CSP’s Achilles Heel – Quest for Content

Despite massive growth in data services over the last decade, annual revenue growth of global Communication Service Providers (CSPs) has been crawling over the last 5 years and is expected to grow at a meagre 1.6% CAGR from 2018 to 2022 . Over-the-top (OTT) players have been feeding into CSPs’ traditional revenue streams, Voice and Messaging, while leveraging Data services to build innovative products and services. For 2018 alone, OTT players are expected to inflict a voice and messaging revenue loss of $60bn and $76bn, respectively , on CSPs, while making significant more revenue from other OTT services such as content, gaming, mCommerce. CSPs are desperately looking for the alternative revenue streams to make-up for the loss of traditional revenue.

 

Diversification as a competitive strategy

The threat to their core business from OTT players has forced bigger CSPs such as AT&T, Comcast, and Verizon, to adopt vertical integration as a competitive strategy. These CSPs have been acquiring media companies to grow revenue inorganically and fortify their customer lock-in by bundling content-based OTT services with their data plans. Bigger CSPs possess a treasure trove of consumer data, which provide huge opportunity for advertisers, but CSPs need scale and content to monetize the data. Acquiring media assets also enable bigger CSPs to own a library of content for their respective video services – thus the media company acquisition frenzy (Refer Exhibit 1).

Exhibit 1: CSPs buying Media Companies: Timeline (Click image to enlarge)

 

The approval of AT&T’s $85bn acquisition of Time Warner on June 12th, 2018 has set the ball rolling for more Telco-Media mergers. A day after the announcement, Comcast made a $65bn all-cash bid to buy 21st Century Fox (Fox), a direct response to Disney’s earlier offer of $52.4bn. As expected, Disney raised its bid to $71.3bn and will probably emerge victorious in this bidding war. In Europe, Comcast outbid Fox to acquire European Pay-TV provider, Sky, and also secured the European Union’s nod (Refer Exhibit 2).

 Exhibit 2: CSP-Media Landscape (click image to enlarge)

 

Driven by a debt binge

The acquisition spree of the bigger CSPs is putting a dent in their balance sheets. Debt has increased during 2013-2018 for all the three CSPs – AT&T, Comcast, and Verizon (Refer Exhibit 3). The Time Warner acquisition added significant amount of debt to AT&T’s balance sheet. The combined entity’s net debt is around $180bn, more than 3.5 times its EBITDA. Verizon is one of the most over-leveraged companies on the S&P 500. Comcast’s cash offer for Fox and a stake in Sky TV is expected to take its debt load to $170bn, more than 4 times its EBITDA.

 

 Exhibit 3: Total debt for select U.S. CSPs (click image to enlarge)

 

Ongoing 5G investments will put additional pressure on their balance sheets. While these companies increased their leverage, operating cash flow has remained stagnant for AT&T and declined in the case of Verizon (Refer Exhibit 4).

Exhibit 4: Operating cash flow for select U.S. CSPs (click image to enlarge)

 

FAANG players not participating in media frenzy

Facebook, Apple, Amazon, Netflix and Google (FAANG) players though keen on the content, have so far avoided participating in bidding war for media companies. FAANG players have strong market valuations (Refer Exhibit 5) and significant cash on their balances sheets. Apple reported $267bn cash in hand in early 2018. Facebook’s cash and equivalents have more than doubled – from $21bn in 2016 to $44bn in 2018. Even though the strong balance sheet of FAANG players enable them to acquire media players, they are instead focusing on creating their own original content (Refer Exhibit 6) to suit the content preferences of the millennial generation, who may not like content catalogue of traditional media players.

 

Exhibit 5: FAANG players market cap (click image to enlarge)

 

Exhibit 6: Media content spending  (2017 non-sports programming spends) (click image to enlarge)

 

Bigger CSPs risk losing focus on core business and beyond

Yet in their quest to acquire media assets, bigger CSPs may risk losing focus on their core business – “building reliable & efficient networks” and “providing value-added communication services”. Customers may not be clamoring for content from bigger CSPs, but for quality service at affordable prices. A weak balance sheet and overwhelming debt can limit the growth potential for these CSPs by reducing their ability to speedy 5G rollout and investment in disruptive technologies such as SDN, NFV, LPWAN to create scalable, agile, and efficient infrastructure.

In early 2000, major CSPs of that time, WorldCom and Global Crossing, accumulated massive debt to fund big infrastructure expansion plans, but those investments never paid-off, and resulted in collapse of many big Telco names. Let’s hope history does not repeat itself and current media acquisitions are successful in creating expected cash flows for CSPs to reduce accumulated debt. Otherwise, FAANG and other major OTT players will certainly be eager to have their own “data pipe” and massive media libraries at a reasonable price point.

Rohit Sehgal

Rohit is the Digital Business Strategy leader for Telecom & Media domain at Virtusa. He has 20+ years of diverse global work experience in Business Consulting, Software Product Development, and Services Delivery. Rohit works with clients to re-strategize their business models, by leveraging new Digital trends, to protect entrenched positions, build new expansion opportunities or disrupt industry value chain. Rohit is MBA from Indian School of Business (ISB) and bachelor’s from Indian Institute of Technology (IIT), Delhi.

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Sanjib Dutta

Sanjib is a Strategy Consultant in Virtusa’s Digital Business Strategy team and works with clients to create and execute their digital strategies.

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