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Telus and Bell have confirmed they’re in merger talks, after BCE earlier announced it was mulling over its options earlier this Spring. Both companies are weakened by declining landline revenues as competition from Wireless and the Cable Guys and, to a lesser extent pure-play VoIP contenders, is heating up. This makes a lot of sense, but probably not for the reasons that your average reporter would think.

It has been known for some time that CableCos would move into the voice business, which thanks to VoIP and their co-ordinated efforts through PacketCable, was almost trivially easy to accomplish. Both of Canada’s major telecom service providers find themselves in a major uphill battle.

This slide, from Telus’ August 2006 Q2 investor conference call tells the story:

Things are not looking good on the home front. To make things worse, and while Telus contends that the wireline side is “stabilizing”, revenues are still dropping and this slide from the Q1/2007 investor call shows:

While it did indeed show that SkaterBoy is in fact Rocking it With IP (say hi Jill Schnarr!), what’s easy to see is that the base is eroding, both in terms of subscriber count and revenues. Their Broadband penetration is not so good, either. Bell Canada, with its larger service area and more densely-populated markets, appears to be doing better when compared to Telus, according to LightReading (see charts below), but they are at present weathering the storm .. not lighting the world on fire.

Bell Scorecard

By comparison to Bell’s numbers here, Telus’ Broadband Internet subscriber base is a claimed 949,000 users as of the end of Q1/07.

Both companies are looking to data and wireless to grow the business. Wireless is a growth industry, of course, but I would contend that, when it comes to wireless subscription growth, we are in a bubble. Saturation has already caused wireless subscriber growth to begin to taper off, and as in the telecom bubble of the late 1990s, that drives up customer acquisition costs (since these companies would sooner pay more $$ for users than innovate in order to attract them). Perusing the Telus Investor Slides linked above reveals exactly that. Data is growing, but likely only within their existing base of wireline subscribers. And if that base continues to churn as fast as it is, that market will reach true saturation a lot sooner than wireless.

Launching broadband as a service is one thing. Broadband is, however, a commodity — as are residential and business subscriber lines. Telus, Bell, and all other ILECs are presently learning what happens when your basic services remains.. uh.. basic, and your only foils against competition are pricing and bundling. Furthermore, service innovation within the ILEC world has totally stagnated, insofar as new service development is concerned, as they’ve focused on pink elephants like IPTV (which, this author contends, won’t work) and Verizon’s IOBI (which suffers from huge capital costs for minimal incremental benefit). The fundamental problem for the Incumbents is simply making things scale on the telecom network. It wasn’t built for that, and even with IP upgrades grafted and forklifted into place, it still doesn’t have the bandwidth for compelling services. The Cable Guys have their own problems, but they get a free ride for now thanks to the fact that their delivery of TV entertainment is broadcast easily down their plain old copper wire — including High Definition.

The Incumbents need to bite the bullet and implement FTTH to get themselves out of this hole, but some analysts estimate the cost to be about $9650 per subscriber. That’s a purchase order that I would not be excited to sign, and more than a few pundits think that Verizon’s $23 Billion bet to wire up 18 million homes will kill the company.

So, while Canada’s two big incompetents incumbents are struggling with a sharpening decline in their base, the Shaw and Rogers folks are starting to kick ass, seeing growth on all fronts. Shaw, which started late in the telephony game, has been growing all of their services, with about 2M cable subscribers, 1.5M internet subscribers, and around 100,000 telephone customers. They’ve added the latter service with minimal cost impact and a very low customer acquisition cost, and the ARPU of a Shaw HD Cable customer with High-Speed Internet and one phone line is very near $200/mo. This is the holy grail of residential telecom. And while they start from a smaller base of customers, their capital cost to deliver multiple services is a lot lower.

So, what does this all mean? Current default logic in the Telecom arena is that all of the players need to be at least a Triple-Play and arguably a Quadruple-Play in order to grow their services and revenues, and defend their userbase. I think that I’ve presented a straw-man case illustrating that the Cable Companies, because their networks already do the harder thing (distributing realtime entertainment cost-effectively) with relative ease, have a decisive advantage leaping toward this, particularly because Rogers Communications already owns a wireless Service Provider.

Telus and Bell should and probably will merge in order to cost-optimize, lay off a bunch of redundant workers, and debt-finance the building of Fiber-To-The-Home. They will need to do so before they are, over the course of the next decade, eclipsed by the more nimble and more entertainment-oriented Cable companies. It will not be easy for Canada’s two incumbents to recognize their lot at the moment as dumb-pipe carriers, and the only network which it has been established can reliably and scalably deliver realtime entertainment and content is Fiber.

Cable Guys ultimately need to get there, too, as we’ll increasingly want to Time-Shift our media, but PVRs and HD are stop-gaps which are saving them from needing to make an early, costly, network upgrade. Besides, Cable Companies needed to upgrade their networks substantially for broadband, and did so during the 1990s, delivering Fiber to the neighbourhood (FTTN). Making that next leap, while costly, will not kill them.

Which leads to the following hypothesis:

Is now the time to merge Shaw and Rogers? As the only major Service Provider in Canada without a Wireless business unit, Shaw is the clumsy kid at the prom in the powder-blue suit. Definitely the smallest of the four, Shaw doesn’t have as diversified a business as any of the other three but has stuck to its knitting. It has also been busily snapping up smaller Cable Companies in the West, including my friends @ Whistler Cable. Mark Evans thinks this is a possibility, too, for the record, and the companies have a history of collaborating to achieve efficiencies. Jim Shaw and Ted Rogers, while officially rivals, often reveal a friendly candor and mutual respect. The idea is alluring.

The reality is that if Telus really wanted to cement its future, it should buy Shaw. But this would create a physical monopoly in the West, rather than the defacto monopolies which exist today, and the CRTC and Industry Canada would never allow it. But one other opportunity may lay on the horizon: If Telus and Bell merge, they will have to release some of their wireless spectrum back to the regulators. If this occurs, then the market may open up for another major wireless carrier to emerge in Canada: one funded by that quiet kid in the Powder-Blue suit. If the Quadruple-Play hypothesis is correct then this will allow Shaw to compete on a level playing field with a merged or non-merged Telus and Bell, and maintain parity with Rogers. And while it’s probably not a great idea to have wireless this consolidated over the long-term, this could allow Jim Shaw to build up some value in Shaw Communications prior to the inevitable merger with Rogers.

Convergence freaks tend to assume that all roads ultimately lead to all of your myriad services being delivered via a fibre-optic cable straight into a hub in your basement (or storage closet) regardless of whether your Service Provider came from Cable or from Telecom. I don’t disagree, but I do contend that its a twisted, heavily contentious road that’ll get us there. And fortunes will be made or destroyed in the process thereof.

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