Wholesale rate decision could lead to focus on flanker brands, analysts say

In the days after the CRTC issued a decision that lowered wholesale wireline Internet rates proposed by large Internet Service Providers (ISPs), financial analysts said the large telecoms could respond to increased pressure through flanker brands, and some pointed to the possibility of decreased infrastructure investment. Desjardins Capital Markets analyst Maher Yaghi said in a note Friday that while it is “too early to quantify the impact” of the CRTC’s new rates, “we believe this decision could push incumbents to sell Internet flanker brands in order to compete against small players.” In the past year, both Rogers Communications Inc. and BCE Inc. have introduced Internet service under the Fido and Virgin flanker brands, respectively, though Telus Corp.’s Kodoo doesn’t offer wireline service. Yaghi noted that the wholesale system has two components — a monthly rate for access to the network and a separate rate for capacity. “Our initial review of the interim tariffs that the CRTC is ordering wholesalers to use until the final tariffs are decided appear to show substantial reductions (up to ) in the price for capacity for certain incumbents, and a 0–39 reduction for the access portion for specific speed bands,” he said. The CRTC’s decision Thursday is a part of its efforts to lower retail pricing for Internet service, or “at least lower Internet price inflation,” Yaghi said. He added it’s likely some of the cost savings small ISPs will see under the new regime “will be passed on to the consumer and thus have the potential to pressure incumbents to respond.” Both Yaghi and RBC Capital Markets analyst Drew McReynolds noted Internet service has helped telecoms offset or hedge ongoing erosion in television and home phone customers. McReynolds said in a research note Thursday evening that the CRTC’s decision is not a “game changer,” but could put pressure on wireline revenue growth. Small ISPs that buy wholesale access have about 15 per cent of the market in Canada, he estimated. “Should final whole Internet access rates tip that balance too much in favour of Internet resellers … Internet revenue growth (market share and pricing power) and thus wireline revenue growth could come under greater than expected pressure,” McReynolds said. Should that occur, the large ISPs would have to put strategies in place to mitigate the impact, including “effective bundling” and strategies involving Internet service offerings though their flanker brands, he said. Barclays Capital analyst Phillip Huang agreed in a Tuesday note that incumbents are likely to respond to the CRTC’s decision with an increased focus on flanker brands. “The industry will certainly be watching closely the resellers' reactions to the decision — whether and to what extent the resellers will pass on their cost savings to consumers,” he said. “In the near term, we would expect the incumbents to broaden their recently established fixed broadband flanker brands to help defend market share against the strengthened resellers Huang estimated the smaller ISPs have about 1.5 million subscribers total — a “rapidly growing” number — mostly in urban markets in central and western Canada. While “the decision will certainly have a negative impact on the incumbents' broadband revenues, we may also see some wholesale market share gain by incumbents that have seen their wholesale rates slashed the most,” he said. Huang added that it “remains to be seen whether could trigger a slowing in broadband investments, given those investments are now likely to generate lower returns and longer paybacks.” Though he predicted the tone of last week’s decision is an indication of the direction the CRTC could take in future wireline wholesale rate decisions, Huang said that wouldn’t extend to wireless, given that the CRTC enforces wireless policies established by the government instead of setting policy itself. Scotiabank analyst Jeff Fan said in a Tuesday note that he was skeptical about whether the small ISPs would be able to leverage the new rates to “price aggressively and gain share.” “The reseller model still does not scale well and lowering prices to drive higher subs will not necessary generate an increase in profits,” he said, adding that the way the rules are set up make it difficult for small ISPs to go after higher-speed subscribers. The small ISPs needed the lower rates in order to be profitable, Fan said. “We believe that in the prior higher rate regime, Internet resellers were unprofitable and that the new rates provide some breathing room,” he said. The decision isn’t likely to have a material effect on incumbents, he said, adding that “significant consolidation of resellers may be necessary to make them truly competitive.” But he also expressed concern that the decision could “ultimately affect the return of network investments, which could reduce the level of aggregate investment in fixed broadband infrastructure.” The biggest impact on the incumbents will be a reduction in wholesale revenue, he said, and given that there are more small ISPs that buy wholesale service in Ontario than in the West, companies that operate in that province will be “disproportionately affected.” Cogeco Inc. and Quebecor Inc.’s Videotron “will experience the largest relative impact as their cable businesses make up a disproportionately larger portion of their revenue relative to the other providers. Rogers will also be more significantly impacted as a result of being a major broadband provider in Ontario,” Fan said. In a press release Thursday, CRTC chairman Jean-Pierre Blais said that “Canadians’ access to a choice of broadband Internet services would have been at stake had we not revised these rates,” a situation that he referred to as “disturbing.” The CRTC lowered the rates proposed by the large companies and criticised them in the release for submitting “unreasonable” rates that were too high, based on cost studies that weren’t conducted “in accordance with well-established costing principles and methodologies.” The Canadian Network Operators Consortium (CNOC) praised the decision. Spokesman Matt Stein told The Wire Report Thursday that it would mean small ISPs would be “free to innovate” on value and technologies like over-the-top (OTT) and cloud services. — With reporting by Anja Karadeglija at akarad@thewirereport.ca and editing by Ahmad Hathout at ahathout@thewirereport.ca

Wholesale rate decision could lead to focus on flanker brands, analysts say

News | October 7, 2016

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Wholesale rate decision could lead to focus on flanker brands, analysts say

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