BT accused of 'choking off' altnets as fiber splurge sparks worry

Brits are not enthusiastic about going on a full-fiber diet. Data just out from BT shows only 27% of the homes within reach of its full-fiber network were feeding on a service at the end of September. This is below the 30% threshold needed to pay off a full-fiber investment in 12 to 14 years, according to Nokia, one of BT's main suppliers. If the take-up rate is likely to be much lower, Nokia's typical advice is to keep the purse strings tied and avoid a full-fiber splurge.

But the gap between this 27% and the take-up rate for BT's main broadband business is substantially bigger. Stripping out what BT calls "non-fiber" connections, around 63% of homes passed by BT Openreach's "superfast" network were paying customers in September, whether via BT's consumer-facing brands or other retailers using the Openreach network. As BT plows £15 billion ($16.8 billion) into full-fiber rollout, narrowing this gap as much as possible is important.

BT's chances of closing it entirely, or even exceeding 63% take-up on full fiber, are slim. The broadband infrastructure duopoly of BT and Virgin Media, the UK's big cable operator, is finished. Today, dozens of companies are building their own full-fiber networks up and down the UK. More than 3 million homes could end up with a choice of more than five providers, according to market research firm Point Topic – far more than is economically viable. Many seem bound to fail, and others will be swallowed up in consolidation. But the survivors will eat into BT's market share. The only question is how much.

Figure 1: BT's share price (pence sterling) (Source: Google Finance)

The strongest is CityFibre. Backed by Goldman Sachs, it plans to cover 8 million properties by 2025 (BT is racing to hit 25 million by 2026) and reached 2 million in September (compared with BT's 8.76 million). A wholesale-only player, CityFibre does not disclose the overall take-up rate on its network. But the figure exceeds 25% in Milton Keynes, its "most mature location," said the company, adding that other zones are "growing on a similar trajectory."

Hyperoptic is another sizeable threat. In contrast to CityFibre, it operates exclusively as a retailer and boasts coverage of about 1 million properties in cities throughout the UK. Roughly a quarter of these are now broadband subscribers. And Hyperoptic also has a major financial backer in the shape of KKR, a prominent infrastructure investor.

Full-fiber frenzy

The frantic pace of BT's full-fiber rollout betrays the nervousness of a telecom incumbent whose entertainment, enterprise and public-sector units are in the doldrums. Openreach is now building to about 62,000 new premises every week as it races to beat rivals. Due to inflationary effects and the full-fiber frenzy, it now expects to invest about £5 billion ($5.6 billion) in capital expenditure this fiscal year, up from a previous forecast of £4.8 billion ($5.4 billion). This would equal about 24% of last year's sales, and growth is proving elusive.

BT's financial performance is not pretty, and its share price was down 8% this morning on the London Stock Exchange (it has fallen by 57% in the last five years). Revenues squeaked up just 1% for the first half, to nearly £10.4 billion (US$11.6 billion), compared with the year-earlier period, and pre-tax profits tumbled 18%, to £831 million ($929 million). Facing higher construction costs and energy expenses, along with a workforce demanding higher wages, BT has upped a cost-saving target from £2.5 billion ($2.8 billion) to £3 billion ($3.4 billion) by the end of 2025.

How it will manage this without cutting into its workforce is unclear. What's more, after reducing headcount from 106,742 employees in 2018 to 98,175 in March, BT has recently been on a hiring spree, finishing September with 99,803 employees. Simon Lowth, BT's chief financial officer, attributed that increase to insourcing of jobs previously done by subcontractors, including fiber build and IT. "Typically, we are doing that because, from a total labor cost perspective, it leads to a cheaper, better, more efficient outcome."

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Still, it leaves BT with an even bigger workforce than Vodafone, which last year made about $21 billion more than BT did in revenues. CEO Philip Jansen knows that any wildly swung jobs axe will hit the shield wall of the trade unions, already fighting him on pay. Energy costs are rising, and his own suppliers are trying to raise their prices. Hence, perhaps, why the latest savings plan sounds more like WWII-style rationing than anything very strategic.

"Leaving no stone unturned to reduce unnecessary costs, look for wastage, look for duplication, use technology to automate whatever can be automated and make it lower cost, better for customers, more efficient," said Jansen on a call with analysts earlier today. "I literally want everybody at BT looking at how we spend our money and treating it as though it was their money."

Bad optics

Its latest strategy for countering the threat posed by alternative operators (so-called "altnets") appears to be something called Equinox 2. The details have not been made public while Jansen discusses it with Ofcom, the UK telecom regulator, but it would essentially cut the wholesale rates Openreach charges for its full-fiber service, making that more attractive to retailers and potentially undermining the altnets building rival networks.

At the same time, BT plans higher-than-inflation-rate price rises for its consumers next year, even though it has rebuffed union demands for pay rises that match inflation. The optics are not good. One analyst put it succinctly on today's call. "On the one hand you are cutting wholesale prices to potentially choke off infrastructure-based competition, and on the other hand you are increasing retail prices. How do you convince Ofcom this is for the benefit of citizens?"

A year ago, during an investor briefing, Openreach displayed a slide indicating that in a worst-case scenario it would lose about 600,000 lines by the end of 2028, noted the same analyst. Yet the latest data shows Openreach has lost 132,000 broadband lines in the last two quarters alone. It hardly squares with Jansen's repeated message that altnet competition is not hurting Openreach.

"We are losing less share than we expected," said Jansen. "There is a lot of build out there, but the key thing is connections. It is connecting customers that will ultimately make a difference and that is why we are so happy with the 27% rate. When we look at the overall business case … that investment of £15 billion never looks more attractive than it does now." Investors may take a lot more convincing.

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— Iain Morris, International Editor, Light Reading