Shares in BT Group PLC (LSE:BT.A) fell sharply following reports that its dominance in the broadband market is set to be challenged by a deal between Sky and Virgin Media (NASDAQ:VMED) O2 (VMO2).
According to a report in the Telegraph, Sky is nearing an agreement to become a co-investor in VMO2’s full-fibre broadband roll-out. The companies plan to upgrade 14 million homes and businesses to ultrafast broadband, the report said, which would significantly increase competition for BT’s network Openreach.
VMO2 is also holding separate discussions with TalkTalk and Vodafone about wholesale access to the VMO2 network, the report said.
Analysts at broker UBS said a deal between Sky and VMO2 would put pressure on Openreach’s market share and wholesale rates, with Sky the largest external customer for BT/Openreach as it spends an estimated £760mln a year on broadband wholesale fees for over 6mln broadband subscribers.
Although a Sky-VMO2 deal is reportedly focused on existing cable footprint, UBS said it believes VMO2 would also be interested in partnering with Sky on footprint expansion.
VMO2 has already said that it intends to increase its UK coverage to 80% from 50% at present by expanding its footprint by 7-8mln homes.
BT/Openreach could lose over £600mln of “very high-margin revenue” if Sky and VMO2 enter into a cable wholesale/fibre joint venture, according to UBS. Openreach currently generates £3.1bn a year of EBITDA and UBS estimates the downside could be over 30p per BT share.
“The risk for BT/ Openreach is that a significant portion of Sky’s wholesale revenues are transferred away and that Openreach sees lower wholesale share in an expanded 7-8 million FTTP [fibre to the premises] footprint by VMO2,” UBS said.
The scenario of Sky-VMO2 co-invesment threatening Openreach has been much debated, said analysts at Jefferies.
“With two large ISPs committed, might a Sky-VMO2 network attract an infra investor at a valuation that would unlock a lot of cash?" Jefferies pondered, saying it would not rule out the two company's main backers prioritising this scenario over long-run prospects of a retail business that would be “undermined" by wholesale.
But Jefferies said there were “strong reasons" for Sky not to make an investment commitment to VMO2.
“It is logical for Sky to develop dual-sourcing for w/sale access. But what the Telegraph points at is Sky co-investing in a JV, the perimeter of which is not described but might logically be the VMO2 network between Level 3 cabinets and home. For such an investment to create value, Sky would need to commit as an anchor tenant," the analysts said, citing four reasons not to do that, including the cost and time to deploy and the risks its exitsting retail business.
BT shares were 6.8% lower at 148p in morning trading.