Bang or whimper? Analysts weigh 2degrees’ market impact

NBR asked analysts to take a tilt at the new mobile operator’s first-year customer numbers, and chances of redrawing the market, ahead of its big reveal Tuesday, and Wednesday launch.

ABN AmroCraigs analyst Geoff Zame sees 2degrees grabbing 2% market share, or 100,000 connections, in its first year.

In its second year, he sees that doubling to 4%.

That would be close to the 5% signalled as the breakeven mark in an early 2degrees business plan.

Mr Zame uses the term “connections” rather than “customers” purposefully. He sees 2degrees introducing a new market dynamic, bringing us closer to Europe, with its customers totting multiple sim cards - a concept being talked up by the telco's new boss. (2degrees says it has already signed 50,000 triallists through its "chin wag" promotion, who will each be sent a sim card loaded with $5 in several waves starting tomorrow.)

Forsyth Barr’s Guy Hallwright says, “I think 2degrees will be doing well to get 100,000 subscriptions or 2% market share in its first year. Hutchison in Australia took 18 months to reach 2% in a less penetrated market. Longer term I would expect it to be a sub-10% share proposition.”

And that could mean a hard road to profitability.

“Third or fourth entrants typically take a very long time to get to [profitability] point, especially if their customers are roaming off onto other networks part of the time,” says ForBarr’s Guy Hallwright (2degrees customers will roam on Vodafone when outside of Auckland, Wellington, Christchurch or Queenstown, although the carrier has promised to extend its own network at a later date).

“Looking at Hutchison in Australia, after reaching 2% in their first year, it took them six more years to get to 8% market share, and they have only recently become ebit positive (before funding costs,” says Mr Hallright.

As of March 31, Telecom 2.25 million (or 47%) mobile connections to Vodafone’s 2.5 million.

Since its May launch, Telecom says it has signed up more than 100,000 customers for its new XT network. Many of them are internal upsells (Telecom has said it wants to migrate 675,000 or one third of customers on its old CDMA network to XT during its first year), but it has also cherry-picked some corporate business in a bid to chase down Vodafone, which holds a disproportionately high share of mobile revenue.

And the crowded field will soon become more so as Orcon and CallPlus (with more thn 300,000 ISP customers between them) set to launch rebadged Vodafone mobile services, ring-fencing 2degrees in value-priced competitors.

Pre-pay, low-end ...
So what type of customer will 2degrees’ target?

“I think they'll focus on the most price-sensitive end of the market which has to mean pre-pay”, says Ernie Newman, chief executive of the Telecommunications Users Association (Tuanz).

Certainly, details spilled by retailers today indicated a focus on low-end handsets (or “stoner phones” as one wag unkindly put it on Geekzone) with at least one partner (Warehouse Stationery) focussing exclusively on promoting pre-pay.

Mr Newman still sees a lot of traction: “I'm betting they'll take pricing into a whole new range and rely on being rewarded by increased volumes,” says the Tuanz boss.

“I would expect the focus to be on sim card customer ‘acquisition" as they are unlikely to want to get into the business of heavily subsidising handsets for post-paid customers like Telecom and Vodafone,” says ABN Amro Craigs’ Mr Zame.

“Plans are likely to be simple and flat rate,” Mr Zame continues. “In voice, irrespective of prevailing MTR's [mobile termination rates], there appears plenty of scope to cut the marginal prepaid rate per minute.

“SMS does not offer the same opportunity given the termination rate and current retail rates - hence I would expect plans that encourage people to talk rather than txt.”

... and some small business
“I think it likely 2degrees will move to target small businesses and trades fairly early. These are often high ARPU customers and would be much easier to sell to than corporate,” says ForBarr’s Guy Hallwright.

“Consumer postpaid would probably need a 2degrees retail presence on the High Street so may be a longer term proposition.”

When will it make money?
New 2degrees chief executive Eric Hertz has almost literally parachuted in for the carrier’s low-key Auckland launch tomorrow, which will take place at a Dick Smith outlet. It promises to be a low-budget affair for the telco, which is keeping a tight rein on costs. But it will also be in keeping with 2degrees’ message that people are more interested in cheaper calls than pyrotechnics or turbocharged data.

Speaking to NBR after his appointment last month, Mr Hertz would not be drawn on any market share targets. But he did say that at other telcos he’d run for both Bell South International and for the US company now known as Trilogy International Partners (which majority owns 2degrees), typically took two to three years to turn a profit, which he pegged as a reasonable time-frame for 2degrees.

That may be optimistic, given Mr Hallwright’s assessment.

Mr Zame adds that market share may not be a particularly insightful metric in the new landscape, where customers own sim cards on multiple carriers, likely pushing down revenue.

Play for $100m domestic roaming market
However, 2degrees does have an inbound roaming agreement with Optus from Australia who have around a third of the market in across the Tasman. “That will help get some revenue in the door,” said Mr Zame.

Prior to XT’s launch, Vodafone enjoyed around 90% of the inbound roaming market, worth around $100 million a year. A spokeswoman for 2degrees said domestic roaming for Optus, and visitors from other overseas networks, had been live since the start of the year.

Telecom, Vodafone willing to shed low-end customers
“I wouldn't expect Telecom and Vodafone to react initially. They are likely to be too busy worrying about each other and matching each others’ price plans,” says Mr Zame. “I would expect they would rather cede some (low value) market share instead of matching 2degrees pricing plans across the board.”

That gels with comments from other analysts, who say pre-pay customers are the least profitable (and indeed, cause Vodafone heartache during big Lotto weeks).

“The impact on Vodafone will probably be greater than on Telecom initially, because more of their base is prepaid,” says Mr Hallwright. “Over time that may change depending on whether voice migration from fixed to mobile accelerates.”

In Mr Newman's view, "The incumbents will have to react if so and this will show up the enormous disproportionate impact of termination charges on retail pricing."

2degrees outgoing boss, Mike Reynolds, said the carrier could not offer market-busting deals while termination rates (what carriers pay each other when calls cross between their networks) remain at their current level.

The Commerce Commission is currently investigating mobile termination rates, and has made a draft recommendation that they be immediately halved, with further cuts to follow. However, an extended consultation and review process is now underway, and communications minister Steven Joyce is unlike to make a final ruling on the matter until the new year.