May 2015. Tim Armstrong, the CEO of AOL, is on CNBC. He is wearing a navy blazer, no tie, blue shirt. He’s talking fast, and in bursts of excited management speak. He has a lot to be excited about. It has just been announced that Verizon is going to buy AOL for $4.4 billion.
This is of course good news for Mr Armstrong. CNBC anchor, Andrew Ross Sorkin, asks him the key question for the whole telco industry:
– “Why [does] the pipe business need to own content now?”
Telcos – the owners and operators of the infrastructural pipes that the internet and other communications run on – regularly go through this exercise. They ask themselves:
- Can we be more than just the backbone for others?
- Should we own more of the value chain ourselves?
- Can we bundle our existing offering with new, value-added services (VAS)?
The short answer to all of these questions tends to be yes. This is then followed by big acquisitions in the content and media space.
After a few years, it then changes back to no. The telco writes down a massive dollar value and tries to divest the media assets. And so the perpetual identity crisis of telecom companies continues.
This is the Telco Identity Loop. Let’s break it down.
Stage 1: “We have to be more than just pipes”
One would think that being the infrastructure for the internet would be a pretty good business. Everyone loves the internet, right?
Turns out, it is in fact a good business. Telcos often have gross margins of over 80%, and profits at around 20%. Not bad, for being pipes.
But since consumers don’t really care which pipes are being used – as long as their services work well – this puts telcos in a situation where competition can get fierce. And fierce competition is expensive, generally speaking.
So, how does one differentiate these uninteresting pipes? Let’s add something to them! Some services, or rather some VAS – value-added services. A favorite acronym in telco world.
VAS are often content bundles, in some shape or form. They serve the purpose of helping with initial customer acquisition, or retaining existing customers longer.
A current example is Disney+ that launches today. Their tie-up with Verizon was what made me write this blog post in the first place. If you are a certain type of Verizon customer, you get a full year of Disney+ for free. List price: $69.99. T-Mobile has a similar deal with Netflix. If you have two phone lines with them, you get Netflix for free too.
Note that neither of these companies have ownership of each other. They are just partnerships, which is indicative of Stage 1. We don’t really want to commit, but we do need something. It also speaks to their competitors’ tie-ups, that have moved on to Stage 2.
Stage 2: “Let’s buy content!”
When partnering isn’t enough, you go to acquisition instead. Let’s build an integrated offering for the consumer! One big bundle of telecommunications and entertainment services on a single monthly bill.
Entering Stage 2 is expensive, because you need to acquire something substantial enough for it to make a difference. Telcos are large companies, after all.
There are plenty of examples. The most obvious one is AT&T that acquired Time Warner for $85.4 billion in June of 2018. Comcast acquired NBCUniversal in 2011. And as per the introduction, Verizon picked up both AOL and Yahoo in 2015 and 2016 respectively.
But this doesn’t only happen in the US. Looking back a little further, the Spanish telco Telefonica acquired Endemol – a Dutch TV producer – for $5.3 billion back in 2000. In the Nordics, Telia has acquired Bonnier Broadcasting, and NENT and Telenor just formed a joint venture. This is a global trend, and it has been going on for a long time.
If we stay with AT&T, last week’s announcement of HBO MAX is the latest example of what this type of consolidation looks like in practice. HBO MAX will consist of both HBO content and a long row of additional content from the WarnerMedia ecosystem. And more importantly in this context – it will be free for viewers who already subscribe to HBO via AT&T. One can imagine some great introductory offers for new AT&T customers, once the service launches too.
This all sounds good, until it doesn’t. This is when it starts becoming obvious that the synergies have failed to appear, and that the corporate cultures of a telco and a media company don’t always jive. That’s when you enter Stage 3.
Stage 3: “Why do we own content again?”
Stage 3 often comes along with a broader management shift. It can be a generational change, or simply sluggish figures for too long. A new CEO is brought in, and they understandably want to pave a new path forward.
In August of 2018, the Swede Hans Vestberg stepped up from CTO to CEO of Verizon. Vestberg was previously at Ericsson – a large provider of telecom services with 5G as their big main bet. Tim Armstrong, who now was running the content division of Verizon (rebranded as Oath), saw the writing on the wall. He left.
As new CEO, Vestberg set out to find out what was really going on inside the company. The process was described like this:
“Vestberg is currently interviewing hundreds of Verizon’s top managers in an effort to refresh the company’s leadership and unify its offerings.”From Fierce Wireless, by Mike Dano, October 10, 2018
A classic strategic review. It had started earlier in 2018, and had led to shutting down Go90 already. But more things were about to change. Time for Stage 4.
Stage 4: “Back to Basics”
In November of 2018, the new future for Verizon was starting to show.
Oath was written down by $4.6 billion. For context, that’s about half of what they had acquired the two companies for about 2,5 years earlier (Yahoo was $4.5 and AOL was $4.4 billion). Verizon stated that they “didn’t see the synergies it had expected from the combination of Yahoo and AOL” and that 44,000 of their staff had been offered voluntary buyouts.
Fast forward a few months, and Verizon divested Tumblr to Automattic. While Yahoo originally acquired Tumblr for $1.1 billion dollars, the sale was less than $3 million. A pretty impressive value destruction in about six years time.
If not content, then what? In Verizon’s case, it’s 5G. Core telco services – infrastructure. Pipes, but slightly wider pipes than before.
This gets us to August of 2019. Hans Vestberg is now on CNBC – also talking to Andrew Ross Sorkin – and predicting that 50% of Americans will use 5G phones by 2024. That’s where Verizon should be too. Back to basics.
Stuck in the loop
Most telcos are somewhere in this loop. The Disney+ deal is a clear example of how Verizon are leaving Stage 4 and are halfway in Stage 1 again (if you want to learn more about Disney+ and what they are getting out of this, then Matthew Ball is the authority). They still have Verizon Media Group (the new name for Oath) but in Q1 2019, their revenue was only $1.8 billion out of a total of $32.1 billion. These 5.6% of revenues aren’t going to hold back a change of strategy.
Vestberg himself said the following in a recent interview with Barrons (my emphasis):
“We think that we are best equipped to leverage the best network and continue to partner with [media companies] rather than us managing it”From Barrons, by Nicholas Jasinski, September 19, 2019.
The CEO and Chairman of AT&T, Randall Stephenson, is clearly deep into Stage 2. They have had to defend that position from activist funds like Elliott Management too. And if margins don’t improve the coming quarters, these concerns will surely come right back again. And then it’s on to Stage 3 again.
Running an undifferentiated business is very difficult, and it’s hard to fault wanting to expand further into the value chain. But these content acquisitions, more often than not, don’t seem to really change the mothership. They’re just bolting on another side business. The culture, what’s considered core business, the way of thinking – it’s all the same as before. And as such, content becomes a secondary priority. Or perhaps a loss leader and marketing expenditure in order to keep the core business going.
The fact that this loop is so recurring also poses the question where a new, innovative vision is going to come from in the telco space. Softbank – that has their core business as a Japanese telco – has certainly tried on a group level. Although you could definitely argue that this vision – including the now infamous Vision Fund – may not be one to emulate for others.
With this loop in mind, where will these telcos go next?
Making predictions is a fools errand really, but it’s fun to both read and write. They also have an asymmetrical upside (you’ll probably only remember if I got it right). So here goes nothing:
Current position: Stage 2 (Content Acquisition).
Comment: They overspent and fought to push the deal through. Now they have make to make it work, but performance will likely suffer. It is a huge behemoth full of cultural differences and conflicting interests. The likes of Elliot Management will come knocking again, and this will force change.
Prediction: Write-downs and lay-offs starting in 2020. I think at least 25% of the $85 billion acquisition price.
Current position: Coming out of Stage 4 (Write-offs & Divestments), heading into Stage 1 (Content Partnerships).
Comment: 5G is their big bet, but it is still quite far away. I think we can expect several partnerships to the marketing going in the meantime. And once 5G is here, they’ll realize that they need to acquire content companies that can make use of this new technology.
Prediction: Major content M&A starting in 2021 (they’ve already bought VR assets from Disney). Could be a company like Magic Leap (if they’ve survived until then).
Current position: Stage 1 (Content Partnerships).
Comment: Merger. The FCC just approved the deal and while there are individual states that are still protesting, this is effectively a done deal. The merger has likely taken – and will continue to take – all management attention for the foreseeable future. I can’t see them moving out of Stage 1 any time soon, even if they would have wanted to.
Prediction: Complete strategic standstill for 12+ months. No major M&A.
Current position: Stage 2 (Content Acquisition)
Comment: Telia have been trying to acquire Bonnier Broadcasting since the summer of 2018. Things are finally looking up, and the deal
is likely to go through just went through. But there have been a lot of stir-ups while they waited. They now have both a new CEO and a new Chairman of Telia. That being said, it would be strange if they immediately divested the very asset they’ve been trying to get hold of – even if it was a different management team doing it.
Prediction: The deal officially passes before Christmas, and the integration begins (Update: The deal went through today!). Once the deal goes through, I predict that they immediately acquire SF Studios from Bonnier too.
Current position: Stage 2 (Content Acquisition).
Comment: This Nordic telco have gone in and out of both content and markets the last few years. But it’s hard to look at Telenor without understanding Telia above. Telenor’s entry to Finland is directly aimed at them. Most recently, Telenor merged their cable-tv Canal Digital with NENT Group (formerly half of MTG).
I think they’d like to keep expanding in content, but there isn’t that much to buy in the Nordics. Egmont got TV2 Norway and probably won’t sell. TV2 Denmark has been rumored to sell forever, but never does. TV4 Sweden and MTV Media in Finland just went to Telia. Maybe Discovery would consider selling their Nordic markets?
Prediction: If I had to make a bet, I think Telenor will make a big offer for 51% of TV2 Norway and Egmont will, somewhat reluctantly, accept it. Staying in Stage 2 for a while, in other words.
And finally a long shot, from the other direction:
Current position: N/A
Comment: Now this is an outsider since Amazon isn’t a telco. But they are one of few players that could come at this from the opposite direction. Prime Video is a strong video offering and they have plenty of other content offerings too (Audible, Kindle, etc).
Prediction: Amazon takes Prime and becomes a US MVNO within 24 months. I don’t see them building any 5G towers any time soon, but they could easily operate in someone else’s network. They could have bought Boost Mobile in front of Dish, but they might be persuasive enough to find another way out there. That would at least stir things up in an otherwise predictable telco market.
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