Singapore Telecommunications last week shed light on the difficult industry dynamics that lay ahead of VHA, the mobile phone business being formed from the merger of Vodafone Australia and Hutchison Telecommunications.
VHA will put pressure on Optus to invest in network quality, product development and innovation in order to compete
SingTel's quarterly earnings results also drew attention to the pressure on profits in its own Optus mobiles business. Optus has been going through a decline in market share, measured by revenue, for the past four years and that looks set to continue.
The creation of VHA may well put Optus under further pressure by forcing it to lift its capital expenditure in Australia. That would lead to a further squeeze of its profit margins.
VHA is being formed at a critical turning point in the mobile technology cycle.
The combination of a near 80 per cent reduction in the cost of mobile broadband over the past three years, ubiquitous 3G services and the easy availability of sleek smartphone devices have given Australians a taste for richer and more enjoyable mobile online experiences.
Customers will be demanding improved services and expect to be offered the next iterations of mobile technology known as LTE and Super 4G. Telstra is setting the pace by offering download speeds of 21Mbps on its Next G network.
The mobile carriers bore heavy capital expenditure bills from providing 3G services. The aggressive 3G strategy of Hutchison cost the Hong Kong-owned company more than $3 billion.
The mobile broadband world brings with it huge subscriber acquisition costs because the handsets are so technology intensive. Optus said last week that its decision to be the dominant partner in Australia with Apple for the iPhone smartphone cost the company $88 million in the nine months to December.
A close look at the Optus results showed that although revenue grew by 10 per cent in the three months to December, expenses rose by about 15 per cent. Selling and administrative costs soared 26 per cent while cost of sales jumped 18 per cent.
The Optus mobile EBITDA margin fell 6 percentage points year-on-year to 26 per cent reflecting higher post-paid acquisition and associated costs. Net profit for the quarter was flat at $143 million. Optus spent $100 million on upgrading its mobile phone towers. That was part of a $315 million commitment made in May last year.
The creation of VHA will put pressure on Optus to invest in network quality, product development and innovation in order to compete, according to Goldman Sachs JBWere analyst Christian Guerra.
He says in a note to clients that demands on capital expenditure are likely to place even more pressure on cash flows at Optus. Free cash-flow at Optus slumped from $267 million in the December quarter 2007 to $167 million in the December quarter 2008. While there appears to be consensus among analysts and commentators that VHA will mark an end to aggressive price competition from Vodafone and Hutchison, there has been little discussion of the potential for higher capex.
One obvious advantage of a debt-free joint venture is that it will be able to finance its capital expenditure from operating cash-flows. Guerra estimates VHA will have free cash flow of $326 million.
It would not be surprising if one of the primary arguments in favour of the creation of VHA being put to Graeme Samuel at the Australian Competition and Consumer Commission include the capacity for the merged business to invest in new technology.
The mobile phone business benefits from having more subscribers on the same fixed network. The costs can be shared more widely, the profits can be higher and the reinvestment can be greater.
The change in the Australian mobiles market from a highly competitive four-tiered market to a three member oligopoly may not necessarily ease the pressure on Optus, which in terms of revenue market share only just pips the VHA joint venture.
This article by Business Spectator's Tony Boyd is reproduced on ZDNet.com.au courtesy of a reciprocal publishing agreement.
7%
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Please Senator Conroy accept the obvious and do not let the Australian taxpayer be the fall guy to the tune of 4.7 billion for the NBN.
The foreign fakers who seek the Government handout desire the 4.7 billion dollars and have no hope of obtaining finance to help fund the network.