Value. Unlocked

There are three levels to Value. Some businesses create value by transforming their inputs into valuable outputs for their customers. Other businesses capture this value by building on top of this output and turning it into a profitable stream of cash flows. Very few of them are able to do both. As the saying goes, even if you create the pie, does not mean you get to divide it.

We’ve witnessed similar dynamics in the world of technology. Telcos, the original creators of the pie back in the 90’s and early 2000’s, built these vast barriers to entry in the communications services business by continuing to invest billions in fixed and mobile connectivity networks. They captured a decent amount of value they created initially when the world was introduced to the Internet. However, their share of incremental value capture has been on the decline for more than a decade since we started to move towards faster connectivity and network technologies, mobile, social, and digital applications. Trust me, their shareholders can tell.

Almost all of the value has been increasingly captured by technology giants that dominate the ecosystem now, by building on top of the “Digital superhighways” laid down by the telecom operators.

Diminishing investment returns

European telco groups have invested more than EUR500bn over the last decade to upgrade their network infrastructure in the last decade. Financially, they have not been able to capture much value and the difference between their market-cap as compared to other tech companies is stark. Total shareholder returns lagged massively and re-investment needs in the business have remained high.

As we moved from basic internet access to high-speed access, higher capacity mobile networks and complex applications, the underlying products and services which telcos provide became increasingly commoditised. Fundamental growth in the business has been hard to come by and additional value created at each new technology inflection point has been captured mostly by other tech giants.

A classical definition of value creation states that you must earn returns above your cost of capital consistently to be able to reinvest at higher returns. For telcos, the ROIC – WACC (the difference between return on capital and its cost) has been consistently falling and is now barely higher than the cost of capital. Given that it is a regulated industry, telcos have had to invest billions in Capex for their network infrastructure with increasing competition and have been unable to offset any of it with higher pricing.

Unsurprisingly, the sector has lagged most other major sectors in total shareholder returns.

Now that the cost of capital is on the way up, and you cannot create and capture enough value anymore, you might as well try and unlock it.

Find more in my latest on the Atomic Investor blog: