Sky investment in Virgin fiber rollout may not add up

It has been a lurching, nausea-inducing ride for BT shareholders in the last five years, with more share-price drops than smooth climbs, but this morning's 8% dip was among the sharpest it has seen on a single day.

The explanation was a weekend report that Sky, one of BT's broadband nemeses, is about to co-invest in a fiber network with Virgin Media O2, the UK's largest cable operator. Investors evidently see that as a big threat to BT.

Some of the early-morning panic had subsided by mid-afternoon, and BT's share price was only 4% down at the time of writing. But investors are clearly worried about a well-funded fiber alternative to the network that BT's Openreach is building. The prospective loss of Sky as a wholesale customer of Openreach must be another concern.

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

BT has little to gain in the UK's broadband market. It already operates a nationwide network made of copper and fiber technologies and customer spending has dropped despite the rollout of higher-speed services.

For the first quarter of the fiscal year ending in March 2020, BT recorded £40.70 ($55.40) a month in average revenue per user. Two years later the figure had dropped to £36.80 ($50.10). New customers are hard to find, as well – even committed technophobes now have a broadband service.

At the same time, BT is investing about £12 billion ($16.3 billion) to extend its full-fiber service from around 5 million homes at the end of June to roughly 25 million by the mid-2020s (although it is seeking investment partners for the last 5 million). Competition authorities have threatened it with a break-up. New fiber rivals are invading its turf.

The end of cable?

Virgin Media O2 is among them. Currently BT's main fixed-line infrastructure rival, it relies on cable technology to serve about 14.3 million homes and full fiber to address another 1.2 million.

In July, however, Virgin said it would upgrade its whole network to full fiber by 2028, apparently deciding that cable will become obsolete. Since then, it has reportedly been on the lookout for investment partners.

But not everyone is convinced that Sky should co-invest or even that Virgin's numbers add up. In a research note sent out today, Jefferies, a bank, pointed out that Sky would have to become the anchor tenant on Virgin's fiber network for the co-investment plan to add up. Dual sourcing for wholesale access makes sense, it says. Anchor tenancy, for numerous reasons, may not.

One of the main concerns is the cost of deployment. Openreach has already shown that it can build quickly at a cost of about £300 ($410) per home passed.

Virgin's July estimate was that it could perform the same job for just £100 ($140), excluding additional installation costs. Asked to back up the calculations, a spokesperson told Light Reading that Virgin had a "younger, fully ducted network" than BT.

The incumbent, he added, "has a larger number of distribution points (which fiber need to be built to)" and still relies on poles for some lines.

Jefferies, however, thinks £100 would only take fiber as far as smaller street cabinets. Going all the way to the home, it reckons, "could add £300," noting that Virgin has not contradicted this estimate.

This would amount to an overall investment of about £5.7 billion ($7.8 billion), which sounds more realistic than the £1.43 billion ($1.95 billion) implied by the £100 figure.

Last month, a report in Spain's El Confidencial newspaper cited unnamed sources who put the entire rollout cost at between €4 billion ($4.7 billion) and €5 billion ($5.8 billion).

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Timing is another issue for Jefferies. Openreach is likely to have covered most cabled locations with its full-fiber network in the next three or four years, about the same period before Virgin completes its own upgrade.

Not taking advantage of BT's full-fiber offer in the meantime would be risky, says Jefferies, and switching later would mean funding the last fiber drop and connection fee.

The full-fiber service available from Openreach also allows Sky to challenge Virgin in cable areas, where Jefferies estimates its broadband market share is 18% versus 39% for Virgin.

And then there is what the bank calls "wholesale risk" in its research note. Consumer wholesale is a complex activity and Virgin has no established platform, it says.

None of this means the co-investment plan will not happen. Dissatisfaction and rivalry with BT could drive Sky into Virgin's embrace.

But a fiber investment of several billion pounds would be a major commitment that raises all sorts of difficult questions. BT's investors may have less cause for alarm than some others.

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— Iain Morris, International Editor, Light Reading