The merger Wind-3 Italia may unlock convergence opportunities

07 August 2015

Quadruple play is not the only way; Fixed-mobile bundles without pay-TV have been successful in some Western Europe markets

On 6 August 2015, CK Hutchison Holdings Limited, parent company of 3 Italia, and VimpelCom Limited, parent company of WIND, entered into an agreement to form a 50/50 joint venture that will become the second-largest telecoms operator by revenue in the Italian market, overtaking Vodafone Italy.

Completion is subject to regulatory approvals including EU competition approval, and is expected within twelve months.

3 Group Europe has been a market consolidator over the last few years (in Austria, Ireland, the UK and lately in Italy). However, Italy is the first country where the merger involves large fixed operations and a convergence strategy.

The second-largest operator by revenue in the Italian telecoms market

The combined entity will strengthen its competitive position in a market that offers significant opportunities as operators are still far from monetizing their LTE investment and new generation fixed asset penetration significantly lags behind Western Europe.

The combined entity will be:

  • The second-largest operator by revenue with a combined 2014 turnover of €6.4bn (~20% share of market revenue), compared to €5.8bn for Vodafone and €15.3bn for Telecom Italia.

  • The mobile leader with 31m customers (34% market share), followed by Telecom Italia at 30m and Vodafone at 25m. Strong presence in the consumer market (38% market share) and ambitious targets in SME-SOHO and large corporate segments.

  • A mobile-driven operator with established expertise in the fixed market. About 80% of the combined revenue comes from mobile services.

  • The second-largest fixed operator with 2.8m fixed line customers (of which 2.2m fixed broadband customers, 16% market share). This represents a key asset for fixed-mobile convergence.

EXHIBIT 1: TELECOMS REVENUE AND MARKET SHARE BY OPERATOR IN ITALY, 2014

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Source: Operators, Pyramid Research

 

Key implications on the Italian telecoms market and European benchmarks

Pyramid Research expects the merger to have significant implications on the Italian telecoms market over the next years. The merger will certainly make the outlook more dynamic and challenging for service providers and may unlock convergence opportunities.

Product and service innovation, household-centric value proposition, simplified and well-priced offers for end-users, and greater attention to emerging revenue streams in the digital economy space will be crucial to win market share and support revenue.

In this article, we focus on two key implications and provide benchmarks of comparable markets. We also assess the impact on our telecoms, pay-TV and multiplay forecasts.  

Fixed-mobile convergence acceleration: quadruple play is not the only way

Fixed-mobile convergence (FMC) take-up has been very slow in Italy because of regulatory constraint, absence of cable operators and the lack of integration between telecoms and media services (satellite and digital terrestrial dominate the pay-TV market in Italy), the latter only recently addressed through commercial partnerships with Sky, Mediaset and, more recently, Netflix.

However, quadruple play is not the only way. Fixed-mobile bundles without pay-TV have been successful in some Western Europe markets (Spain and Belgium), and may be replicated in Italy.

In Spain, the adoption of fixed-mobile bundles without pay-TV is higher than quadruple play adoption as leading operators Movistar, Vodafone and Orange have constantly tuned their value propositions in order to meet changing consumer behaviors.

Exhibit 2 shows that 33% of households had a fixed-mobile bundle (fixed telephony, fixed broadband and mobile) in Spain in 2014, compared to 13% quadruple play penetration. From 2012 to 2014, the adoption of fixed-mobile bundles without pay-TV multiplied by 5x (from 6% to 33%).

EXHIBIT 2: FIXED-MOBILE CONVERGENCE IN SPAIN, 2012-2014

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Source: Operators, Pyramid Research

 

Telecom Italia claimed ~700,000 TIM Smart customers in March 2015, and a slight acceleration of the average daily acquisitions over the last six months. The household-centric value proposition proposed by the combined entity Wind-3 may drive demand for fixed-mobile bundles and unlock convergent opportunities for the whole market.

We will raise our multiplay forecasts for the Italian market to reflect higher cross-selling and fixed-mobile bundling opportunities. Expertise in both fixed and mobile markets is a key driver for a successful convergence story (as demonstrated by integrated operators in France, Spain and Portugal).

Fixed-mobile convergence allows operators to win customers and will also have a positive impact on churn as shown by several players across Europe, including for Orange in France and Movistar in Spain.

However, fixed-mobile convergence may turn into higher telecoms revenue pressure, particularly on mobile which is normally sold as the last element of a bundle and at discount. France and Portugal are good examples of increasing revenue pressure due to fixed-mobile convergence.

In France, Free entered the mobile market in 2012 and total telecoms and pay-TV revenue in the market declined by 4.5% (CAGR) between 2012 and 2014. 84% of this revenue decline was on mobile revenue. Free reached 13% mobile market share in 3 years since the launch of its mobile services.

In Portugal, where quadruple play (including quintuple play, that is 93% of all 4P+ bundles) reached 29% of households in March 2015 and is nearly as high as triple play adoption, the average incremental monthly cost of mobile handset services as part of a quadruple play bundle decreased from €29 in 2013 to €21 in 1Q 2015, and the average incremental cost of mobile broadband in a quintuple play bundle is €9 per month (for reference, the average mobile ARPU in Portugal is €12).

Price competition may intensify in 2016 and 2017 as the combined entity may pass part of the Opex/Capex synergies to end-users

The combined entity expects to generate a net present value of Opex/Capex synergies >€5 billion (net of integration costs), mostly coming from Network & IT. Annual run-rate synergies are expected to be €700m, 90% expected by third year post-closing. €700m is 7% of the combined Opex+Capex in 2014 (€10bn).

The merger between Orange and T-Mobile in the UK in 2010 (creation of EE) is a good benchmark of successful execution of expected synergies. The Opex savings reached two years after the merger represented 83% of the run-rate target, slightly above the initial target of 75%. EE is now the LTE leader in Europe with 10.9m 4G users at the end of June 2015.

The combined entity may pass part of the achieved synergies to end-users through even more aggressive prices and offers. It may also invest part of the synergies in retention (churn improvement) and acquisition efforts.

Passing €200m savings to end-users could mean a 5% average cut of mobile spend, which may be strategic to stimulate both convergent and LTE services. The combined entity aims to accelerate its roll-out of 4G services with 90% population coverage by 2017, nearly in line with main competitors Telecom Italia and Vodafone.

Further flexibility for the combined entity may come from a possible obligation to sell part of the combined spectrum as it will be slightly higher than its competitors Telecom Italia and Vodafone in the 2.6GHz band (FDD and TDD spectrum).

- Pablo Iacopino, Research Director, Europe

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