The moment that Liberty Global said that it is selling its stake in JCom also known as Jupiter Communications, the Japanese cable TV provider, picking up $4 billion on the deal, the so called smart money immediately went down on Liberty switching the funds to Germany and putting it into a bid for Kabel Deutschland Group (KDG). And it might.
But perhaps the real story is why KDDI, the buyer of the J:Com minority stake, would pay a premium to buy control, but not majority ownership, in a cable TV company that while still growing, has seen that growth slowing.
Typically Japanese investors cannot see the bleeding obvious, primarily because competition is so hot in all aspects of the Japanese telecommunications market, that a tried and trusted formula, like triple play, is expected from all players, and is not the savior solution that it can be elsewhere.
In this case the motivation is that KDDI has dabbled in quadruple play economics, by laying its own fiber and acquiring smaller fixed line and cable operations, but so far cannot offer anything to stand in the way of the NTT juggernaut. KDDI bought control of Japan’s No.2 cable firm Japan Cablenet back in 2006 and has bought up fiber-optic operations from power companies and has around 5 million homes on its broadband network. JCom will add 3.3 million to these existing homes, which is just 8.3 million, out of the 49 million homes in Japan which are dominated by NTT.
So in Japan, unlike the US, it is cable that is being flattened by the leading Telco (although that situation may only be a few years away in the US as well). KDDI, as number two mobile phone company, plus one of the leading cable companies, seems to make a perfect fit. It will take a few years (not months) before the services can be so well integrated that a proper quadruple play can be offered.
What do we mean by a ‘proper’ quadruple play? There needs to be price flexibility to offer any of the four services ‘ mobile, fixed telephony, broadband and TV ‘ cheap or for free, while getting paid for the other three. So that against a mobile company, mobile deals can be offered by KDDI’s au, which match rivals, but throw in a cheap or free extra service, to give it the edge. Against NTT, it will need fully fledged bundled offerings with all four services ‘ simply billed, and even more simply signed up for and deployed, with unified call centers for both sales and support. That needs time. But without this and other fixed line acquisitions, KDDI would begin to suffer at the hands of the dominant NTT.
Some people are predicting the same kind of outcome in the US with AT&T’s dominance, which is why there is so much concern that the Bush administration allowed the AT&T Frankenstein (made up of different parts of other Teclo bodies) to be created.
Immediately KDDI’s share price plummeted on the news that it had paid so much, a 65% premium on the public share price, for the JCom shares, but also on the fact that overall KDDI revenues had begun to decline in its quarterly results. We see this deal as the remedial action that KDDI is taking to give it a future answer to investor criticisms. Sure it is fair that KDDI suffers an initial valuation adjustment for the acquisition, but in the long term if it didn’t do something about its future growth potential, it would have suffered a lot more.
The valuation was fairly straightforward for Liberty Global. The operation did not throw off lots of spare cash, it had $3.5 billion of goodwill on its balance sheet for JCom and will leave around $661 million in its coffers. Any lower valuation would not have been attractive to Liberty Global, which is run as if it was a venture capital or private equity firm sometimes ‘ with shareholder value being sacrosanct. In the past Liberty Global has bought, tidied up and sold off the cable operations of entire countries (such as France), and even where it has spent a fortune on new infrastructure and even where it has lost subscriptions, it has gained on the deal, and it has done so once again here.
The third quarter figures are the last on record for Liberty Global, and there JCom was shown to be growing revenues at 30%, however much of that was associated with a recent acquisition of cable operator Mediatti, and without that growth would have been a mere 5% (which in the current economic climate is more than acceptable). There are investor murmurings that the next quarter would be far worse, but that seems to us unlikely.
KDDI will have a long haul convincing Japanese investors that this is the right move for the company, and the trigger will be when its mobile arm brings new customers to its fixed line or vice versa, and that will be a ways off.
So what will Liberty Media do with the money? Well a valuation of KDG is being put publicly at around $7 billion, and yes it is very much up for sale. Private equity owner Providence Equity Partners has had it on its books since 2004, for far too long, and has publicly stated that it would be interested in selling the company on the right terms.
Financially a deal can be done here fairly easily. Providence would be happy with either no holding or a smaller holding, so could sell managing control and either a majority or a large controlling minority, for about that $4 billion.
Already KDG has an MVNO with Telefonica in Germany, and has the beginnings of a Quadruple play emerging, where it can offer 4 way services bundles up against Deutsche Telekom, but it has no national footprint in which to do this.
So Telefonica, in return for a stronger MVNO play in Germany, might also be tempted to put up some cash, or make other contributions.
However given that this is Vodafone’s heartland (it is the second largest mobile operator in Germany and this is its biggest territory in Europe, even bigger than its native UK) it would be crazy for it to allow Telefonica to build such momentum on its patch. It could be tempted to aggressively bid to offer its better known German brands to work alongside KDG in new, Liberty Media, hands. Which is perhaps why Vodafone has been mentioned in the last six months as a bidder for KDG.
It could, but why would it? Vodafone has its own IPTV system, built around the Arcor broadband brand it acquired from Mannesmann, and while this has got off to a false start, selecting perhaps the wrong technology for its IPTV offering, it’s likely to opt for a Microsoft Mediaroom partnership and continue on its own. Why does it really need KDG.
But the same can be said of Telefonica, which has just spent $1.3 billion in its bid to buy Hansenet, to add 2.3 million DSL lines to its German holdings, from Telecom Italia in November.
Supporting a quad play then with an MVNO, working with Liberty Media right the way across Germany, after a KDG acquisition, while juicy, has its draw backs for both Vodafone and Telefonica, because it creates a more powerful competitor, and the more likely concern here is that Telefonica might pull out of its existing MVNO, only just launched, if a new, more powerful owner appeared.
But the other issue for Liberty Media to cope with in doing a German deal, is getting the German financial regulator to agree. It was only a few years ago that it blocked a merger bid between Kabel Deutschland and Unitymedia, and Liberty Global this week only just got EU clearance to acquire Unitymedia, so this would be the same kind of request and may not get clearance.
It is possible that the German authorities will see that without a national cable operator Deutsche Telekom would grow unrestrained, and give it its blessing, after repeated refusals in the past. One concern in the past was that private equity groups would buy all the four biggest German cable operators, merge them and then sell them back to Deutsche Telekom as their only exit outlet. It had already made Deutsche Telekom divest them in the first place.
That’s almost impossible now, because Deutsche has invested so much money in its own IPTV network, and because it has actually managed to sell a considerable number of German homes the service.
So we see Liberty Global either returning some of that JCom cash to its shareholders, including the majority holder Liberty Media in the US, or spending it filling out portfolios in Germany with offers for smaller operations like Kabel BW and Orion or in other weaker territories such as Eastern Europe or South America, rather than a big gamble in a single territory.
However the pressure is on Liberty to stimulate sales through the creation of viable quad plays, and it has yet to reveal its strategy for mobile operations in any of its territories, and a lot may focus on that MVNO which KDG has with Telefonica and what it may or may not do for the growth prospects in Germany, up against a resurgent Deutsche Telekom.