PART V: GROWTH STRATEGY LOOKING FORWARD
We should begin by segmenting the opportunities for growth. A logical way is simply following how Cincinnati Bell segments its business: Consumer and Enterprise. Additionally, we should simplify by only focusing on growth from its core business of providing internet services.
- Should Cincinnati Bell grow its consumer internet organically or through acquisitions?
- Should Cincinnati Bell grow its enterprise internet organically or through acquisitions?
- Of these four opportunities, which is of priority? Which would be most pragmatic?
Currently, cablecos hold the majority of share in the consumer segment. Telcos on the other hand have good reach to enterprises because they run off the historic telephone copper network. Like cable in its early days, fiber optics is now being pushed to the consumer segment and gaining share. This should happen quite organically due to the superiority in technology. The enterprise segment should at the same time become more competitive.
We think it would be pragmatic to organically grow the consumer segment. There isn’t a need to aggressively grow this through acquisitions, which could further disturb the competitive environment. On the other hand, it is worthwhile for Cincinnati Bell to invest and more aggressively defend its enterprise segment. Breaking down the enterprise segment, there is two sub-components: internet and IT Services (eg. VoIP, network security, hosting). Let’s review our industry map.
The Enterprise Customer is looking for an internet connection, Unified Communication, network security, and hosting. It engages a Service Provider for this packaged solution. The Service Provider acts as an integrator, leasing the internet circuit from the local carrier (in some cases, its competitor). There are two paths in investing to boost the enterprise business,
- Directly – through focusing efforts on the Service Provider (IT Services)
- Indirectly – through investing in the wireline infrastructure (which local Service Providers will in turn purchase for Enterprise Customers)
We think it would be most pragmatic to focus efforts firstly on the Service Provider who services the Enterprises. In the case of Cincinnati Bell, this would mean focusing on building that enterprise relationship first, even if they do not own any wireline infrastructure in service area. This could mean having to lease the underlying wireline infrastructure from a competitor to service the end-customer. This offers a key ancillary benefit. Over time, the fiber wireline infrastructure can be built to the end-customer, knowing they already have the relationship in place. When the fiber arrives, the existing cable circuit can be cancelled. This is the approach Cincinnati Bell is taking to expand its footprint into Michigan.
PART VI: RISKS
The wireline competitive landscape has weighed heavily on DSL carriers over the past year and we believe this will continue for the next few years. As DSL continues to lose share, there is a compounding effect because the costs of supporting the infrastructure do not symmetrically move downwards. Measures such as augmenting the DSL network with fiber (Fiber-to-the-Node) will help, yet these improvements still struggle to compete with cable speeds. In our next section on Valuation, we redefine what we believe to be true Legacy assets. We think it will take about three years until CBB’s Fioptics business surpasses ‘legacy’ as a percentage of total sales. As such, a reasonable argument is to wait. This disproportion negative emphasis on DSL legacy assets could continue. The rebuttal is that with high probability the competitive landscape will subside. At that time, the less noticeable fiber assets will be proportionally valued.
The risk in turn shifts to the robustness of fiber growth. Categorically, the concerns are either [i] a disagreement on a macro supply-demand for fiber assets in the future, or [ii] Cincinnati Bell’s ability to build out their fiber network. The first concern we discuss in Appendix J: Fiber Supply vs. Demand. The second concern we briefly discuss in the following section on Valuation. This concern relates to whether CBB will have sufficient cash to continue its fiber build out. Not currently issuing a dividend to its common shareholders puts them in a good position. This contrasts with names like Frontier who has had to cut their dividend. The immense importance of maintaining this dividend policy is difficult to describe. For those interested, we recommend reading in on Telus quarterly conference calls. As Entwistle describes, everything that relates to financial engineering is in servitude to their dividend growth model – their top priority. Regardless, it is highly recommended to follow Telus’ quarterly commentary as Entwistle is likely the most articulate and formidable competitor in the telecom space.
In Cincinnati Bell’s case, we would closely monitor its cash availability to pay down debt, in addition to investing in its fiber network. Any sudden movement in its leverage ratio would justify a reassessment of our short-term thesis. This quandary has been weighing on firms like CenturyLink as they are also trying to build out their fiber network. Over the past few quarters, their capital has been able to fulfil their dividend quite effortlessly. However, looking holistically, it has fallen short in improving its capital structure.
PART VII: CATALYST/ENTRY
Our three-year timeframe is in line with the 2020 target for 5G technology. Over the past few years there has been skepticism around high frequency mmWave spectrum and its application in 5G technology. The latest bidding war for Straightpath hopefully settles this debate. In the world of 5G, the demand for new fiber is a prerequisite for the technology to come to fruition.
The fiber thesis and catalyst follows the same logic of mmWave spectrum. That is, the catalyst are typically events that validate the demand for the spectrum or fiber asset. How will fiber/spectrum technology play a role (if any) in the future? Some of these catalyst in spectrum included,
- The Federal Communications Commission (FCC) publishing a Notice of Inquiry (NOI) in October 2014, in which they sought comments on several bands as potential for 5G
- The FCC confirming StraightPath’s high frequency bands are of value by fining them for hording it
- Verizon acquisition of XO Communication’s spectrum
- AT&T intention to buy FiberTower’s spectrum and cell backhaul network
- Technical reports from Samsung, Qualcomm and other vendors validating their adoption of the technology utilizing the high frequency bands.
In the present environment, wireline remains highly competitive with carriers offering significant improvements in speed at little to no cost. One could make the argument that an optimal entry point is during these competitive environments when uncertainty is most prevalent. Unfortunately, determining this slowdown in competition likely unknowable. What we do know is that historically the industry has been known for its tacit coordination and lack of direct price competition. The likelihood that the price wars will persist for more than three years seems unlikely. As the competitive landscape decelerates and CBB’s fiber reach scale, they have the option of instituting a dividend.