BSkyB is counting the cost of the move into broadband but is not yet reaping the rewards.
BSkyB
(LSE: BSY)
has just started on the journey of the transition from a standalone Pay TV company addressing a £7bn market to an integrated communications company addressing a £25bn market.
Yesterday's interim results reflect the cost of the transition to shareholders (£400m over 3 years), but not the benefits (operating cashflow dropping from £514m to £365m.)
More worryingly for shareholders is that churn -- the proportion of customers who have left the service -- has actually increased to 11.8% rather than decreasing as originally envisaged. The medium-term target for churn is 10% and James Murdoch says this will be achieved in 2008. The increase in churn is due to Sky withdrawing retention discounts and the company thinks churn will be maintained at the 11.8% over the next couple of quarters before starting to drop.
I think the problem in this analysis is that I can't see competition lessening in the short or medium term. Rising churn pushes up subscriber acquisition costs, so it's vital that BSkyB keeps churn under control.
One of Sky's proudest boasts currently is that its LLU network (where Sky has access to local telecom exchanges) now has a larger footprint than the UK's cable TV network. Although this is welcome news, the more important figure is density in terms of customers per exchange and this is currently extremely low. I estimate the number of paying customers per exchange is around 252.
Therefore, it is really important to add paying LLU customers on these exchanges as soon as possible to reduce the broadband losses - the target for June is 700k customers. Sky has not revealed long term market share aim, but I believe that 20% is probably the minimum level at which reasonable profits will be achievable which probably equates to around 4m customers by 2010. This shows the amount of investment required in customer acquisition required in the long term.
Sky is also busy in investing in content with the investment in 365Media and MyKindaPlace likely to be repeated over the next couple of years with other online content companies. An important part of the Sky business model is gaining a share of online advertising revenues and this requires high usage of Sky owned properties which is growing fast but still in sub-scale. Sky also faces huge competition from the BBC who are offering advertising-free content which is extremely difficult to compete with.
The purchase of a strategic 17.9% stake in ITV for £946m is also looking expensive and was only worth £741m at the end of last year. This investment will be a big mistake if the UK regulators force BSkyB to dispose of the investment on competition grounds.
Long term, I believe the BSkyB strategy, however I am dubious whether right now is the optimal time to invest, given the competitive challenges in the short term and the need to quickly build scale in the communications business.
