The race to provide faster broadband is on. But will incumbents be disrupted by the challenger providers: the 'altnets'?
In 2018, UK consumers spent a total of one day a week online, more than twice as much as in 2007. Time spent online, demand for data and the number of devices connected to the internet all continue to grow, generating demand for ever faster and more reliable internet connections.
Across Europe, different investment approaches have been taken to providing faster broadband to meet these needs. Some countries – such as Portugal, Spain and Sweden – are well under way to nearly universal full fibre-to-the-home (FTTH) coverage, which provide speeds up to 1000 MB/s. Others – including the UK – have taken a different investment approach, combining fibre with copper network upgrades, typically delivering speeds of around 60MB/s. With the government and regulator now pushing for full fibre, broadband operators in the UK are playing catch-up.
Alongside the traditional broadband network providers in the UK, BT and Virgin Media (owned by Liberty Global), there are now as many as thirty new entrants (so-called ‘altnets’) investing in fibre rollouts and vying for market share. As investors in the traditional players and the new altnets, we need to consider whether full fibre build-outs will create value and how that value will be shared between the incumbents and the challengers.
To answer that question, we need to look at two of the key drivers of returns: user demand and build-out costs.
Hyperfast speeds are not a pressing current need for the majority of internet users. Video content streaming (watching Netflix) is one of the most bandwidth-hungry activities regularly carried out by UK consumers, and at present FTTC (fibre & upgraded copper) networks are able to comfortably deliver ultra-high-definition streams close to 100% of the time. Longer term, however, we believe that demand for hyperfast internet will continue to grow as the number of connected devices per household and the sophistication of content continues to increase.
Turning to deployment capex, there is a considerable disparity between the costs of rollout between different developers, depending on the geography. Large operators such as BT benefit from economies of scale in this respect, and the cost per household of passing rural homes is understandably much higher than in densely populated urban areas.
Full fibre adoption tends to be driven by users with the poorest quality of existing connection, rather than by advanced users seeking to upgrade to hyperfast internet speeds. Balancing this against the high cost of rural rollouts, the would-be fibre developers are most likely to target incremental deployment in previously under-served geographical areas with medium population density and attractive demographics, rather than starting a nationwide capex arms-race.
Altnet rollouts are still in their infancy (over one million homes passed), but the sector has lofty rollout ambitions: around 15 million households – about half of the UK total - by 2025. In practice, these plans almost certainly target overlapping geographies, and there will be a first mover advantage. Combined with the economies of scale for network rollouts, we think that consolidation in the altnet space looks very likely over the coming years.
For direct infrastructure investors, fibre deployment at the moment presents opportunities for enhanced-yield strategies. Track record, industry consolidation and more clarity around uptake rates will be needed for fibre assets to move down the risk curve to core strategies favoured by the majority of infrastructure investors. Consolidation of fragmented altnet market will be the likely first step in that process.
BT currently passes less than a million homes with full fibre, targeting 3 million by 2022, and potentially leaving the company vulnerable to market share losses from the altnets in the long term. However, we believe that BT is at a strategic crossroads. The company has just appointed a new CEO whose top priority must be to determine the right investment path. With BT’s dividend yield at 7%, we think the market is already pointing to a lower payout, and we believe that the money saved could be applied to a more comprehensive fibre roll-out. We believe that the viability of the altnet business model and therefore BT’s own future market share path depends on this investment decision – will management be willing to take some short term pain to preserve its long-term success?