Recent events set scene for UK telecoms market change

Results and TradingM&ACapital Markets

Life in UK telecoms is never dull, but the pace of change is picking up in particular in terms of the structure and ownership of the market among the larger players. Yesterday, Ofcom gave the effective regulatory green light/support to BT's 20m premises FTTP rollout, while last week, CityFibre revealed full details of its 8m premises rollout targeted for completion by 2025, with potential extensions, and TalkTalk is close to completing its Tosca-backed take private. This week's 5G spectrum auctions meanwhile boost capacity by 18%, albeit with the Huawei issue delaying rollouts. Meanwhile, with the CMA narrowing its concerns on the Virgin Media/O2 merger to just a couple of areas, the deal should close this year, establishing a clear equal competitor to BT. This article looks back at a fairly seismic year for the sector – which has proven very resilient through COVID-19 – and what the future holds in store.

Free broadband and all that

Back in those halcyon early days of 2020, when COVID-19 was little more than a nasty virus in far away lands, the UK telecoms market was entering a period of stability, with the December 2019 General Election result removing the threat of Labour’s Free Broadband policy (which we analysed here). The first tangible sign was a flurry of infrastructure deals, including CityFibre’s ￡200m acquisition of TalkTalk’s FTTP business FibreNation, enabling it to up its FTTP target from 5m to 8m premises (out of circa 32m UK premises). 

This was followed by BT upping its own target from 15m to 20m premises, subject to appropriate regulatory support, and now confirmed following Ofcom's decision on fibre pricing, copper network switchoff and other measures. The fibre opportunity has continued to attract a flood of start ups/follow on funding/new investors, including Gigaclear, Hyperoptic, Community Fibre, G.Network, toob and Zzoomm. We’ve identified over 30 fibre network builders with a combined new build target of 23m premises, suggesting a high degree of overbuild (Ofcom estimates that 70% of premises will have a choice of FTTP provider).

Whilst BT and Virgin Media account for the bulk of next-gen premises with their 20m premises FTTP and 16m Gigabit network upgrade/Project Lightning respectively, CityFibre will become the third national network. The company last week published all 285 UK towns and villages to be fibred by 2025, comprising up to 8 million homes, 800,000 businesses, 400,000 public sector sites and 250,000 5G access points, at a cost of ￡4bn. It currently passes 650k premises. CityFibre also hinted at an expanded rollout, with press reports suggesting support from additional investors alongside Antin and West Street. The company's warm welcome of the Ofcom announcement presumably paves the way to an expanded rollout.

Major market consolidation

In May last year, Liberty Global and Telefonica announced the ￡31.4bn merger of their respective Virgin Media and O2UK operations. This planned deal took a big step forward in January this year when the UK Competition and Markets Authority announced a focus on two relatively narrow areas; O2’s supply of wholesale mobile services to MVNOs, particularly those that are also fixed line players (e.g. Sky); and Virgin’s supply of wholesale leased lines (both active and passive (dark fibre)) to mobile network operators for backhaul. In contrast, the CMA found no issues at the all-important retail level suggesting that, even if remedies are required on one or both of the identified issues, the merger will go ahead largely as planned.

At the time of the deal announcement last May, Telefonica published an interesting map of the major UK fixed and mobile telecoms and pay-TV players in terms of 2019 revenues, EBITDA, FCF and subscribers. We have attempted to reconcile and update that map for 2020 both to show the impact of the merger and quantify subsequent changes in the market (in so far as it relates to the major players). 

According to Telefonica, based on 2019 numbers, the combined entity would have 32.6m mobile, 5.3m broadband, 4.9m fixed voice and 3.7m pay TV subscribers. As such it would vie with BT for leadership of the UK comms and pay TV market in terms of subscribers (46.5m versus 46.3m for BT), revenues (￡11.3bn versus ￡13.5bn), EBITDA (￡4.1bn versus ￡4.2bn) and FCF (￡2.1bn versus ￡2.6bn). In fairness, this is a bit tough on BT; the numbers are based on BT’s Consumer and Enterprise divisions, whereas one could also include the UK element of Global Services (last published UK share of 42%, of ￡4.4bn, so ￡1.9bn revenues on top of the ￡13.5bn). BT is also much larger overall at ￡23bn revenues (and ￡7.9bn EBITDA) including Openreach and non-UK Global Services.

On Telefonica’s definition, Sky is the clear number three because of its pay TV operations (22.7m subscribers, ￡9.4bn revenue), with Vodafone a distant fourth (20.2m subscribers, ￡5.5bn revenues), followed by 3UK (11.6m subscribers, ￡2.4bn revenue) and TalkTalk (9m subscribers, ￡1.6bn revenue). In total, these seven players in 2019 generated ￡43.7bn revenues, ￡12.9bn EBITDA and ￡7.4bn FCF (implying ￡5.5bn capex) from 156.3m revenue generating units. Excluding Sky, the ￡34.7bn of revenues is close to Ofcom’s ￡31.5bn estimate of the UK telecoms market size, with the former also including Virgin, BT and TalkTalk Pay TV revenues and mobile hardware sales. In reality, total industry revenues are substantially higher (we estimate ￡57.2bn; more on this to come), including BT’s total revenues and the UK telecoms channel, reflecting the fact that ￡1 of end user spend can be reported two or more times given the UK market’s well developed reseller/wholesale channel structure.

So what does the picture look like for 2020? 

We can’t fully reconcile Telefonica’s subscriber estimates so will focus on financials. Note that disclosure on Sky is now limited as part of Comcast, so we have used growth rates for Sky in total (also including Germany and Italy). In headlines terms, estimated 2020 numbers for the seven players were revenues of ￡42.0bn (-4%), EBITDA of ￡11.5bn (-12%), capex of ￡5.2bn (-5%) and FCF of ￡6.3bn (-17%). However, the numbers are heavily distorted by a significant (38%) decline in EBITDA for Sky (and lack of clarity on its capex); excluding Sky, revenues, EBITDA, capex and FCF fell by 4%, 6%, 5% and 7% respectively. Not bad for a year of major economic upheaval, particularly for a market that is in decline at the best of times anyway.

By operator, BT bore the brunt of declines (7-9% for revenue and EBITDA and 13% for FCF), whilst Vodafone actually grew (+2% for revenue and 1% for EBITDA), benefiting from fixed line growth. Interestingly, the combined pro forma Virgin Media and O2UK fared relatively well, with a 2% decline in revenue and 4-5% in EBITDA and FCF. As such, it is now actually larger than comparable BT operations in terms of EBITDA (by 3%) on revenues 12% lower, though a larger capex bill means that in FCF terms it is also 12% smaller. The aforementioned caveat re BT Global services still applies. BT also remains much larger in pure telecoms terms, given Virgin's considerable pay TV operations. 

As we noted at the time of the deal announcement, the obvious loser of the merger would appear to be Vodafone, which goes from a top 2/3 spot in terms of telecoms, and similar in size to Virgin and O2UK, to a distant third in telecoms and fourth in telecoms+ pay TV, and facing a newly converged player. Indeed, the UK stands out as the one market where Vodafone remains reliant on its mobile activities, with just 876k fixed broadband subscribers versus 17.3m mobile subscribers, and its FTTP wholesale agreement with CityFibre will take time to have an impact.

TalkTalk goes private

The smallest of the seven-soon-to-be-six is TalkTalk, which completes its estimated ￡2,079m enterprise value/8.5x annualised EBITDA take private anytime now (its shares were delisted last week). Note that the 8.5x EBITDA is based on a downgraded EBITDA outlook versus the 6.9x when the deal was first flagged in October 2020. At ￡1.5bn revenues and ￡0.2bn EBITDA it is just 4% and 2% of the big boys total, with its 5% revenue decline (based on the first half of fiscal 2020/21) slightly faster than the broader market decline. 

So how will going private save TalkTalk? The official documentation notes that going private provides access to different forms of equity and debt financing structures that are not readily available to listed companies (pretty much the same take private rationale for Kcom in 2019 and CityFibre in 2018). As a private company, TalkTalk plans to invest in fully fibre services through wholesale agreements with fibre network builders such as CityFibre, leverage its own extensive UK unbundled local loop-based network on a wholesale basis, and position itself as an aggregator of OTT video from the likes of Amazon and Netflix. We understand that new funding in the form of a bond and facilities from Ares will be at considerably higher leverage than the 4x currently, although part of this is to fund the ￡486m cash element of the take private (the other approx. ￡626m of equity rolled over into the new company). The proposed strategy appears to play to its relative market differentiation.

Looking ahead

These events lay the foundations for a period of considerable change for the UK telecoms market, led by an element of disruption as Virgin Media and O2UK consummate their marriage. Meanwhile, the accelerating rollout of fibre by all parties, and particularly CityFibre and BT, and the associated phased closing of the BT copper network and PSTN switchoff by 2025 will trigger an unprecedented amount of service change by end customers (14m of 31m lines need migrating to All-IP services), further exacerbated by post COVID-19 accelerated digital transformation/adoption of digital technologies. Looking slightly further out, 5G adds more change to the mix, with this week's spectrum auction set to boost capacity by 18%, albeit with the Huawei issue delaying rollouts. Although the market backdrop remains one of constant price pressure (and continued COVID impacts on revenues such as mobile roaming and business fixed line calls), an increasing pace of change should play to the strengths of the smaller resellers rather than the bigger network operators, who can help their customers navigate the new world.