Deep Fibre, Clouds And Airspace

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The FNArena Editor is still recovering from his injury. While recovery is steadily progressing, it is occurring at slower pace than hoped for. Which is why we repeat a story written by Greg Peel for this week's Weekly Insights. Let's hope Rudi will be able to resume writing down his regular market insights from next week onwards.

By Greg Peel

Mircowave specialist BigAir ((BGL))'s internet access is comparable to fibre cable.

This would seem to make the NBN a competitor, at least by the time fibre cable reaches everywhere it is expected to reach. This is not, however, the case. BigAir's wireless internet can fill the gap while a company awaits connection to fibre, but most of BigAir's clients use, or will use once fibre is connected, both. Just as buildings have a back-up generator in case the power goes down, or investment banks build whole back-up trading rooms in remote locations for use in the case of disaster, BigAir can provide a back-up high speed internet connection to supplement a land-based fibre connection which may for whatever reason be interrupted. The cost of interruption for most companies far outweighs the cost of the back-up.

BigAir also provides microwave connections as the easiest solution for more temporary structures, such as site offices on construction sites and press rooms at major sporting carnivals. But fixed corporate connections are the bread and butter, and alternative connections are becoming increasingly important as the corporate world moves into the cloud.

It was recently sent a newspaper article from Ireland, which reported on a speech made by a councillor in a particular Irish county which, like the rest of Ireland, has been suffering economically. The county should look to attract investment locally, he suggested, in two growing areas of technology – wind farms and cloud computing. For as we all know, he said (and this is not an apocryphal story), this county is always windy and nearly always cloudy as well.

Cloud computing is the new Big Thing although it's been around for some time, with Google's Gmail a prime example and offerings from the likes of iTunes also introducing the retail consumer to the concept. Quite simply, at a corporate level, cloud computing means keeping all files and file servers at a remote data management centre which becomes sort of one big offsite computer which can be accessed by anyone in the company through any means (computer, smart phone etc). Clouds save the cost of buying ever bigger servers and establishing complex intranet systems and overcomes the issue of having to transfer data to be available for access from one's phone etc.

Clouds are just another form of outsourcing. What clouds do imply, nevertheless, is a far greater frequency of internet access. Rather than installing expensive on-site systems which can be accessed by all employees in the building via the in-house intranet, a company uses an off-site cloud service with employees all accessing via the internet. When a company “goes cloud”, it will need to be damned sure of the integrity of its internet access. Were that land-based fibre, all one needs is for a guy in a fluoro vest to stuff up down a manhole and any number of companies can be offline for any number of hours.

Which is why the demand for BigAir's standalone wireless internet connections is growing – not as an alternative but as a parallel.

This growing demand ensures BigAir's microwave towers are fully employed during the day, even if they aren't actually being used. The typical working day means the towers aren't really earning anything much at night. At least that would be the case if not for BigAir's most recent push, into “community broadband”.

Once upon a time university share houses provided formative experiences for young students at an affordable rent. Today in Australia's major cities and university towns, cash-strapped students have been priced right out of the rental market. Even if three or four can afford the rent together, no landlord will pick a bunch of students out of the stack of applications. For this reason, and to accommodate the growth of the foreign student market, universities have themselves begun to invest heavily in low-cost student residences outside of existing university colleges.

For BigAir, the student share house of today – an apartment block of small rooms and shared facilities – is proving a major growth area for its high-speed wireless connections. Students can't afford to wait for fibre to arrive and even if it has, a disconnection episode could be equally as devastating. The economies of scale of BigAir's growing army of microwave towers means the company can deliver cheap high speed internet while not beholden to some government mandated national pricing scheme. This is perfect for the poor student who can enjoy internet access in residence on a prepaid arrangement.

The best thing about students is they tend to attend uni during the day, and then put in long hours on their assignments at night. While BigAir's transmitters were once idle once the sun set, now they are are buzzing 24/7. BigAir does not need to build more transmitters to exploit community broadband so it's all added margin.

And it doesn't have to stop at students. Retirement villages are increasingly calling out for internet access. Demountable mining villages which will never see fibre are an obvious customer. Construction camps for the country's resource sector and infrastructure mega-projects are another candidate.

BigAir is now the leading provider of internet access to the student accommodation market, acting as exclusive operator at some 120 locations representing some 27,000 students. Meanwhile BigAir's towers are now found in nine major Australian city and regional centres and the footprint is growing all the time. For each tower, additional customers provide increasing margin.

A month ago BigAir acquired Queensland competitor Allegro, which boasts dominant wireless coverage in South East Queensland and more recently in Mackay and Gladstone – the latter the home to the bulk of the state's coal seam gas and coal transportation industries. BigAir has the opportunity to significantly increase the margin on Allegro's existing infrastructure.

In FY11 BigAir reported $5.4m in EBITDA. In the first half of FY12 that figure reached $4.55m, and current FY12 guidance is for $9m. In a tough macro environment, BigAir's share price has risen from 24c last August to 37c today to a market cap of $57.5m.

Industry surveys in the US suggest that by 2015, 50% of all companies expects to operate the majority of their IT applications and infrastructure via the cloud. As the world becomes cloudier, reliable high speed internet access becomes ever more critical.

The cloud is just one aspect of a greater convergence underway between the once separate concepts of IT and telecommunications. Communications systems are being linked to IT frameworks, voice-over-internet is a clear convergence, and IT managed services rely more and more on communications networks. Data centres are growing rapidly and require unfettered access through varying means. For many in Australian business, the government's NBN is not a solution. While substantially faster than copper, the NBN fibre network, when it does eventually reach everywhere, will be fabulous for many applications but not as fast as other private sector solutions can provide.

Amcom ((AMM)) is an Australian company with a $260m market cap which owns and operates its own fast broadband fibre networks servicing the converging telco and IT markets. Amcom has connected Brisbane, Sydney, Melbourne, Adelaide, Perth and Darwin through a combination of owned and third party networks. The company provides internet access, data networks, data centres, hosted voice and video over internet, IT integration, cloud services and general managed services of all of the above.

While clouds offer the outsourcing of data storage and access, the convergence of telco and IT is also leading to greater outsourcing of company IT requirements to outsourced IT solutions providers and managers. If you outsource the system you might as well outsource the service as well.

To exploit the trend towards IT-as-a-service, Amcom recently acquired L7, which boasts 130 IT professionals servicing 200 corporate and government customers. The acquisition brings to 900 the number of Amcom corporate and government clients. Amcom operates on a split of direct sales teams (servicing 78% of clients), wholesaling to other telcos (12%), and reselling Amcom products through business partners under a “white label” system (11%). Resellers currently number 160.

Of Amcom's 78% direct clients, 52% represent corporates and 26% government. A high proportion of government clients ensures greater client retention and Amcom's general recurring billing relationships ensure largely annuity-style revenues. The first half FY12 saw strong sales growth across all product lines, with fibre sales up 45% on the first half FY11. Product offerings have been broadened, allowing for cross-selling, and the L7 acquisition has accelerated Amcom's cloud penetration. Amcom has continued to invest in FY12 for the next “step change” in FY13.

On a three year compound annual growth rate basis (CAGR), Amcom's revenues have grown by 31%, profit by 33%, earnings per share by 23% and dividends per share by 26%. Amcom shares have risen from 80c in September to around $1.10 today.

Now, there's fibre and there's “deep fast microwave connections can either substitute for or, in more cases back up, ground-laid fibre, Vocus' deep fibre still has to be laid in underground conduits to connect CBD addresses. It costs Vocus an average of $70,000 to connect one client, and that client's internet spend will only cover that cost. But one client means access to only one of 156 fibre pairs. For Vocus, the connection of the other 155 pairs in an already laid cable means free money.

Deep fibre and related ethernet networks are the fastest growing segment of the Vocus business. (In case you're wondering, the “internet” is your world wide web of global information sharing while an “ethernet” is the network of cables which connects your computer to the internet via modems, routers and other network devices.) Vocus owns and operates deep fibre networks in the CBD and metro areas of Sydney, Melbourne and Brisbane, provides carrier ethernet networks and managed ethernet services, and provides ethernet connection between Sydney, New Zealand, Singapore and the US.

When Vocus kicked off in FY08, its business was all internet. Vocus continues to operate Australia's largest wholesale internet protocol backbone (including voice applications) after Telstra and Optus with 21 points of presence (POP) in Australia, five in New Zealand, four in the US and one in Singapore. The company provides internet access to ISPs and telcos in all those international centres and, more recently, is now growing a direct internet offering to the corporate sector.

Through acquisition, Vocus also owns data centres in Sydney, Melbourne, Perth, Auckland and Christchurch. The company leases data centre units or private suites and sells bundled connectivity and data centre sevices. And what does this all mean? Clouds.

In the March quarter of FY10, Vocus' sales were all internet based. One year on, its data centre business was providing 22% of sales and fibre/ethernet 18%. In the last March quarter, internet had fallen to 31% and data centres to 18%, leaving 51% fibre/ethernet. In FY11, 4% of sales were to corporates and 96% wholesale. In FY12 that balance should come out at 18% corporate and 82% wholesale.

The lesson here is that while the wholesale business is bread and butter, direct corporate access to deep fibre and ethernet services is only just starting out on the demand curve. And cloud computing is clearly in its infancy as well.

Vocus expects FY12 revenue growth to be 45% over FY11, and earnings (EBITDA) to be 63%. The figures are indicative of the scalability of Vocus' margins on its infrastructure spend. From FY10 to FY11, revenues were split as 54% for internet, 29% for voice, 9% for data centres and fibre/ethernet was only beginning. From FY11 to FY12 (estimated), internet will represent 45%, voice 21%, data centres 18% and fibre/ethernet 14%. Fibre/ethernet revenues are expected to have grown by 186% over the past year.

Vocus will continue to focus on growth in its now more traditional offerings of internet and voice, and is also on the hunt for acquisitions. Meanwhile, the company's enviable revenue and earnings growth is being fuelled by the expanded suite of offerings allowing customer access to a range of complementary products. In the March quarter FY10 Vocus' customer numbered 103. Last March quarter they numbered 363.

At the beginning of FY12 Vocus Telecom shares were trading around $1.30. Today they are at $1.94.

(This story was originally published on 26th June, 2012. See Sell&Buy-ology category on the FNArena website)

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