The basic economics underlying the deals between Clearwire and both DirecTV and EchoStar are so compelling, that given decent execution and an increase in the rate of build out by Clearwire, the outcome could be a doubling of value of all three organizations.
The underlying rules of thumb for valuations of pay TV and other operators are simple. They are essentially bound up in the amount of cash they can generate now and in the future, and the likelihood of this increasing or decreasing due to churn rates, average revenue per user and network improvement. A small change in Churn can create a large change in stock value.
The stock market interest, the coming together of three determined corporate cultures used to success, and unafraid of gambling, is set to create a third end to end quadruple play in the US, to compete with the cable and Sprint combination and the RBOCs.
Of course all of this depends entirely on the way in which the two sets of efforts, those of the Direct to Home (DTH) satellite providers and those of Clearwire, are integrated. But we would expect that they would have enough sense between them to coordinate their respective activities.
At present Clearwire is attracting around 50,000 new customers each quarter, although this is accelerating at around 8,000 per quarter. It is doing this with a brand that has quite simply not been heard of among the US public, with a network footprint of only 36 US markets, covering just 9 million US citizens.
Already it has cut deals with AOL to sell its broadband lines along with the AOL service and it has signed up US retailer BestBuy to retail the service, to speed up progress. But it’s unlikely that it could have done anything quite so aggressive as sign up with both of the US DTH suppliers.
Even if Clearwire continues its build out at the current pedestrian rate, it has enough spectrum to eventually reach 117 million US citizens, in places where it can offer 30 MHz of spectrum, which is what it currently believes is the best basis for its service. If it decides that it can manage with less spectrum, it says it can reach a population of 223 million in the US, out of a total of 300 million. These two figures represent 40% and 74% of the total US population, which is an exceptionally high number for a wireless footprint, beaten perhaps only by Sprint’s 2.5 GHz licenses and the combination of the two largest RBOCs, who have less appealing spectrum but of course also have fixed lines .
On top of this it must be remembered that Clearwire has spectrum to reach 199 million Europeans across Belgium, Germany, Ireland, Poland, Romania and Spain. It has been extremely active in cutting deals for roaming and for cross marketing in all of the other markets where WiMAX spectrum has been auctioned. In other words, through partnerships it is likely to offer more than double this roaming size across Europe.
The reason for building out in 30 MHz is that it has, to date, been trying to offer all things to all people and to be in a position to compete with DSL and cable bandwidths. It only offers around 1.5 Mbps broadband to customers, and also offers fixed voice and will gradually move to portable and eventually mobile voice services, which take a very small part of that available spectrum.
But just because Clearwire’s current implementation only gives customers a reliable 1.5 Mbps, doesn’t meant that it has to stay that way. The 802.16e standard relies on using 4k carriers, and properly used this can increase the throughput on existing tower and base station layouts.
The way WiMAX works is that a base station will usually use one of 6 channels for each of 6 radios, each addressing 60 degrees of a 360 degree coverage area. Each one will work in a different channel so the neighboring base stations won’t conflict with the signal. If the aggregate bandwidth available to that 60 degree arc is not enough, more base stations can be inserted between existing base stations, backhaul permitting, which will offer services on different channels. In this way a WiMAX network can grow slowly over time removing the need to put in all of the capex up front.
Since it usually has at least 32 levels of Quality of Service, achieved by allocating a set number of carriers to each activity, different customers can be offered differing levels of service. So it’s not that 1.5 Mbps is some kind of physical limit to the technology, more it is an informed decision about what the market requires, which allows the cheapest level of network build at a given point.
As Clearwire moves on to 802.16e compatible equipment, something that its new supplier Motorola (it used to own its supplier NextNet but sold it to Motorola) has targeted for its first compliant base station, there will be even more flexibility.
At WiMAX World Europe last month, Clearwire was boasting that it would soon be able to introduce more nomadic and even mobile options to its service. It has been carrying out first phase trials of 802.16e compliant equipment in Hillsboro, a suburb of Portland, Oregon and claimed the results exceeded the expectations, with average user speeds of 2 to 4 Mbps.
So that 1.5 Mbps is a moveable feast and by astute network planning, a more dense base station population and migration to 802.16e equipment Clearwire can offer customers something closer to 4 Mbps.
The importance of this in the DirecTV-EchoStar deal is that it can better support one key function that the DTH partners needs and that’s Video on Demand.
It is a core selling point of the cable companies and would be for the RBOCs once their IPTV operations are running problem free, that the satellite operators cannot offer VoD. Both of them are currently offering it anyway, piecemeal on broadband lines they don’t own, something that might become an Achilles heal if Net Neutrality laws are never passed (and in the US they look like never being passed under the current administration).
That kind of broadband line is plenty fast enough for an SD video signal, and given that VoD tends to need provisioning for at a ratio of ten to one (one customer in ten is currently watching a VoD service), rather than the contention ratio of delivering SD broadcast video (every home watching it at once) it should be able to support that application. In fact a WiMAX network could be configured to recognize a video file download, work out that the network isn’t that busy right now and deliver it ahead of real time at the fastest speed a CPE radio can take, around 23 Mbps, to DVR storage. Over time WiMAX networks will get smart to this and configure accordingly. This might mean that DVR based VoD could be worked with HD files.
WiMAX has always been inherently fast enough to support non-HD video on demand. But it isn’t fast enough for broadcast SD TV in its current iteration, and it won’t be ready for HD VoD without further work on in the next generation or so, perhaps ten years (also near HD streaming quality will be achievable on a 4 Mbps connection in the next few years, given codec advancement).
So, in a way, the reason that DTH and WiMAX are perfect partners is that each suffers from a weakness. WiMAX can offer VoD, VoIP and html browsing and other best effort internet applications, but not broadcast TV, while DTH can offer SD and HD broadcast TV only.
The combination puts a single, two stage platform in a position where it can deliver everything that cable and the RBOCs can do and that includes the provision of a mobile TV option, either through the use of multicasting on WiMAX or more likely through another Craig McCaw company that is a sister to Clearwire, ICO Global Communications, which has just signed with Alcatel-Lucent to deliver mobile TV from its satellite by 2008 using DVB-SH.
By using standard Customer Relationship Management techniques the DTH companies can target the areas that Clearwire has already built out, and drive up density so that the networks are full, or close to capacity in a short period of time. They would probably get most benefit from pushing this into homes which they currently have not previous been able to attract, getting a double payback on their marketing activity.
That will make an enormous change to the speed at which Clearwire markets which have been built out, are profitable. And this will be especially effective if it is marketed as a ‘triple play’ for $99 (or less) in the same way that Comcast and Verizon are both marketing such services from their web sites.
And if a market is profitable more rapidly, then Clearwire can accelerate its rate of build out. It could virtually double it overnight and the effect of that is that instead of growing the uptake rate at 8,000 improvement in customers each quarter so that the progression of customers additions might go 58,000, then 66,000, on to 74,000 and up to 82,000 adds in a single quarter a year from now for a total of about 280,000 new customers over a 12 month period. The net add rate for the coming quarters might be closer to 66,000, followed by 82,000, 98,000 and on to 114,000, for a total increase over a 12 month period of more like 360,000. This number is getting closer to the type of numbers that the DTH companies are more used to, which is 200,000 to 225,000 a quarter each.
And if the DTH companies are bringing business at that rate, then Clearwire would be only too happy to let them dictate the most advantageous markets in which to build out its network. So in the same way Verizon dictates to MedaiFLO which markets to build out next, and coordinates marketing, EchoStar and DirecTV could agree between them the markets where cable (and potentially the RBOCs) are weakest (or strongest). And at that rate it only takes a couple of years until every sign up is a triple play sign up across the entire US. Instead of taking five years to break even, Clearwire could either break even sooner, or it could build out its full spectrum ownership a hell of a lot faster. In our view Craig McCaw is not interested in building immediate profit, he wants to drive up exit value in five years time.
But the combination of US DTH and US-wide Clearwire will get two dips at the ice cream. Not only is combined triple play marketing driving down the price to consumers and at the same time driving down the number of relationships that each consumer will have to have. But also all three of these organizations are running on churn rates of between 1.4% and 1.6% per month. That equates to between 17% and 19% churn.
France Telecom and Chungwha Telecom in Taiwan, some of the earliest triple plays in some of the world’s most competitive markets are achieving churn of under 12% per annum, and to prove this is also possible in the US, Verizon Wireless is also managing that having brought down its churn from 1.3% two years ago to just over 1% now.
If that could also be achieved by the DTH companies in a move that tied much of their churn to Clearwire connections, then Clearwire would also achieve that kind of churn, then it would mean that billions of dollars of existing revenue would be protected among its existing customer base.
Taking figures from when DirecTV was more aggressive, a few quarters ago, it had to sell 1 million new customers in order to increase its customers by 255,000. So it lost 745,000 customers through churn.
With just a 1% per month churn rate, this would mean that it would only lose 480,000 customers each quarter, so it could either spend a huge amount less (not just advertising, but CPE equipment and other costs) on acquiring customers, or acquire a lot more customers. If everything else remained unchanged it might just about double its rate of growth.
The numbers for EchoStar are virtually identical and that fact that two very similar organizations with very similar sized customer bases (DirecTV has 16 million and EchoStar has 14 million customers) are achieving such similar numbers suggests that it is inherent in what they are doing, and the fact that companies offering a triple play are achieving such a similar (and better) churn rate to each other, suggests that this will be the new metric for the coordinated effect between these companies.
The revenues from that saving would equate to $954 million a year on a monthly ARPU of $75 (around what DirecTV’s ARPU will be this year), and over a few years that would multiply up. Of course this is a calculation based on the triple play being available across the entire DTH footprint, and that will never happen and to get close will take years. But the amount of money is so compelling that it gives the partners an extremely good reason to build out EVEN faster than we have suggested.
They don’t only get almost a billion dollars once, but get it for every year longer that those customers stay with the triple play. After two years this becomes $2 billion of increased TV revenue, plus the cost of the other two services. In three years it’s $3 billion and so on.
It would create a new, higher ceiling that they DTH subscribers could reach for, where their growth and their churn balanced out. At present that might be at around 20 million customers each. These new figures would be closer to 30 million each as a natural ceiling. In other world’s they could both continue to grow instead of stalling after another 4 or 5 million new customer additions.
None of this will happen overnight, in fact far from it. These companies would rather that they did not have to go down this route. They have been winning against cable, but that has only been with the help of the marketing efforts of three of the largest RBOCs, two of which are now merged and all of which feel that TV is their next market.
The triple play needs to demonstrate its effect on churn, and then the Clearwire footprint has to accelerate dramatically, and all of that might take two years to achieve and one year before we know enough to be sure it is working. And all that will gradually sink into their share price as the evidence emerges.
They should have better cash flow, improved profits, higher market saturation points and will continue to outgrow the competition. After that the math is not difficult.
We know that one private company, little Israeli start up WiNetworks, will be delighted with this turn of events. WiNetworks has a few patents on combining the cabling and antennas of WIMAX and DVB-S and has been marketing this at both DirecTV and EchoStar for two years.
The ensuing combination of an existing, working hybrid between WiMAX and DTH would likely create an eruption of look-alikes, over the next few years, across Europe, which might just be the making of WiNetworks, as a technology supplier, and it will also give a much needed shot in the arm for WiMAX operators generally, and Clearwire’s ambitions outside the US, specifically.
News Corp may have dragged its heels with regard to signing up Clearwire inside the US, but once it is handed a working formula on a plate, it may be likely to sign up local WiMAX franchises across the world, to work with its abundant supply of DTH services. In the UK its BSkyB DTH service has already gone down the broadband route, but there it was forced to buy the leading DSL unbundled loop supplier and invest heavily in further DSL plant which was far more expensive than buying or partnering with an incumbent WiMAX play.
Despite all this promise, US analysts have been keen to advise Clearwire, and the DTH suppliers to steer clear of competing with the US RBOCs, and the precise strategy that is adopted by the DTH suppliers can either avoid or confront the RBOCs. They might target the US rural areas first and fulfill the rural broadband requirement, and a WiMAX DTH hybrid is a good way to go about this, or in the face of intensified competition from the RBOCs, and the dropping of their reseller agreements with either one or both of the DTH offerings, they may choose to go head to head.
DirecTV is likely to lose the support of AT&T once a decision is made early next year for AT&T to offer just one DTH service and drop the other. It is likely to continue to have Verizon’s support for a while yet, but this might dictate its strategy. It will need a new source of customers, or a reduction in churn, especially in the states outside Verizon’s heartlands and perhaps that’s why this deal was announced now, to prepare the way for that.
In fact the delay of this deal between the two largest US DTH services, which was first mooted well over a year ago, closer in fact to two, needs explanation in itself. Clearwire did swap some spectrum with Sprint as each of them tidied up their various holdings so that they would not go head to head and had the potential to roam across each other’s networks with the same equipment.
Clearwire perhaps felt it had an option to get even closer to Sprint and support it in its bid to take the US cable operators’ TV assets mobile, in the new joint venture called Pivot, which pretty soon the top five US cable operators (minus Cablevision) will be marketing as their mobile arm.
There would have been a natural play for Sprint to work with Clearwire here, spreading Pivot distribution further afield and sharing the build out costs for a trans-US network. This week Sprint has been in the press saying it may spin out its WiMAX business. This is the last thing that Sprint wants to do as this is its future, but it might share the burden of costs with another organization in order to keep its shareholders comfortable that the WiMAX network build will not eat their share value.
So perhaps Clearwire was waiting for the point when this was definitively NOT on the table, and then it went ahead and cut what it may see as its second best deal, a partnership with DTH.
This deal will eventually, perhaps in as short as a three year time span, leave three groups of players with a feasible quadruple play. The first is the cable companies, working alongside Sprint for mobility; the second are the RBOCS, great at both fixed and wireless telephony, but inordinately weak at delivering TV over wires, with Verizon using fiber, and building out too slowly, and AT&T building out copper, but perhaps not delivering enough stability; and finally the WiMAX DTH hybrid, which seems to be the only survival route for direct to home satellite players which will also work in other hybrids with both satellite and powerline broadband as well, where it suits them.
Whatever the outcome, there is no getting around the idea that the hybrid combination has the biggest hill to climb, that it may also have the biggest share gains to achieve and that it must do this at a price point that sits underneath both of the other players. That said, it can still be done.
There is one other issue to consider here. And that is that in order to cover both of its bases, AT&T could perhaps agree to buy EchoStar, and offer both U-Verse and Homezone in perpetuity. If that was a likelihood, then why would EchoStar have joined in the party and agreed to resell the Clearwire broadband service? But now that it has shown that it will go up against the RBOCs if it has to, it gives AT&T an extra reason to consider making takeovertures to EchoStar.