Rogers, the Telecom Cannibal

One of the most difficult choices that an established and very profitable company must make when faced with a small and nimble competitor, one that has everything to gain and nothing to lose, is lowering their prices or investing in new technology to address the new competition. They quite sensibly will put off these decisions for as long as possible. The delay will be criticized, and even ridiculed by the competition, yet it is still the right choice. Rarely is the decision so urgent that a company will forgo current profits to chase what may turn out to be a mirage. That is, they will strive to avoid cannibalizing profitable businesses -- by lowering prices, offering new services or investing in new technology -- until it becomes unavoidable.

The reasons why delay if often the best business decision are several:

• The new competitors, especially in the telecom business, must invest heavily to deploy a new network. The massive debt load when combined with lower prices (to differentiate from the incumbents) and what may turn out to be a slow acquisition of customers can derail or destroy the competition, even when the incumbents make no changes to their prices or products. Time is often on the side of the incumbents.
• It is not unusual that new technology, while dazzling to customers and the media, is not adopted rapidly by customers. Consider VoIP as a good example of this phenomenon. Rapid investment in the new technology that competitors are also deploying can often be done at a slower pace when combined with good marketing. In effect, telling the market that the technology is being deployed (which is true) while doing so quite gradually.
• Lowering prices does not guarantee customer retention. First, even if prices are held steady, many customers will no switch since they will be more conservative in their choice, opting to go with, for example, good wireless coverage and service dependability. Second, customers preparing to switch will often do so even if the incumbent lowers their prices since there are other factors in their decision, such as escaping poor customer service.
• Investors may rebel or will at least defect (sell their shares) as the incumbent damages short-term profitability by lowering prices and increasing capital expenditures, even though they may understand the reasons for the company's decision. It is no certainty that the competitors will be irreparably harmed by the company's actions, or how long it will take. Yet for the present they must tolerate a lower company valuation, due to lower profits, and therefore lower share prices; the company's share price in part reflects investor expectation that company profitability be sustained or increased.

With this background, let's look at yesterday's quarterly results from Rogers. As recently as this summer I wrote that Rogers was still looking good since there was unlikely to be any near-term impacts on their financial state due to new competitors such as Wind and Mobilicity. It would take time for them to build out their networks to become a credible alternative and take a significant bite out of Rogers' subscriber base. This appears to be the case, despite some analyst warnings to the contrary.

The new landscape includes a handful of upstart wireless firms, such as Wind Mobile and Mobilicity, that are building traction with consumers through discounted pricing, simplified agreements and aggressive marketing campaigns.

And this one:

...Dvai Ghose, a telecom analyst with Canaccord Genuity, in a research note earlier this month. “In our view, the market is ignoring reprice pressure in Canadian wireless, both from new entrants and incumbents.”

Nevertheless, Rogers did respond with their flank brand, chatr, to mimic Wind's pricing to compete with them without threatening their core wireless business. That has, in part, had an impact on their quarterly results.

The modest year-over-year increase in net subscriber additions for the quarter primarily reflects increased prepaid subscriber additions offset by an increase in the level of postpaid churn associated with heightened competitive intensity. The increase in prepaid subscriber additions was the result of Wireless' launch of its urban zone-based unlimited voice and text 'chatr' product and also its continued offering from earlier in the summer of prepaid wireless service plans for Apple's recently introduced touch screen tablet computer, the iPad. In addition, Wireless introduced prepaid Rocket stick wireless data plans that offer the same speed and reliability as existing postpaid plans but designed for customers seeking the convenience of prepaid online credit card activation.

Although Rogers has taken steps to restrict new chatr plans to the areas when competition is now ongoing, they are to some extent -- thought it is not really possible to say how much -- cannibalizing their own business when their existing customers switch to chatr. It is also interesting that their subscriber growth is slowing despite the additional services they are offering for new devices such as the iPad and internet access for PCs and netbooks.

The number of new Smartphone subscribers was the second highest ever in a quarter. This resulted in subscribers with smartphones, who typically generate ARPU nearly twice that of voice only subscribers, representing 37% of the overall postpaid subscriber base as at September 30, 2010, up from 28% as at September 30, 2009.

This is another impact on their results which is not only a sign of future growth and not at all related to competition. When you buy a smartphone from Rogers -- iPhone, Android or BlackBerry -- they must purchase the phone from the supplier at full price while selling it to you at a heavy discount. They make it up over the contract term(including data plan), but account for the expense in the current quarter. Yet these subsidies, and current quarter losses, indicate future revenue and profit.

Some analysts feel that smart phone upgrades, as opposed to pure subscriber growth, is a more important indicator of success in the industry as wireless data revenue – which was up 28 per cent in the quarter – becomes more important than revenues from voice services.

That is, a ramp in these subsidies is a good indicator of future profits and corporate health. We should also note that they are not only on the receiving side of competitive pressures, they are taking telephony market share from Bell Canada and other incumbent telcos.

Cable telephony lines in service grew 9% from September 30, 2009 to September 30, 2010. At September 30, 2010, cable telephony lines represented 27% of the homes passed by our cable networks and 43% of television subscribers.

Although Rogers B-class shares lost 7.7% on Tuesday in response to their quarterly results, I do wonder if this is either an overreaction or a overly-negative interpretation of their earnings decline. I don't like Rogers as a customer, and I am not currently either a customer of theirs or a shareholder, but I would not write them off just yet. I would also suggest that they may be too aggressive in cannibalizing their wireless business, even though they've segregated budget pricing to the chatr brand. Perhaps they really are running scared, though that does not seem likely to me. More likely is that they hope to hurt the competition now while they're still at the critical market-entry phase and very sensitive to meeting subscriber and revenue objectives.

As consumers, not shareholders, we do have some choices even if their coverage and options are still limited. That can't be bad. There is even good news for Rogers shareholders since, if my guess is right, this drop in share price could turn into a buying opportunity for those willing to hold for another quarter or two.