One of the inevitable results of commoditization is consolidation, and Wall Street (Oppenheimer in particular) has started predicting who among the “providers” in telecom might be acquired by somebody else. It’s worth looking at their list of eaters and “eatees” to see what we can learn about industry direction.
Top of everyone’s list is T-Mobile, and most realize the challenges that the company faces—mostly competitive but also challenges in marketing and churn. The problem for mobile operators is less that of roaming (as some have suggested) and the need to build giant service areas as it is about advertising scope. Mobile services are promoted and sustained by brand recognition and that’s achieved largely through TV ads. If you buy ad space on a primo show and half or more of the audience can’t get service from you because you don’t have towers in their area, you’re wasting your time.
That makes the cost of running an aspiring mobile telco about the same as that of running an established one, and obviously the revenue is a lot less if you’re trying to fight your way up. But I’m not sure that T-Mobile is an easy grab for somebody for that same reason—return on investment for the buying company is going to be harder to achieve. T-Mobile can’t likely be acquired by Verizon or AT&T, so if there’s going to be any action, look for it to come from a cable company who wants to leverage mobile services for quad-play. I’m skeptical even there.
Level 3 is another company that gets an acquisition target nod, and here I think the thesis is better though still complicated. From a profit and ROI perspective the company isn’t exactly sterling, and I don’t see that changing at this point. What Level 3 could offer is national backbone capacity and peering with the major access ISPs. That could be valuable for either 1) mobile backhaul if somebody like T-Mobile really wanted to push their cells into everyone’s territory or 2) if the overturning of neutrality sticks or if a new rule permits inter-provider settlement, provider-pays content delivery, or QoS peering. I don’t think that Verizon or AT&T need Level 3, though, so again we’re left looking at either offshore players or a cable MSO to be the acquirer. If the FCC and Congress cooperate on neutrality and settlement, this could happen.
DirecTV is second on Oppenheimer’s list and third overall among the broader Street players. I think there’s value in video delivery for sure—it’s actually about the only thing that can be truly profitable in terms of consumer network services. The problem with M&A here is less value than “valuable to whom?” A company with a video franchise already has little reason to pick up DirecTV because they already have content services so that rules out the cable companies and AT&T and Verizon. The only thing that DirecTV could add is fringe coverage, where customer density and opportunity were too thin in a geography to make any wireline delivery of content pay. I think that’s a marginal game, so I think DirecTV is on the block only for an offshore player.
Probably the most “interesting” speculation on provider M&A is somebody buying Rackspace. The thesis here ranges from the sublimely stupid (“Telcos have to get into the cloud”) to the semi-sensible (“Operators could wring a lot better margins out of Rackspace’s infrastructure, and quickly become players in the cloud”). This is actually a tough call, because it is true that as former public utilities the telcos could surely deliver better results and also tolerate low ROIs better. However, it’s not clear how much a telco would have to pay for Rackspace, and unless the telco has specific technical options to reduce costs and specific service objectives beyond IaaS, it’s hard for me to see how this works. Still, Rackspace was the impetus behind OpenStack, which is the favored telco cloud. Cable companies might be a better bet since they typically have less invested in the cloud than the telcos do (both AT&T and Verizon already have cloud services). They’d also need to have some specific technical strategy to raise service agility and drive down costs, though.
I think this last point is the most interesting, because in truth the M&A prospects for all the companies I’ve named would be better if we assumed that the prospective buyer had a good idea of how to raise revenue and lower cost that goes beyond consolidative economies, which are always potential drivers for M&A. Here I’d point to AT&T and their Domain 2.0 strategy, which promises to create a new and more agile/efficient telecom. If that could be done, then AT&T could benefit from any of these acquisitions except that of Level 3, and it’s possible they could use Level 3 CDN capability to deliver content from U-verse out of area.
The key point about consolidation driven by commoditization is that it can be both promoted by and defended against using measures that drive up margins. If the buying player can wrestle better profits from what they acquire, then they are more likely to take the plunge. If the target company can create better margins internally, they can perhaps sustain themselves independently or make the price of acquisition unattractive. SDN and NFV are both shifts that could boost efficiency and agility. The cloud could improve revenues. At the technology level we have path toward better profitability, if we can harness these trends.
Necessity is the mother of invention. The same forces that encourage consolidation also promote the need for operational efficiency and service agility, those two common buzzwords of our time. As we’re considering whether the industry will commoditize and consolidate, we need to consider whether it could fight its way out of both painful consequences by simply doing a better and more efficient job. I think that’s very possible, and referencing again AT&T’s initiatives, I think people are really trying to do that right now.