Vodafone and CityFibre shake up British broadband

Homes in the Bellway Estate are directly connected to Openreach’s network of fibre-optic cables, which deliver the internet significantly faster than traditional copper. But Openreach, which was recently spun out of (but is still 100 per cent owned by) BT (BT.A), has failed to provide these connections to the majority of the UK. Although the company claims that 86 per cent of homes have access to fibre-optic broadband, most of these are reliant on ageing copper cables to carry the connection from a street cabinet to the owner’s home. This so-called fibre-to-the-cabinet (FTTC) broadband is just a tenth of the speed of fibre-to-the-home (FTTH).

The problem is that Openreach has a near monopoly in the UK broadband market. Liberty Global’s Virgin Media is the only other fibre owner with serious financial strength, while other providers include mid-cap CityFibre (CITY) and start-ups Hyperoptic and Gigaclear. This lack of competition means little incentive to invest in upgrading the infrastructure, particularly during a time when other divisions of BT have absorbed excessive amounts of cash.

Ofcom – the UK’s media and telecoms regulator – attempted to solve this monopoly by forcing BT to legally part with Openreach. And, to a certain extent, the split looks as though it may be having the desired effect: Openreach recently agreed to expand the FTTH network to a further 10m homes. But consumers will inevitably be forced to pay for that investment. Openreach has already tried to persuade the government to let it raise the wholesale prices charged to telecoms companies, such as TalkTalk (TALK) and Sky (SKY), which lease the cables to provide their own broadband packages. Higher wholesale costs are likely to more expensive contracts.

But now Openreach’s dominance may not be as clear cut as it once was. Telecoms giant Vodafone (VOD) and CityFibre have entered into a partnership that will see the latter provide full fibre connectivity to 1m homes in 12 towns and cities. Vodafone has committed to lease the lines off CityFibre for a minimum of 10 years and has been granted a period of exclusivity, largely during the construction period. With the financial might of Vodafone behind it, CityFibre now looks to be a credible opponent to BT and Openreach.

EY telecoms analyst Adrian Baschnonga thinks the deal is good news for the market as it will “accelerate the roll-out of fibre in the UK”. Ultra-fast broadband is considered important to the future of the country as it is necessary for 5G mobile networks and the 'internet of things'. For BT, the deal is not likely to be so welcome. With the landscape now more competitive, the group may not have such an easy time persuading the government to let it raise wholesale prices.

But the cost of fibre investment could yet unstick the deal. CityFibre thinks it will cost roughly £500m to fund the first phase of the operation, with each home costing between £350 and £480 to connect to the new network. But the group – which raised £200m from investors in March – is unlikely to be terribly popular with shareholders if it comes back to the market for another cash injection. One market expert speculated that Vodafone would help contribute to the upfront costs.

Meanwhile, Numis – which is advising investors to offload shares in CityFibre – thinks the company may have underestimated the costs of a major FTTH roll-out. The broker points out that Openreach is expecting to pay an average of 8 per cent more per property, while Virgin Media thinks that each home will cost £630 to connect. “CityFibre has overpromised and underdelivered before,” warns analyst John Karidis. Mr Baschnonga at EY doesn’t share these concerns. “CityFibre exists as the alternative to the incumbent,” he said. Therefore, development shouldn’t be too much of a risk.