2degrees at five: the highs, the lows, the questions

2degrees turned five earlier this month.

A spokeswoman told me the company might do something on social media to mark the day. Otherwise, nothing was planned (in fact, the most noise came from a grenade lobbed across the Tasman - see "Only a matter of time before 2degrees gobbled up or disappears – analyst" below").

That was quite in keeping with the company’s meat-and-potatoes approach.

The mobile phone company launched on August 4, 2009 at a modest event hosted in a Dick Smith shop in downtown Auckland. When it hit the million customer mark in August 2012, then CEO Eric Hertz stood on a patch of concrete on the waterfront and fielded press questions while some staff held up polystyrene numerals behind him.

I approve. Customers don’t care if there are lasers and dancing bears at a launch, or not, or whether calendar anniversaries are marked. Actions speak louder than words, and we’ve seen a lot of action during 2degrees’ first half decade.

The company’s first TV ad was an instant classic (at the time, Mr Hertz fretted to NBR that it was too good. Would future efforts match up to Rhys Darby’s giant logo effort?)

It quickly gained customers.

A helping hand
The scene had already been set for a running start.

The Helen Clark Labour government’s move, which provided iwi-backed Hautaki Ltd with cheap 3G spectrum, helped kick-start the company that became 2degrees, with Hautaki trading its airwave rights for a (soon-to-be-watered-down) minority holding.

And the year before 2degrees launched, Labour gave it another major leg-up as it pushed though number portability or the right to keep your number when you switch mobile phone companies.

National pushed through two more reforms that buoyed 2degrees: slashing mobile termination rates (or what phone companies charge each other when calls cross between their networks, benefiting the big guys) and splitting Telecom in two.

Under the current government, the Commerce Commission, through monthly monitoring and the threat of regulation, has also leaned on Telecom (now Spark) and Vodafone to reduce “best mates” plans, or those that offer cheaper calls to buddies on the same network (again, something that benefits big players, and makes life harder for a new market entrant).

The lows
Along the way there have been lows, including the death of Mr Hertz and his wife Kathy when their small plane crashed off Raglan in March last year, and a bad-tempered falling out between 2degrees’ top management (mostly drawn from Trilogy) and the company’s maverick founder Tex Edwards as a dispute over Mr Edwards’ shareholding, role and remuneration headed for the High Court (the two parties settled in November 2012).

There was also a spat with the government recently over 4G spectrum (keep reading).

The highs
But, overall, life has been good for the mobile newcomer.

It raced to that one million customer mark, hired 780 Kiwis and, as CEO Stewart Sherriff notes, it pioneered new features like carry over voice minutes and data, shared data and free calls to Australia.

2degrees has spent $400 million-plus building its network, most of it thanks to foreign investment (when minority shareholder Hautaki went looking for capital to stop its holding being diluted in a rights issue, there were no local takers).

That’s all good stuff. The market is more competitive for 2degrees’ arrival.

But 2degrees hasn’t updated on customer numbers since August 2012.

Focus on revenue over total customers
Mr Sherriff wouldn’t give any new total active customer numbers when he met NBR earlier this week, or update on how many customers were on contact (it was 100,000 or 10% in August 2012). The privately-held telco just doesn’t want to share that information anymore, Mr Sherriff says.

The CEO says he would rather focus on revenue share, where 2degrees’ holds around 14% to 15% of total spending on mobile telecommunications of around $2.3 billion.

Last year, 2degrees made a net loss of $35.9 million, a 20% improvement on the $45.2 million lost in 2012.

Mr Sherriff says it has been ebitda positive for the past nine quarters, and by that measure it was $35.3 million in the black in 2013 compared with $3.8 million in 2012.

Revenue rose 22% to $344 million last year.

Traditionally, 2degrees has been strong in pre-pay, a market that accounted for 900,000 of its first million customers.

Vodafone NZ CEO Russell Stanners indicated he wasn’t particularly sorry to see them go. He described some of the departing pre-payers as “glove box customers.” They preferred taking calls, and a large Lotto jackpot often saw a dip in pre-pay sales as they skipped their weekly top up.

Overall, Vodafone’s total mobile connections have stayed pretty stable since 2degrees’ arrival, with the company hovering around 2.3 million.

In the end, it was Spark that was hit hardest by 2degrees, in part because the disastrous XT launch coincided with the newcomer’s arrival. And in part because 2degrees was able to exploit the closure of Spark’s old CDMA network as Spark’s total mobile connections plunged from 2.1 million to 1.57 million. Spark has since recovered to 1.92 million, helped by its Skinny sub-brand, which has run attack ads targeting 2degrees and a generally pepped up mobile division. (Yes, the total mobile connection count does exceed New Zealand’s population. The discrepancy is put down to so many people having more than one SIM card in an age where cellphones jostle with USB sticks, iPads and other gadgets capable of making a mobile connection).

Neither 2degrees nor Vodafone NZ release average revenue per user (arpu) figures, but at its most recent half-year result, Spark said it had monthly arpu of $53.89 for contract customers and $12.01 for pre-pay.

So Mr Sherriff’s desire to gain revenue share implies a bid to move up the food chain and gain more contract customers.

How’s that going? Do contract customers still account for 90% of its connections? (39.2% of Spark’s mobile customers are on contract according to a July 30 update; a Spark February 21 update said it had 49.83% on contract).

Mr Sherriff won’t say.

He does offer that 2degrees’ estimates it now has 28% of the pre-pay market, putting it behind Vodafone but ahead of Spark (not particularly a negative for Spark, given shareholders and analysts focus so heavily on those high-yielding contract customers).

In the consumer contract market (about 32% of spending) it has around 15% share. In the business contract market (42% of spending) it has 5%.

Mr Sherriff wants to increase the share of the business market but for now the focus is on SMEs and entrepreneurs (although he notes 2degrees does have some large customers, notably Victoria and Waikato universities and the Manakau Institute of Technology).

4G focus – though still smarting about that auction
What else is in the pipeline?

A major focus is on 2degrees’ 4G rollout, which only began mid-year, putting it behind Spark, which began in October last year, and Vodafone which kicked off in February 2013.

2degrees is still sore over the government’s recent auction of 4G-friendly 700MHz radio spectrum freed up by the analogue TV switch-off.

CEO Stewart Sherriff complained that the “deep-pocketed” Spark and Vodafone were using the auction to entrench their dominance (the January 2014 auction saw Spark bid $149 million to secure 2x20MHz of 700MHz spectrum – a 2x15MHz lot and a 2x5MHz lot, Vodafone $66 million to secure a 2x15MHz block and 2degrees $44 million to gain a 2x10MHz lot).

2degrees wanted the government to offer it spectrum at “a fair price”; ICT Minister Amy Adams pushed ahead with the competitive auction process.

Afterward, she told NBR that she’d heard Mr Sherriff saying 2degrees’ had a “plethora of spectrum.”

And he confirmed to NBR this week that his company has all the 4G spectrum it needs for a nationwide network rollout, even assuming all his customers use 4G phones and gadgets.

So what’s the problem? The chief executive says because Spark and Vodafone have more spectrum, especially in the most efficient 700MHz band, they don’t need as many celltowers so it’s cheaper for them to upgrade their networks.

The final 2x5MHz lot in the recent 700MHz auction wasn’t needed by any player, Mr Sherriff says. It should have been left on the shelf. The government would have got a lot more money auctioning it at a later date once 4G has gone mainstream and there’s more demand for faster mobile downloads. The Telecommunications Users’ Association has backed this position. In the end, the Crown didn’t do too badly from the final 2x5MHz lot as a bidding war between Spark and Vodafone drove up the price to $83 million (compared to the $66 million or $22 million per 2x5MHz each paid for their first lots).

Mr Sherriff says Spark and Vodafone’s spectrum dominance and the way it will help them in the infrastructure spending arms race will help them keep a lid on 2degrees, and inhibit its ability to grow contract customers.

The CEO is after regulatory remedies. 2degrees wants to see carriers co-locate gear on shared celltowers. It also wants the Commerce Commission to examine ways it can make the contract market more competitive. 2degrees won a recent minor victory here when it got the Commerce Commission to agree there are two separate elements to the contract market – consumer and business.

A landline play
2degrees’ second major point of focus is a move into the landline market (which these days means fixed-line broadband with internet calling).

Mr Sherriff says NBR’s speculation was correct: his company was in the running to buy Orcon. On July 20, the ISP was sold to CallPlus in a July 20 deal insiders valued at $30m-plus.

When the bidding war was still in full flight, IDC research director Peter Wise told NBR it made sense for 2degrees to make a fixed-line play. Lack of a land line option was costing 2degrees deals in the business market.

This week, Mr Sherriff told NBR, “We will be in that space. It’s a case of when rather than if.

“We’ve got a team that’s working on our various options and you’ll see us in the fixed line space certainly within the next 12 months.” “And there are three different ways we can get in there: buy, partner or build.”

Buy
Of course, his company has already had a stab at the first option. What happened with the bid to buy Orcon?

“We decided we weren’t going to over-pay for that so we were unsuccessful but it wasn’t terribly upsetting that we didn’t get it.

Mr Wise agrees. When Orcon went to CallPlus, the IDC analyst’s verdict was that 2degrees had “dodged a bullet.”

He explains, “Integrating an ISP into a mobile operation is not easy and could have easily been a distraction for 2degrees. They’d be better off doing some sort of co-selling partnership with an ISP.”

If 2degrees does decide to press ahead with the buy option, there is really only one option: CallPlus with its 220,000 customers (including the 60,000 brought on board with the Orcon deal). CallPlus holds around 12% of the market. Above it are Spark (49%) and Vodafone (32%); below it are tiddlers.

Partner
This approach has its pros and cons, Mr Sherriff says. “It has limitations from a product offering.”

NBR notes that 2degrees and CallPlus share a “challenger” culture. And as with the “buy” option, the two largest fixed line broadband players (Spark and Vodafone) are obviously out of the picture and beneath CallPlus there’s no partner of any scale.

Build
This third option isn’t as crazy and expensive as it sounds, thanks to the fact 2degrees could piggy back on ultrafast broadband fibre, now being wholesaled by Chorus, Enable, NorthPower Fibre and Ultrafast Fibre.

“New Zealand’s in a unique set of circumstances with the UFB being rolled out. It’s just a case of getting a provisioning system up and running, then you can roll out UFB,” Mr Sherriff says. “I think you want to see UFB further penetrated before you get into that market,” he qualifies. “But that’s certainly an option for us.” (The latest MBIE quarterly update, released August 5, says UFB fibre has now rolled past 517,000 premises, with 39,510 customers or 7.7% choosing to connect.

The Scotsman’s eyes light up at the UFB suggestion. If I had to bet my life on it, I’d say it’s 2degrees’ favoured fixed line option. Bear in mind that in the regulatory wars, the company has always agitated for shared resources behind the scenes in mobile, such as all three telcos’ gear located on cell towers owned by a third party. The UFB broadly gels with the 2degrees world view.

But of course UFB fibre is more than 12 months away from the mainstream. So ... buy, partner or build for the fixed line play? “We’ll probably be hybrid to start with,” Mr Sherriff says.

ckeall@nbr.co.nz

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Only a matter of time before 2degrees gobbled up or disappears – analyst

It wasn’t much of a birthday card.

As 2degrees quietly celebrated the fifth anniversary of its launch, high-profile telecommunications industry analyst Paul Budde sent a note to his clients saying, “Five years on and to a certain extent it is a bit of a wonder that the company still exists.”

Mr Budde added, “It actually is one of the few surviving so-called ‘late mobile entrants’ in the world – companies that entered the market when more than 70% market penetration had already been achieved by others. Most operations similar to 2degrees but in other parts of the world have since been gobbled up by others or have simply disappeared. It looks like it will only be a matter of time before this happens to 2degrees.”

Ouch.

The Sydney-based Mr Budde – who has done consultancy work for the New Zealand and Australian governments and boasts gigs advising the UN and Obama White House – says that in Europe and Asia, mobile arpu (average revenue per user) “is at best stagnating but more likely declining … New Zealand will see a very similar development in perhaps one or two years’ time. In such a hostile environment the only longer-term scenario will be for Spark to buy 2degrees, in order for it to finally improve it position in the marketplace; it could operate 2degrees as a low-cost brand.

Late last week, Reuters reported that “Indonesia’s biggest telecom firm, PT Telekomunikasi Indonesia (Telkom), through its unit PT Telekomunikasi Indonesia International (Telin), is considering acquiring a 27% stake in a phone operator in New Zealand, said Telin CEO Syarif Syarial Ahmad. Negotiations are underway and the deal is expected to be finalised within this year, he added. Telin plans a capital expenditure of 1.5 trillion rupiah ($1.28 billion) for this year and has already spent 40% of the amount in the first half of the year.”

The word spread

A clipping of that story was sent to a couple of NZ media, including NBR, by someone close to a company that owns shares in 2degrees – leading to immediate speculation that the company was the target (currently 2degrees is 58% owned by US company Trilogy International Partners, 27% by Dutch company Tresbit, and 10% by Hautaki, with minor shareholdings including its founder Tex Edwards’ investment vehicle KLR Hong Kong holding the balance).

Mr Budde doesn’t see it happening. In his mind, it’s Spark or bust. “I don't envisage any overseas investor being interested in buying the company, not even at a discounted price.”

2degrees declined official comment, but one insider noted Mr Budde has been predicting its demise since it launched in 2009.

2degrees’ billionaire backer joins Microsoft’s board

2degrees director, John Stanton, who also serves as chairman of 2degrees’ majority shareholder Trilogy International Partners, was made a member of Microsoft’s board earlier this month.

Forbes has estimated Mr Stanton’s wealth around the $US1 billion mark, despite an investment in US wireless broadband network Clearwire going south.

The Seattle-based Trilogy owns 58% of 2degrees, having earlier gained Overseas Investment Office approval to lift its stake as high as 100%. Trilogy alumni and appointees control key executive positions.

Beyond his company’s New Zealand foray Mr Stanton led four of the top wireless operators in the US over the past three decades, and operated wireless networks in Europe, Africa, Central and South America. During the 1980s, he served as chief operating officer and vice chairman of McCaw Cellular where he met Craig McCaw, a legendary buccaneer of the early US mobile scene with whom he would later collaborate on other startups (today, Mr McCaw is worth around $US13 billion).

From 1992 to 2005 he served as chairman and chief executive officer of Western Wireless Corp. Between 1995 and 2003, he served as chairman and chief executive of VoiceStream Wireless, which was acquired by Deutsche Telekom and subsequently renamed T-Mobile USA. He also served as director and later chairman of Clearwire, a brave WiMax experiment whose backers included Intel, Warner and Google, from 2008 to 2013 (Clearwire was brought out by Sprint, primarily for its spectrum).

Mr Stanton said in a statement, “I’m happy to be joining Microsoft at such a pivotal moment in the company’s history. I’m excited to have the opportunity to help shape Microsoft’s future.”

For the next six months, a lot of that shaping will be done with an axe.

The company is currently undergoing a restructure under new CEO Satya Nadella, who wants to lay off 18,000 staff, or about 15% of Microsoft’s global workforce.

The bright spot for remaining staff is that the restructure is being made from a position of relative strength. Microsoft’s net income for its fiscal fourth quarter ended June 30 was $US4.6 billion (a 7% dip on the year-ago quarter but not bad given a $US700 million wallop associated with its Nokia acquisition). Revenues rose to $US23.4 billion from $US19.9 billion. Look for less emphasis on Windows and more on the company’s fast-growing cloud business.

It will be one of the most keenly-watched restructures in the US corporate landscape, and 2degrees’ CEO Stewart Sherriff is correct to say a Microsoft board appointment carries a lot of prestige, and shows the respect his company’s founder is held in in North America. Just don’t ask him if 2degrees’ lineup is about to become dominated by Windows Phones (answer: no).