to higher revenue and profitability (assuming all other factors remain constant).

Finally, please note that although all 3 telcos have mobile telco operations, Starhub has other business segments and Singtel has overseas operations and investments. 

P.S. I am vested in M1 and Singtel.

See related blog posts: