3 Defies The Critics
By Steve Wallage, Tue Apr 26 08:15:00 GMT 2005
Many people have been quick to rubbish 3 and predict its demise, yet its numbers keep growing and ARPU -- if not data revenue -- is well above average.
3 is a complex company. Of course, we shouldn't say 3, but the telecoms holdings of Hutchison Whampoa, which include networks in Italy, the UK, Australia, Austria, Sweden and Denmark, as well as Hong Kong and Israel, all under the umbrella of the mighty Hong Kong-listed conglomerate.
But that is just the start of the problems in understanding 3. Take its ARPU numbers, which "equal total revenue before promotional discounts", with promotional discounts an ongoing and wide-ranging part of the 3 strategy. Or its much-discussed customer-acquisition costs that are much higher than they appear, as the standard figure is an average that includes the unsubsidized Italian subscribers. Or even what it considers active subscribers, which need to have made just one call in the last three months.
Before looking at the numbers, I must admit that I have always had a very negative perception of 3. I thought Hutchison were mad to invest so much in building out their 3G networks, and the lack of a 2G installed base would be the death blow. The much recounted early horror stories -- poor customer service, lack of handsets, network problems such as dropped calls, limited coverage and an unstable service platform -- all helped to reinforce my thinking. Now, I have to admit I may have underestimated the company.
The first thing to understand about 3 and Hutchison is that they do not think in the same way as other operators. 3 does not worry about the "key performance indicators" so beloved of the likes of Vodafone, but instead the sorts of numbers that more traditional quoted companies live by: EBITDA, revenues and costs.
Behind this, lies two other important facets to 3. First, success for the company is measured by the ability of Hutchison to divest its country operations. The current plan is for the Italian unit, or at least 25% of it, to be sold off in October or November, and the UK to be divested in 2006.
Second, revenues and margins are key, not getting the highest data proportion of operators. There has been much debate about the fact that 3 gets a roughly similar proportion of revenues from data as predominantly 2G competitors. For 3, depending on market, this is around 24% at the moment. Analysts have made great play that this supposedly revolutionary 3G network is being used mainly for voice. But, Hutchison couldn't care a bean about this. Of course, they care about margins and competitive positioning, but if a voice-based revenue model is hitting their targets, they don't see a problem.
Getting back to the numbers, most, in as far as they go, are good news for the company. Subscribers went over 8 million in March. New subscribers in the first quarter of 2005 were 1.7 million, ahead of most financial analysts' expectations. But the really impressive figure is the ARPU, which is an average of 52.36 euros, though this figure masks marked differences. In Italy, where only 10% of subscribers are contract customers, the figure is 47 euros, in the UK with 45% contract, it is more like 58 euros.
The bottom line is that, although 3 may have paid a lot to attract these subscribers, it is getting a good mix of high-volume voice users and users of new services, such as video calling and music downloads. Research firm Analysys, although in a rather arguable study on "The World's Top Ten Wireless Services", (where it identifies those services that exhibit high market potential, effective implementation and suitability for reproduction in other markets), gave 3 two of the top three places for these services. The music download service in the UK attracted 10 million music videos in its first six months, although these numbers were aided by the heavy users who could get unlimited downloads for £5 per month.
The Italian media have suggested that 3 Italy will be worth around EUR 10 billion. They also suggest, based on both financial analysts and the company itself, continued strong growth from the operator, from 3.5 million subscribers at the end of March to 5 million by end 2005 and 8 million by end 2007. Sales are estimated to go from 1.8 billion euros in 2005 to 3.2 billion euros in 2007.
However, the numbers to really get the financiers salivating are the profits. Using the EBITDA measure, this rises from a loss of 400 million euros in 2005 to a positive 810 million euros in 2007.
Merrill Lynch is similarly optimistic on falling costs for 3. It sees capital expenditure spending, that is building out the network, as just maintenance from 2006. 3 itself sees its customer acquisition costs falling due to rising prepaid customers, but also what it calls the "rapidly dropping average handset prices."
Italian Float Is the Key
There are some potential blots on the horizon, Merrill Lynch worries about churn, which it estimates at 1.6-1.9% a month. It also worries about the growing dominance of prepaid, which it believes will knock 10% off UK ARPU in 2005. The fact that it has generally ignored business customers may yet bite 3, as the consumer markets grow increasingly competitive.
3 has spent a fortune building out a network which is mainly used for voice and is being increasingly matched by the 3G networks of competitors. Yet, its financials seem to add up and it keeps winning in new country markets -- take the 414,000 subscribers already in Sweden and Denmark. If it can float the Italian group at a reasonable price, this will be the validation of its business plan and lead to a new level of aggression from the well-funded Hutchison Whampoa.
But the changing nature of 3 can be related in a recent chat I had with a CTO at a UK operator. A year ago, at least publicly, competitors were very negative on 3, and were typically more worried about the effect they were having on 3G as a new mobile offering than as a direct competitor. Although, he was not particularly positive on 3 now, he saw them as a worthy competitor and as an equal in the market. 3 has survived, against the odds, and is now starting to reap the benefits.