The ultra-fast broadband race

    30 September 2017

    ‘Telecommunications’ is not the perfect name for the transmission of data at speeds that the late Mr Alexander Graham Bell of Edinburgh would simply disbelieve. Nowadays — though some of us may still hanker after older, slower ways of keeping in touch — this is a technology sphere that is about so much more than telephone calls.

    The ability to alter the wavelength of light — and the development of optical fibres that permit light’s transmission without distortion from magnetic fields and other factors — has changed everything. In addition, computer power has permitted sound and visual images to be digitised into electronic pulses that can be transmitted at speed and in volumes (or bandwidths) that have ushered in a world of potentially instantaneous communication. This is the new world of ultra-fast broadband.

    For the non-specialist, it is a world of perplexing abbreviations, such as FTTP, FTTC and FTTT, meaning fibre to the premises, the cabinet or the terminal. In effect, we are in the midst of a data-transmission revolution, from copper-wire networks to optical fibre ones, that is already giving significant commercial advantages to those who have the latter. Cisco, the world’s biggest Internet Protocol Provider (IPP), estimates that internet traffic will be growing at an annual compound rate of more than 22 per cent between 2015 and 2020. Only optical fibre can cope with this growth, never mind the speed of its transmission.

    Last year the UK regulator for the sector, Ofcom, published its Digital Communications Review. In it we read that of the 30 countries analysed for ‘fibre coverage to premises’, Spain leads the world with 79 per cent, Canada, France and the US have achieved around 25 per cent penetration, but the UK figure is only 2 per cent, leaving us trailing shamefully at 29th in the table.

    Lack of optical fibre cable to premises simply means that businesses and retail customers cannot receive the volumes or speeds of data that most of our trading competitors now enjoy. Governments worldwide now realise that they are in a race to invest in the infrastructure that will permit their economies to stay competitive in a world where almost instantaneous data-sharing is vital. Put simply, physical networks need to be built that incorporate trenches, towers and vital connections from cabinets to individual premises.

    The UK, once a leader in mobile communications, is now well behind many competitors in terms of availability of data at speeds of anything much more than 15 megabits per second. Speeds of over 100 megabits are now commonplace from South Korea to Sweden. The Gigabit City (1,000 megabits per second), a concept much talked about in the US, is, technically at least, within reach.

    BT has been and is the UK’s monopoly provider of copper-wire telecommunications. The problem for the UK has largely been that it has not suited BT, or been financially possible, to scrap its largely copper-wire network and replace it with optical carbon fibre ducts and all the associated kit. Now under pressure from government and with rivals snapping at its heels, there is a consultative process taking place that will set the rules for a massive roll-out of optical fibre. As well as Ofcom, others at the table will be Sky, TalkTalk and Virgin Media, and the listed companies mentioned here (see box, right). Sharing of both optical fibre and copper-wire networks and a range of related technology issues are all on the agenda.

    In November 2016 the last government pledged £1.1 billion to help with the roll-out of fibre and 5G infrastructure, and £500 million has already been made available to invest alongside the private sector. This has had immediate success insofar as at least another £500 million has been invested by private companies and local authorities — particularly in the south and south-west, where two private companies, Gigaclear and TrueSpeed, have identified rural communities wealthy and willing enough to pay up for faster speeds.

    Now to the point: reducing such a technically complex and regulated business to a few investment ideas is fraught with difficulty, but made a bit easier by the fact that there are few public companies to choose from. Indeed Macquarie, the infrastructure investment bank, reckons that at the moment there are only two pure optical fibre players, BT and CityFibre. However, there are others whose business models will involve offering enhanced broadband speeds. These include Manx Telecom and KCOM, also featured here.

    As with any large infrastructure investment programme (possibly
    £30 billion or more to be spent in the next 15 years), there will be many opportunities for entrepreneurs to provide timely products to the larger players. But most of these are and will probably remain private or in private equity funds.

    In particular, many technical advances in switches, capacitors, amplifiers and electronic circuits already exist. These components of the ‘boxes’ or ‘cabinets’ take signals from the optical cables and change them to the visual or audible messages we understand. This ‘last yard’ at the ends of the networks is the area in which transformational changes lie further ahead, and perhaps great opportunities for investors.

    But for the time being, here are four companies poised to benefit from government-backed initiatives to help the UK catch up with the rest of the world.



    Share price £2.82;
    Market cap £28bn
    The share price of this monolithic business suggests to me it may be on the verge of recovery from well-publicised problems of recent years: in two years, it has declined from £5 to £2.82. It will always be difficult turning around such a huge company, but the urgency of delivering faster broadband to many more households is the stimulus that’s needed to make changes in management and structure, and negotiate a less stultifying regulatory environment. Already Openreach, BT’s broadband division, has a board independent of BT, which will allow it to initiate private talks with competitors and industry partners. Openreach is working with government and industry partners to find a middle way that can use existing copper networks but improve ‘last yard’ connections. Not every household will be willing to pay for ultra-fast services but a fibre optic infrastructure is the endgame and BT/Openreach will be exploring ways of getting there, probably via joint ventures: there were recent reports of talks with Vodafone, whose broadband experience in Spain and Portugal could be valuable. What’s certain is that BT isn’t going out of business: it’s far too dominant in the UK telecoms industry for this to happen, and has technical expertise second to none as well as a vast customer base that might be wooed into paying more for better service. So this is the safe horse to ride and it carries a 5 per cent yield.
    95p; £491m
    As befits the 2017 City of Culture, Hull and its hinterland are well ahead of the rest of the UK in penetration of fibre to premises. This is largely due to far-seeing Hull councillors, who, in 1902, received a licence to set up their own telephone network, which in 1987 became Kingston Communications. The company went public in 1999, when the city council sold its controlling interest. Now called KCOM, it started installing fibre optic cable to premises as early as 2012. A series of disposals and acquisitions has created a company with a solid earnings base well placed to continue investing in fibre optic cable, and not just in East Yorkshire. KCOM has created an IT division, Enterprise, which offers services in such areas as Cloud technology, and advises on private communications systems for clients such as HMRC. In a recent excellent research report on the telecoms industry, broker Peel Hunt describes KCOM as a company of two halves with a 6 per cent yield. It gives a target price for the shares of £1.50 and I don’t disagree with their view.
    45p; £286m
    Since its formation in 2011, CityFibre has grown both by acquisition and internally: a key acquisition in 2016 was 1,350 miles of optical fibre from KCOM for £90 million. Recently the company raised £210 million at 55p a share, essentially doubling its size. As the prospectus says: ‘CityFibre provides fibre connectivity services through designing, building and operating fibre optic network infrastructure. Today it owns and operates more than 2,000 miles of optical fibre and has a presence in 42 towns and cities in the UK, providing infrastructure that is an alternative to Openreach (BT).’ Its services and assets are available to other telecom companies such as Sky, TalkTalk, and Vodafone, as well as TV and film content providers The recent fundraising will allow more debt to be raised, quickening the pace of expansion. The new funds have also been used to buy a company called Entanet, which specialises in ‘connectivity’ services, i.e. the bit of the communication train that connects the end user to all signals that use mobile, cloud, optical fibre or indeed old-fashioned copper. This acquisition signals CityFibre expanding from its traditional role as wholesale provider of optical fibre networks towards new ventures and marketing initiatives.

    This is a sector that is growing exponentially so the game (as with the likes of Amazon and Facebook) is less about quick profitability than running fast to secure market share. How businesses such as CityFibre should be valued is a puzzle. For the time being, investors can be comforted that they are buying at a discount to the recent institutional placing. Macquarie, a broker to the recent issue, has a target price of 100p. This should be regarded as a long-term investment but prepare for excitements in the short term as market participants jostle, acquire and perhaps merge.
    £1.97; £222m
    There’s something comforting about investing in a monopoly — and that’s certainly what Manx Telecom has on the Isle of Man. On the other hand, as BT investors know, monopolies attract regulation that can stultify performance. It was once part of BT, but after several owner changes it floated free by an IPO in 2014.

    Manx benefits from providing telecoms and services to a loyal community on its low-tax island. It has invested in recent years in fibre-to-cabinet infrastructure but announced recently that it will be offering fibre-to-premises for about 80 businesses and locations. The company should benefit from wealthy Isle of Man residents who can afford to pay for this enhanced service. It has also launched a small investment business, Vannin Ventures, that will look for opportunities as the broadband revolution gathers pace. There is no reason why Manx cannot expand quickly on its solid domestic earnings base, and the balance sheet seems stable with debt of £69 million and available cash of £10 million. Earnings before depreciation and tax are a comfortable £27 million so the dividend yielding 6 per cent is well covered. Peel Hunt has a target price of £2.50.
    (All prices as at 22 September).