Fibre Attracting Significant Investment, Traditional Business Models Revised

Fibre optic networks, perceived as a sunrise sector, have attracted significant investment.  Aside from meeting altered patterns of demand, the experience of the Covid pandemic and attendant distributed working underlined the key role of broadband telecommunications in all industrial and commercial sectors.  Fibre is the bedrock technology of broadband telecommunications.  It is so in its own right, and also in that it provides the pipelines that allow broadband mobile networks and data centres to function.

Fibre investment has featured in access networks, in backbone networks and in submarine cables.  Interest has been attracted from established infrastructure funds and from pension funds.  Digital Infrastructure, in this as in other areas, including towers and data centres, has emerged as a dedicated asset class.  It is against this that previously universal business models have come under scrutiny.  Important changes are afoot, and, indeed, are evident in advanced markets.

Fibre Operators by Type, Disaggregation

Technical advances, together with regulatory considerations and emphasis on specific investment strategies have given rise to levels of disaggregation and fragmentation across the fibre sector. 

Some organisations opt to focus on asset ownership, some on infrastructure operation, and some on service provision.  Some combine two, and some combine all three.  Stating this succinctly –  

1. Level 1 Operations encompass infrastructure ownership and basic management and maintenance
2. Level 2 Operations encompass infrastructure management and provision of network-centric services
3. Level 3 Operations  encompass delivery of comprehensive ISP Services, including OTT

Level 1 Infrastructure Owners primarily focus on expanding network coverage, with key metrics being Premises Passed and, to some extent, Premises Connected.  Level 2 Service Providers exploit expertise in network design and engineering.  Level 3 operators must possess insights into B2B and B2C demand and market segmentation.

Historically, fibre operators were vertically integrated, and operated across all three levels.  Commercial, financial and engineering logic  have now given rise to disaggregation.  The skills necessary at Levels One and Two are predominantly technical.  Those required at Level Three encompass much broader considerations of demand for specific end-user services, and, indeed mass-market consumer behaviour. 

This situation prompts operators to revisit their perceived competitive advantages and review whether they actually have the necessary skill sets for their selected sectors. For instance, a highly skilled metropolitan or campus network manager does not need the same economies of scale as a commercial provider of standard ISP services. This poses questions for large operators about their continuing ability to compete effectively across all three levels. At any given level, they may be challenged laterally or vertically.

Questions are also posited for smaller operators regarding the adequacy of their skills for their selected sectors. Established players may need to revaluate their business models radically.  Elements of this are in evidence at this time.  We are seeing the emergence of InfraCos focused on infrastructure management, and possibly ownership, and of ServiceCos, which, in the limit, may not own any telecommunications infrastructure themselves.  The competitive outlook has changed, as, indeed, have the metrics of economic returns achievable.

Fragmentation and Consolidation

The fibre industry exhibits significant fragmentation in various regions.   While it would be an exaggeration to state that fibre design and engineering are simple, barriers to entry are typically much lower than, to take one example, those that present in the mobile sector.

Europe has seen numerous fibre mergers and acquisitions, with more anticipated.  In the UK alone, there are over 100 active fibre operators. Most of these operators do not benefit from economies of scale, and their technical and commercial capabilities vary significantly. As a result, consolidation and withdrawals are bound to happen, and, indeed, have commenced.

Investor Perspectives – Separating Winners from Losers

Matters of importance to investors include construction costs, end-user connection expenses, targeted sectors, unique selling propositions, and investment goals.  Not least, accurate perspective on operating skills is also required.  Insight in to all of these is essential to determine whether a company presents a viable acquisition prospect, a potential candidate for consolidation, or indeed merits any investment whatsoever.

Investor sentiment in emerging or ‘sunrise’ markets – such as the fibre sector – can become clouded by rapid early-stage growth and overly optimistic projections.  This is clear in the UK, where an ambience of ‘FOMO’ – Fear of Missing Out – has influenced some investment decisions. Market value of individual operators may not match the value ascribed on investment.  Similar situations can be observed in German and in certain smaller Indian operators.

Expanding on matters of investment assessment, specific issues that need to be considered include:

1. What are the construction costs required to pass an adequate number of premises?
2. What are the final costs involved in connecting premises to the network ?
3. Which sectors are being targeted i.e. – B2B, B2C, FTTH, Fibre to Towers, or Fibre to Data Centres? Each has unique CapEx and operational structuring requirements.
4. What are the organisation’s claimed Unique Selling Points, and how valid are they?
5. Do the executives possess adequate competitive knowledge?
6. Do the executives have  appropriate expertise and experience in relevant sectors ?  What is the operating model, and is it durable ?
7. Ultimately, what are the investment objectives? If a sale is planned within 3-5 years, specific challenges arise that are vastly different to those of long-term investments.

Naturally, the due diligence process highlights the importance of matching investment opportunities with investor profiles. Some investors require more guidance than others in assessing core drivers and business or operating models. While certain investors can draw on their past experiences, others cannot. Additionally, some may have dedicated resources for technical analysis, whereas others may not.

Stasis, Evolution and Discontinuities

A major and important backdrop is understanding that, in the telecommunications sector is rarely linear. Instead, it undergoes transformative changes in response to significant disruptions and discontinuities. Currently, the main drivers include those discussed in this paper, and, most importantly, the ongoing disaggregation that is already impacting past and present business models.  Indonesia is to the fore in these areas, and may provide a reference model for other SEA regions forward.