Lessons From Iliad's Free Odyssey

Which "triple-play" broadband service provider posted the highest EBITDA margin for the first half of 2007: Comcast Corp. (Nasdaq: CMCSA, CMCSK), Time Warner Cable Inc. (NYSE: TWC), Charter Communications Inc. (Nasdaq: CHTR), Cablevision Systems Corp. (NYSE: CVC), or France's Iliad (Euronext: ILD)?

You'd be right if you picked Comcast, weighing in at a hefty 38.2 percent. But the surprising No. 2 on the list is Iliad, operator of the French broadband service Free . Maybe there is something we Yanks can learn from the French, besides how to bake a fine baguette.

Table 1: EDITDA Margins for 1H07

Comcast	38.20%
Iliad	35.80%
Charter	35.40%
Time Warner Cable	35.00%
Cablevision	30.10%
Source: The companies

What is particularly impressive about Iliad's performance is that the company delivers its data, video, and voice service bundle over IP using ADSL and copper plant owned by France Telecom SA (NYSE: FTE). Better yet, Iliad earns its margin on a bargain-priced €29.99 (US$41.50) per month data, video, and voice bundle in a hypercompetitive broadband market. The company just launched a fiber-to-the-home (FTTH) service, but it is currently a minor contributor to the business. (See Free Unveils FTTH, Better Profits.)

The heart of Free's offering is the "Freebox," an IP set-top box and service gateway designed and supplied through another Iliad subsidiary. The newest incarnation, the HD Freebox (with a separate ADSL2+ adapter) integrates hi-def and standard-def decoders (including MPEG-4), a digital video encoder, S-Video and HDMI connectors, WiFi, plus landline VOIP and mobile voice over WiFi. Some 40 percent of Free customers now have an HD Freebox. The Freebox packs some punch.

HD Freebox

The HD Freebox, aided by an ADSL2+ adapter, integrates HD and SD decoders.

Free's €30 package is chock-full of value-added service features. At the top of the list is unlimited telephone calls within France and to 49 other counties, plus integrated messaging and a WiFi VOIP client for mobile phones. Also included are over 100 digital TV channels, plus up to 28 Mbit/s downstream Internet access via ADSL2 (for those customers on short copper loops) and 1 Mbit/s uploads. It also offers a user-generated video app called TV Perso Free that leverages the video encoder capability of the HD Freebox. (See Iliad Launches TV Perso.)

For €5.99 ($8.28) a month, Free sells a subscription video-on-demand (VOD) package with access to more than 50 films and 100 TV series, updated weekly. That's a package any U.S. broadband consumer would envy. Free's FTTH offering ups the ante, adding 100 Mbit/s downstream and a whopping 50 Mbit/s upstream. Once again eschewing the status quo, Free is rolling out a point-to-point FTTH architecture, rather than GPON.

While Free gives its customers a great bang for their euro, the company is not sacrificing financial results in the process.

In addition to strong EBITDA results, Free generated a gross margin of 43.5 percent on its broadband service in the second quarter. Marketing acquisition costs are healthy at €50.00 ($69.20) per customer, while personnel costs are steady at a thin 4.1 percent of revenues. Equipment costs for its ADSL service, including the CPE and DSLAM, clock in at €210 ($290.67). FTTH is a bit heftier, coming in at €1,500 ($2,075), with the expectation that customers will foot the bill for the install.

Table 2: Free Fast Facts (June 2007)

1H07 revenue	€574.1 (US$794.08)
ADSL subscribers	2.6 million (78.4% on-net)
Basic bundle	€29.99/month (US$41.50) for broadband
ARPU	€35/mo (US$48.43)
Share of French ADSL market	19.70%
Subs with HD Freebox	40.20%
DSLAMs installed	2,800 in 160 COs
FTTP homes passed planned for YE07	167,000

Earlier this month Free inked a deal with Cisco Systems Inc. (Nasdaq: CSCO) to double the capacity of the broadband provider's IP backbone, to up to 2.5 Tbit/s using a CRS-1 multi-chassis configuration. (See Iliad Upgrades IP Backbone.)

Who says the best things in life aren't Free?

One has to wonder: If Free can deliver these kinds of results using leased copper loops from France Telecom with less than 40 Mbit/s of bandwidth, what upside exists for MSOs that can streamline their own operations and service offerings?

Clearly, Free has benefited from the opportunity to build an IP-optimized infrastructure from scratch, rather than being saddled by legacy voice and video technologies. Why can't U.S. cable operators do the same?

Here's a wild thought. Why doesn't a cable operator like Comcast carve out a small slice of its HFC spectrum – say four 6 MHz channels (equal to 160 Mbit/s of capacity) – and rent it to a renegade subsidiary? Encourage them to roam "Free," break the mold, and build an IP-crazed service offering from the ground up. What new features could be enabled, and better yet, what new economic models?

If successful, the renegade subsidiary might ultimately swallow the entire cable enterprise. A better alternative than a competitor doing so.

— Michael Harris, Chief Analyst, Cable Digital News