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Vumatel/Fibrehoods deal underlines the FTTH Economics of Scale Factor

Summary

Economics of scale is a critical success factor for open access fibre networks. Achieving scale gives open access network providers a strong competitive advantage. Mergers and acquisitions (M&A) is a critical tool used by fibre network operators in achieving scale. The Vumatel acquisition of Fibrehoods represents the latest M&A deal in the open access fibre market. This deal continues the fibre M&A trend seen in 2016.

Vumatel buys Fibrehoods

In 2014, Vumatel entered the Fibre To The Home (FTTH) market. While there were existing fibre network operators, the entry of Vumatel kick started the entry of many new operators to the market. This in turn triggered a rapid fibre land grab. By March 2016, we estimate there were 196 thousand houses passed. Note this number excludes VDSL subscribers, as in some markets VDSL, who use FTTC, are included in the reported FTTH numbers. The figure below shows the rapid growth in FTTH houses passed over the last two years.

FFTH Market Oct 2016

Scale is critical for an open access fibre network operator

Fibre network scale is a critical success factor for an open access network provider, with scale being measured by the size of its FTTH network. The network operator’s expanding network footprint drives sales momentum among retail service providers using its network. In effect, the open access network operator offers more opportunities for the retail service providers to sell retail services.
The key benefit is that FTTH scale also translates into economic scale in that the operators balance sheet grows stronger. Economic scale means that the operator can access cheaper capital with better terms than smaller operators. This is a strategic competitive advantage as building out FTTH networks is a capital-intensive business.

Open access operators can gain scale through a combination of a build and/or buy strategy:

  • Build strategy: In terms of building out FTTH networks, we foresee a total of R12 billion being invested in open access FTTH networks over the next three to four years. This estimate is based on market announcements and our assessment of capital required to deploy the announced fibre networks. This strategy works well when an operator deploys fibre in areas where there is no existing fibre network to compete against.
  • Buy strategy: We have seen the buy strategy exercised over the past two years, with a significant ramp-up in 2016 MA activity.

M&A is part of the fibre network strategy

“M&A is a key tool used by fibre network operators to expand their networks”

Fibre network operators typically start out as niche operators, who focus on a specific high-income geographical residential area. As the operator gains market traction, it seeks new areas to deploy fibre thus driving the scale of its business.
In doing so, it faces two challenges: (1) funding the network expansion, and/or (2) deploying fibre in an area where there is an existing competing network.

  • Funding: Network operators either sell equity or take on long term debt to fund network expansion. We have seen both options exercised in South Africa. For example, Investec acquired an equity stake in Vumatel and Rainbow Capital acquired an equity stake in Metrofibre Networx.
  • Competitive: The operator can choose to (1) buy the existing network operator, (2) reach a network sharing agreement, or (3) decide to not enter that geographical market. Typically, we see options (1) and (3) being taken. Network sharing and co-build strategies are seen on long-haul fibre routes.

In SA, we have yet to see a new FTTH entrant build FTTH infrastructure in areas where another new entrant has already built out their FTTH network. We have seen new entrants build-out in competition to Telkom’s DSL network. Part of the reason is that there are enough attractive geographic areas for new entrants to choose from. This has led to an explosion in new FTTH players over the last two years that in turn has resulted in a fibre land grab.

There are a limited number of early win attractive areas wherein to deploy fibre. To gain scale and to enter these attractive markets means that the SA fibre operators must move into the M&A phase, and the market has done just that.

The following table (as at 25 Oct 2016) lists the M&A activity in the FTTH market. As can be seen, we have moved aggressively into an M&A phase. Note that the table excludes the establishment of fibre network operators and only focuses on M&A.

FTTH M&A Deals

Source: Company press releases 2015 to 2016, the Date column represents the year in which the deal was completed. It is not the deal announcement date. The Not Complete comment implies that the deal is still awaiting final regulatory/competition approval.

Here are noteworthy fibre deals that were terminated:

  • Vodacom offered to buy Neotel, the deal was terminated in Q1 2016 given the regulatory hurdles that the deal encountered.

The table shows that the year 2016 will be remembered as the year that FTTH M&A commenced.

The FTTH M&A activity seen in SA is reflective of global trends. Global market observations show that consolidation is a natural part of the FTTH market. Examples of such country markets are the UK and USA.

Fibre Network M&A Outlook

Long term sustainability in the open access FTTH network market is defined by one key word “scale”. Scale is generated through network expansion. Operators drive scale through a combination of a build/buy strategy. To date, we see little evidence of operators building competitive fibre networks in the same geographical area.

Furthermore, the South African National Integrated ICT Policy White paper (Oct 2016) promotes open access networks with the objective of limiting duplicate infrastructure build. We therefore expect that M&A will continue to be an important tool to grow network scale. In addition, we expect that more private capital will be attracted to the fibre market.

In 2017 and 2018, we expect further consolidation in the FTTH market. Small open access network operators, who cannot generate enough scale, will ultimately close or be acquired.

The M&A fibre market theme for network operators will be: buy or be bought.