Vodafone's Hidden Catalyst: It's Green!
Given the impressive adaptation rate of mobile handsets it was really just a matter of time before telecoms came under pressure from weak demographic trends and slower subscriber growth rates. Regulatory price cuts in mobile termination rates, intense competition, and a tough global economic environment have been an additional drag on the sector.
These trends look set to persist as the outcome of U.S. and European debt issues remain unsolved and regulatory pressures remain unabated, as senate anti-trust subcommittee chairman Herb Kohl has stated that he is against the AT&T (T), T-Mobile merger. Furthermore, market saturation for mobile devices in urban areas has forced carriers to look to other means of driving subscription growth. All of which has been weighing down stock prices.
The hidden potential of the telecoms is the role they are sure to play in the building out of the smart grid. It would be pure speculation on my part to assign a number to the amount of money that is at stake, but for scale of reference Jeffrey Immelt has called the smart grid, "the biggest investment of the next 50 years."
By 2020 the British government plans to have a smart meter in every home under a program whose cost is expected to top $11.5 billion. This will require enormous amounts of data to be wirelessly transmitted from those smart meters back to Britain's energy companies. So a big chunk of that data is certain to pass over Vodafone's (VOD) network. Telecoms are racing to enable utilities to meet EU regulations regarding the smart grid, such as the requirement to bill customers on their actual energy usage instead of flat rates, and the call for "the same open access principles that apply to the Internet today." This is interesting because it moves the telecoms into building energy management software, a market that is crowded with heavyweights like Cisco (CSCO).
Green technology is a different market than green energy. With the massive finds of shale gas recently in the U.S. and around the world, industry experts expect natural gas prices to stay below $8.00/Mcf for the foreseeable future. Gas at that price roughly equates to electricity at around $0.05/kWh. That makes it hard for alternative, or "green," energy sources to compete, even with subsidies. But one area of the green movement that has a proven payoff is energy efficiency. It doesn't matter how much electricity costs, if you consume less you save money. The same goes for smart grid investments. Reducing congestion and grid inefficiencies is profitable no matter what the cost of electricity, and it is a necessary condition for introducing more renewable energy capacity in the future. That's the green potential for telecoms.
The battle over market share and subscribers between the telco giants has now decisively moved over to the smart grid. For telecoms, the smart grid is all about using their wireless networks to sell machine-to-machine services. M2M services (not to be confused with the Vodafone subsidiary of the same name) run data over networks used by devices like electricity smart meters. A smart grid utility contract, or an M2M service, is relatively low maintenance and can diversify traffic on a cellular network. Phone companies can only add so many new subscribers in mature markets, so M2M services will be a hot area of growth and competition.
Bringing the management of smart meter data to cloud computing-style services could be a revolution for the telco industry. Cloud computing essentially offers the ability to use computing power on demand as a service. While the telecom giants are not cloud computing companies in the common use of the phrase, they are using their networks and data centers to offer cloud-like on-demand services. Utilities will likely choose to work with cell phone companies because they can rent space on an existing network and therefore will not have to make the capital expenditure investment to build and maintain their own networks.
Telecoms also offer utilities the benefits of the billions of dollars they spend enhancing their networks, so when the next upgrade cycle begins the utility company will reap the benefit without having to pay for that investment directly.
Conversely, some utilities are opting to build out their own smart grid networks. One reason is that owning the network allows utilities to avoid sharing bandwidth with other customers and gives the utility more control over network security. The real reason for choosing to build rather than rent is that in the U.S. regulated utilities are allowed to earn profits on capital expenditures like building their own networks, even when it can be proven that it is cheaper to use a third party provider.
It is inevitable that the scope of product offerings from telecoms will expand far beyond phone, Internet and cable services. You can add energy management services and cloud computing to that list. In many areas telecoms and utilities already have robust relationships behind the scenes, and many cell carriers currently provide backhaul networks for grid communications. One can imagine a world where you will be offered bundled packages that offer lower rates if you wrap your cable, internet and phone in with electricity.
Most people already think of their cable, internet and phone bills as traditional utility services and a merger of electric utilities and telecom services is starting to make more sense as a system for demand response, distribution automation, and load transferring requires that the two industries form partnerships. Central Indiana Power, a small co-operative in the suburbs of Indianapolis, has merged with a local telecom, Hancock, to offer electricity, phone, broadband and home security services through one company now called NineStar Connect. I don't think regulators would really allow Duke Energy (DUK) and AT&T (T) the opportunity to form a huge conglomerate, but broad scale partnerships across the industry make sense, as does bundling energy services with existing telecom services. This concept offers the telecoms an interesting opportunity to increase revenue and increase costumer switching costs.
Another opportunity for telecoms to expand their empires lies in the cloud computing sector. They are already working hard to provide enterprise-ready clouds that offer the same computing, storage and software services that every other cloud service provider is targeting. I have no doubt that telecoms will capture their fair share of that overcrowded market space. However, I just don't think it makes sense for telecoms to go head to head with the likes of Cisco (CSCO), or potentially even Microsoft (MSFT).
I think the real prize for telecoms in the cloud space is selling access to the network. Looking at it this way, the telecoms would be in the business of providing a toll road between the enterprise and public cloud providers. The business of selling access to the Internet is nothing new to the industry. What will differentiate this service is that it would be focused on delivering connectivity solely between enterprises and cloud services providers and not between enterprises or between clouds. In order to make network access cost effective telecoms would need to provide dedicated leased lines to the networks of major cloud service providers. The value added would lie in preserving the network for its intended use by the enterprise.
This is an area that telecoms are uniquely positioned to compete in because they have already made extensive capital expenditures into building the infrastructure and should be able to extend their network service offerings to be the enterprise's entry point into the cloud (rather than the cloud service providers like MSFT mentioned above).
The above paragraph is my summation of an idea presented by Allen Leinwand, which he calls CloudNAPs. The thesis is that having a middleman to the Internet would ensure high performance as well as high security. Having private inter-clouds could be key to preserving net neutrality.
The telecom industry is at a mature stage where growth rates are declining because markets have become saturated. There are many new challenges and opportunities for the telecom industry to expand its range of services and continue to grow. The hidden catalyst for this future growth is the role that telecoms will likely play in the development of the smart grid and the "Internet of things." This development will allow telecoms to extend their product offerings to include energy services and access to the cloud. Not that it is most investors primary concern, but both of these developments qualify as "green tech" initiatives in that they allow energy to be consumed and distributed more efficiently.
These new opportunities for the industry will draw fierce competition and require significant investments, but will also provide a new wave of growth for the sector. It is almost certain that telecoms will continue to form partnerships with electric utility providers, and possibly cloud service providers, in order to enhance competitive advantages. The scope and scale of the investments telecoms are making to get in ahead of the smart grid build out suggests that there is plenty of green to go around.