Emma Wall: Hello and welcome to the Morningstar Series, Ask the Expert. I'm Emma Wall, and I'm here today with Senior Equity Analyst for Morningstar, Allan Nichols.
Hello Allan.
Allan Nichols: Hi. Thanks for having me, Emma.
Wall: So we're here today to talk about telecoms. There's been a lot of news in the telecom sector over the last year. BT (BT.A) looks to be buying EE. Of course BT, not that long ago launched its own television. Sky (SKY) is moving into this, the four-play, all this convergence. Of course, EE before that was two separate, it was Orange and T-Mobile. What does it mean for investors?
Nichols: We think quad-play is the way the market is moving especially in Europe. And so the U.K. has been behind many other countries in Europe, and really with BT making that announcement to acquire EE, has really jumpstarted the quad-play convergence movement here in the U.K. And after that, TalkTalk has offered a four-play service. Vodafone (VOD) has said we're going to offer one.
Sky has announced an MVNO relationship with Telefónica starting next year, so they will be able to offer one.
So one of the things that we like about the quad-play, one it saves significantly on churn. We've seen that in other markets where it's much bigger. So for example Belgacom has announced that a quad-play customer only churns 2.5% of the time versus a single-play does 22%, so huge differential.
Wall: Loyalty.
Nichols: In loyalty. And the loyalty then reduces. They may have to spend on advertising and marketing, because you can keep your customers longer. Additionally, in many cases, particularly with like BT, getting back a wireless network again which they had lost in '02, they have enhanced their unique asset which we think is a major part of building a moat is the unique asset. And so by having that full service, it enhances their position, and so they will now be number one in fixed line broadband and wireless.
Wall: And this provides an economic moat, a phrase that Morningstar's borrowed off Warren Buffett, this competitive advantage over peers. Economic moat is one of the things that we look for as investors that will sort of hopefully predate long-term returns in the future.
Nichols: Right, and so like moats, because they – exactly that reason that they do tend to have more sustaining power and so you are able to earn a return on capital that's higher than your cost of capital. And over time, in telecom, the spreads are much smaller than they are in something like software. But even the 50 to 100 basis points spread over a compounded period is extensive and very meaningful.
Wall: What about the argument then, that these companies are going to become 'jack of all trades and masters of none' because we sometimes you know accuse some of the conglomerates in India and indeed some companies of Japan are trying to do too many things, is that a worry with quad-play?
Nichols: No, because it's all communication based, so it's – your offering basically the same service to the same customers. Where there is some of that empire building is that they are moving into – in some cases other areas where finance or something where they are trying to use their network, and that's – finance maybe is okay, because in many cases it's like with an NFC, so it's using – they are still using the same network to do financial services.
The bigger – in places like Korea, then they are buying all kinds of things that have nothing related to do with telecom, but that's not happing in Europe.
Wall: And what about the differentiators, I mean the ones that come to mind, I suppose are the ones that own the infrastructure. BT owns the fixed-line in the U.K. If you want to have any supplier or telephone, you still have to BT £10 a month and Virgin owns the superfast broadband, doesn't it?
Nichols: Yes.
Wall: Are those the sort of things that we should be looking for investors? People who own the infrastructure rather than having to rent it?
Nichols: So generally speaking, we prefer those that actually own it. With Virgin Media, their network covers about 55% of the British population. They've recently announced that they think they can through some infill investments take it up to about 70%. But beyond that, even if you are using Vodafone or TalkTalk or whatever, you are having to use BT's copper network for the last mile what's referred to as the last mile, last copper piece. Vodafone did buy cable and wireless worldwide a couple of years ago.
That gives them the second largest fiber backhaul network, but it really goes to corporate clients and they've been using corporate – doing of quad-play service to corporates for years, but it doesn't go into the residential neighbourhood. So even for them, that last little piece they've got to use BT's network, which is an advantage for BT. But, it doesn't mean that they can't be successful. But all else equal, we would prefer them to actually own the network.
Wall: Alan, thank you very much.
Nichols: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
