Press comment by Rupert Wood, Principal Analyst at Analysys Mason
The sale of Tiscali’s UK operations to The Carphone Warehouse Group, parent of TalkTalk UK, comes at the end of a very drawn-out process during which the asking price has fallen and several different kinds of potential buyer (including Vodafone and BSkyB) have been ambivalent about the acquisition of the UK’s number-four ISP. While an eventual sale is unsurprising, the fact that the sale is to the UK’s other major price-leader focuses attention on the role of independent price-leaders in the retail consumer telecoms market.
The rationale for the acqusition is posited on scale and associated cost benefits. The combined group will be the second-largest ISP in the UK in terms of subscribers and the largest in terms of residential subscribers. Tiscali as a whole was in a dire financial situation, struggling to refinace debt of over three times its 2008 EBITDA with negative operating free cashflow (OpFCF – that is, EBITDA minus capex), and the performace of its UK operations (which accounted for 69% of the company’s total revenue) has been substantially weaker than that of its Italian operations. TalkTalk UK has similar EBITDA margins, it too had negative OpFCF in 2008 and the net debt/EBITDA ratio of The Carphone Warehouse Group was 1.9: close to the telecoms industry average, but high for an altnet, and growing.
TalkTalk has stated that it believes the acquisition will enable the combined entity to realise annualised savings of between GBP40 million and GBP50 million by March 2011. These are expected to come from the creation of a single unbundled network, from integrated backhaul and core networks, and from an integrated billing platform. Note though that 78% of TalkTalk’s subscribers are already on its own multi-service access nodes (MSANs), and the total on its MSANs within 24 months is expected to be only slightly higher, at 80%.
These savings have to be considered in the context of the other problems besetting the price-leader end of the retail broadband, especially in the highly competitive UK market. This market will still have five major national players (arguably six, given the ongoing rise of O2 in DSL), which is more than any other in Europe.
- In many of the more advanced economies in Europe, the total DSL subscriber base is stagnating and revenue has started to decline. In many cases this is due to better alternatives from cablecos and some nascent fibre providers, but some of the slowdown can also be attributed to mobile broadband, which can siphon off some of the lower-end casual users of DSL, of which both TalkTalk and Tiscali have many.
- The ability of multi-play operators to leverage their strengths has become particularly apparent in the recession. Across Europe, players with a substantial triple-play offer have tended to fare better over the last twelve months. Paradoxically, price-leaders with simple fixed-line service propositions (including Tiscali UK and TalkTalk UK) may not be able to thrive in a recession simply because they have too little margin to invest in as a means to buy loyalty and pull through the recession. And while most cablecos (such as Virgin Media) have high debt levels, they typically have good (in some cases very good) margins. What appears to have happened to consumer purchasing behaviour during the downturn (particularly among those that are experiencing financial uncertainty, rather than outright distress) is that consumers are happier to make savings by sacrificing choice and tying themselves to longer contracts and broader bundles than they are to make savings by looking for simple cut-price offers. This, as it turns out, is generally the experience of supermarkets, too. People want more volume of goods for their money, but they will not necessarily want to spend less, so margin and volume are played off against loyalty and spend.
- There remains great uncertainty over the cost and value to ISPs of next-generation broadband. The cost side remains a big unknown for UK ISPs, but the evidence from other European markets on demand shows a reluctance by most consumers to pay a great deal more for the higher-speed suite of services. While the end of the recession may ease the pain a bit, the future for the time being looks like higher costs for ISPs and weak demand.
Several, although not all, of the remaining independent providers in the broadband market have thin EBITDA margins, and several still have negative OpFCF. Ultimately, what killed Tiscali UK off as an independent price leader were the cripplingly high financing costs (over 60% of EBITDA for a company with a capex burden that meant it was OpFCF negative), which it was unable to meet.
