Foxtel's triple play may be Telstra's bundle of joy

It’s been a long time coming. This week’s announcement – that Foxtel would begin bundling broadband and voice services with its pay television offering next year – points to looming shifts in the competitive dynamics of both the telecommunications and pay TV battlegrounds as the national broadband network becomes more tangible.

On Monday, Foxtel announced its shareholders, Telstra and News Corporation (owner of Business Spectator), had approved its plans to launch broadband internet and fixed-line telephony services bundled with its pay TV product. Foxtel has signed a wholesale agreement with Telstra.

For both companies there would appear to be a mixture of both defensive and offensive strategies behind the decision to allow Foxtel to enter the telecommunications market and compete with the dominant player and its half-owner, Telstra.

Since its inception, Foxtel has been prevented by its ownership (by Telstra) from offering entering the ‘triple play’ bundle that has proved so effective in other markets. Telstra had no interest in allowing a half-owned business to cannibalise and accelerate the decline of its own high-margin fixed-line business. Telstra has bundled its services with Foxtel’s without discounting them, but prevented Foxtel from pursuing a genuine triple-play offer.

From Telstra’s perspective, the expectation that the Coalition government would accelerate the rollout of the NBN would have altered its thinking.

In an NBN environment, it is inevitable that Telstra will be a loser amid a more level playing field for telecommunications retailers. The rate at which it loses customers and earnings – and the magnitude of the losses – will matter.

Optus, TPG, iiNet and others are putting together customer bases, infrastructure and product offerings to compete far more vigorously. If Telstra is to be cannibalised, it makes sense that it loses share to a company that it has a stake in, rather than to competitors. To the extent that Foxtel does pick up some of its customers, it will keep the wholesale margin and get 50 per cent of the profits that Foxtel generates.

Foxtel has long desired the capacity to offer telecommunications services. It offers additional revenue streams to leverage its existing sales and billings platforms, and therefore additional margin and profits at incremental cost. Importantly, the bundling of other services with its core pay TV product should make its customers ‘stickier’.

Given the high cost of acquiring and servicing new customers, one of the challenges for all subscription businesses is customer churn.

Foxtel’s churn rate is high: more than 14 per cent of its customers leave the service each year. It is costly, given that its penetration of Australian households has been stagnant at about 30 per cent for some years.

Foxtel has been able to steadily increase average revenues per user by introducing new products, cut-down versions of the service (Foxtel Lite) and a new range of IP products and on-demand services. Still, it hasn’t been able to enlarge its overall customer base.

If it can reduce the churn or get some momentum into its customer numbers, there could be a significant impact on its bottom line. The overseas experience of triple play offers suggests this could work. Goldman Sachs has estimated that a triple-play offer could add $130 million to Foxtel’s earnings before interest, tax, depreciation and amortisation by 2020 and increase its value by a cool $1 billion.

Like Telstra, Foxtel would also be watching its competitors, knowing that they will be an increasing threat as the NBN rolls out.

Optus and iiNet already offer the Fetch TV service, a cut down (and much cheaper) pay TV service that is starting to build a reasonably sized customer base. There is also the spectre of the imminent full-scale entry of the US giant Netflix, whose on-demand internet streaming service is changing the landscape of the US television sector. Netflix has a declared strategy of expanding internationally.

Some of Foxtel’s more recent IP products – Foxtel on T-box, Foxtel Play, Foxtel Go and Presto – were designed as pre-emptive launches with Netflix in mind.

It has also ratcheted up the pressure on the federal government to relax anti-siphoning laws. These laws shore up the position of the free-to-air networks by giving them exclusive or at least ‘first rights’ access to the most attractive live sports programming – a driver of pay TV take-up elsewhere.

The more it can add to its existing hoard of sports rights, the more compelling its proposition will be – and the less vulnerable it will be to new ‘over-the-top’ competitors.

For both Telstra and Foxtel, the worst-case outcome from the deal they have struck is that they lose fewer customers and/or earnings than they might otherwise have done. Telstra’s best case is that fewer customers defect to its traditional competitors and that it adds real value to its Foxtel interest. For Foxtel, the deal could add both customers and earnings.