Competition fierce between telcos

The latest SmartCompany Dun & Bradstreet Industry Growth List for the telecommunications sector reveals an industry in flux.

Telcos both large and small are benefiting from the transformation of internet access from a luxury purchase into a commodity. The increased adoption rate of new technology such as wireless connections are also driving growth, along with increased demand for mobile data plans as internet-enabled smartphones flood the market.

But competition in the sector remains fierce and margins tight. The telecommunications industry is set for a period of massive consolidation in order to sustain its growth.

The total revenue of the top 50 companies came to $39 billion for the 2008-09 year, representing a solid increase from the $33 billion recorded during 2007-08. Average revenue was $781 million, with average growth of 78%.

But while telcos are benefiting from new services and technology, growth has levelled off and this has resulted in a massive wave of consolidation. With smaller companies unable to grow by themselves, larger businesses are looking to acquire smaller services-based telcos which bring large customer databases and specialised skills.

Perhaps the biggest consolidation effort over the past year has been Vodafone and Hutchison’s merger, creating the new VHA entity. But most of the acquisitions have been in the SME space, for example, with TPG purchasing Pipe Networks and Vocus being bought out by a private equity firm within the last few months.

M2 Telecommunications Group, a telco which offers services to SME customers, has been one of the largest acquirers in the industry since the financial crisis began. Last year it finalised two massive purchases of People Telecom and Commander Communications, adding over $200 million in revenue, while recently it acquired certain assets of Clever Communications.

Managing director Vaughan Bowen says the company is growing organically and is keen to keep focusing on its core customers, but says consolidation will be the order of the industry for the short-term.

“There is certainly a lot of consolidation going on,” Bowen says. “We are obviously a statistic in that and have been active in that space over the past three years. But I think 18 months ago when the industry got a shock it made vendors’ expectations a little more adjusted, and now discussions are being made on more realistic financial levels.”

M2 is seventh on the industry growth list, with 2009 revenue of $202 million, from $109 million during 2008. It recorded a solid growth rate of 85%, due in no small part to the acquisitions from the previous 18 months. But Bowen says organic growth is a core part of the company’s strategy.

“There are a lot of participants in the industry which are acquiring other businesses, but we are not just an acquirer. We are growing organically, we still have ambitions for growing organically and we are very much focused on that as well.”

“We are also not at all interested in the acquiring of businesses which aren’t operating in the SME market. We’re not trying to be all things to all people, because the possible mistake you can make there is when you expand beyond your level of awareness. We’re not participating in markets outside our core presence.”

But while consolidation is certainly occurring, some say the trend isn’t really consequential. Ovum research director David Kennedy says that while IT companies are acquiring to grow in a tough environment, many of them are too small to matter and larger mergers rarely occur.

“There are only about a dozen telecommunications companies that count in the Australia market, the rest are small ISPs. There does seem to be a process of consolidation going on, mainly second tier players like iiNet acquiring small regionally-based ISPs in order to grow scale, or TPG acquiring Soul and Pipe to grow scale and get control of their transit costs.”

“There have been many predictions of ISP consolidation over the years, but they often haven’t come true. But if the NBN gets up, this might accelerate consolidation since it’s a resale model where scale is more important.”

Perth-based ISP iiNet, currently the country’s third largest telco, has been keen to acquire smaller companies in an attempt to challenge the industry leaders, Optus and Telstra.

It most recently bought Melbourne-based ISP Netspace for $40 million, giving it a significant base on the east coast from which to enter Tasmania. Prior to that, the company bought Westnet in 2008 for $81 million, boosting its subscriber base by thousands and providing it with a significant increase in revenue and profit.

Managing director Michael Malone says the company has been able to challenge market leaders and grow its market share to 12.4%, closer to its 15% target, through marketing new services such as Naked DSL to financially-conscious customers.

Additionally, he says while the past year has been a hectic one for the business, he feels the next 12 months could be even bigger and is open to the possibility of further acquisitions.

“Buying an ISP is easy if you’ve got the money, it’s just a matter of negotiation. We don’t expect that purchase to be the only one in the next one or two years. We’ve already seen VHA and Hutchison and a few others. Three of the top 10 have either sold or are in play, and I think that’s a significant factor.”

The past year has been a massive one for the company. Not only has it undertaken a push onto the east coast with a comprehensive marketing campaign, it also successfully dealt with a legal challenge from some of Hollywood’s largest entertainment companies.

The group, represented by the Australian Federation Against Copyright Theft, accused iiNet of authorising illegal downloads made on its networks. However, the Federal Court ruled that just because iiNet provided internet access to copyright offenders did not make the company itself liable for those infringements.

“Every conversation would be about it, even with friends down at the pub. But I didn’t want staff talking about litigation, I would want people talking about what we can offer our customers and what new experiences we could offer.”

The company has recorded revenue of $418 million for the 2008-09 year, up from the $251 million recorded during the previous year. Its most recent half-yearly results show revenue increased by 11% to $228.1 million, up from $205 million during the previous corresponding period.

Some of that revenue has been from expanding into new areas, such as consumer electronics. Malone says developing the BoB phone and router combination was new territory for the company, and something they will explore further with the launch of IPTV.

But Malone says the industry is at a point where growth is hard to come by, and acquisitions will become more common as firms struggle to gain market share.

“The market is saturated. For the last few years, as long as you’ve been able to do a fairly good job, you’ve gotten your fair share of market growth. But now we are growing slowly, and now companies are really fighting for market share.”

Malone points out that as broadband products become more complicated, users want more service – not less. This is why he says broadband is not a commodity just yet, and customer service is more important than ever.

“In the home, it used to be just one computer connected to the phone socket. It isn’t like that anymore. Now you have a bunch of devices all interconnected. I don’t think it’s a commodity yet, because if a product is generic you really don’t need help using it. I think broadband is going the opposite way.”

“But I think that’s a positive thing because we’re differentiated as a service-based company. People want a trustworthy brand, loyalty, and I think we’ve held up well in that regard. Several years ago we saw males making the decision for the household, but now 70% of internet-related decisions are made by females. They want a brand position, service offerings and so forth. It’s a big market shift.”

As iiNet grows, it is increasingly being compared to the nation’s biggest telcos – Telstra and Optus. But Malone says competing with Telstra is harder than it looks, and that its position as the safe and default option for telco services makes it more difficult for the company to operate.

“I don’t think Telstra is doing a bad job, I think they’re doing a good job and it’s something I worry about constantly. When people move houses, there is a perception that to connect your phone you need to call Telstra. It’s a perception issue, and that’s where we lose customers to Telstra.”

“On the other hand, we have people moving away from Telstra, saying they want better value and service. It’s a customer relationship issue. Telstra has the highest margin in the industry, and people go there because of safety – if they invest that in outstanding service, they will dominate that factor as well.”

But Malone isn’t afraid of the two biggest telcos taking more ground. He says iiNet is growing organically, and he’s constantly searching for ways to increase revenue.

“We are still growing organically. I could probably go and play golf for a year and the business will be fine. But I want to know where we’re going to get our growth for the next three years. What customers do we need, and what products? That’s what I’m worrying about – not tomorrow, but three or four years from now.”

Sydney-based My Net Fone has been one of the smaller telcos in the country over the past few years. The company reached 13th on the list, recording $6.8 million in revenue during 2007-08 and a further $9.7 million during 2008-09, representing growth of 43% over the previous three financial years.

The company focuses on VoIP services, and recently introduced Naked DSL to broaden its customer base. But it recognises its reach is small, and is open to the idea of being bought out – or buying out another firm – to increase its scope.

“Consolidation isn’t anything new. The telecommunications industry is another industry whereby you have constant changes, and that is for all sorts of reasons. New business models, different technologies and customer preferences all change, especially with new additions of social media like Facebook and Twitter.”

“You basically have to keep changing with the trends of the customers, and obviously consolidation occurs apart of that. We would consider an acquisition, sure, because we are here to serve our shareholders. Whatever is best for the shareholders is best for the company, that could possibly include an acquisition.”

Fung says this offer was extremely attractive during the downturn, as customers were looking to retain their internet connection but save money at the same time. But Fung says the company has also adopted many of its products to businesses. Its Virtual PBX product allows SME customers to set up an internal network without the need for purchasing upfront physical cable equipment.

Doing away with traditional telephone rental lines frees up some spare cash, and MyNetFone attempts to keep subscription prices as low as possible to draw customers in from its larger competitors.

“Obviously with our call rates, and the savings in capital costs, we’ve gained a lot of popularity. VoIP and Naked DSL really allows customers to make a lot of savings, up to 60% in some cases, and the second factor is that VoIP offers a practical advantage in terms of flexibility.”

“It’s giving the extra value and convenience of a flexible phone and internet system. Changes happen in organisations, people move offices, new staff come in, and with traditional systems it’s confusing setting someone up. These systems are more flexible and you don’t need any more administrators spending their time with confusing systems.”

The company’s success is slightly surprising, given that it shuns traditional advertising for the most part. Instead, it focuses on word-of-mouth and wants to draw up a solid customer base before it embarks on advertising through traditional media.

“We don’t actually advertise all that much. The word-of-mouth marketing is actually very important because we don’t really heavily advertise in the public endeavour. People use the service, find they are happy with it, and then go and introduce it to their friends and colleagues.”

“I should clarify that we do advertise, but we also do it very specifically and make targeted efforts in promotions. We’re not doing that, at least not yet anyway, while we build up the company’s strength in other areas.”

Even with advertising, MyNetFone faces some tough competition. Larger competitors such as iiNet, Telstra and Optus all offer Naked DSL, and have a larger customer reach. How does Fung keep MyNetFone’s popularity high despite the larger players in the market?

“The way we position ourselves is the value of our services. We can do a lot of things, such as going online to a portal and sending SMS messages. Not a lot of other providers can do that, and that’s been at least one thing that’s set us apart.”

“Competition is fierce, and it’s always tough to get your voice heard, unless you have a massive advertising promotion budget. You’ve just got to compete with the other players out there who have bigger budgets, and that’s really a challenge, but even despite that I think we have gained a lot of ground.”