Paying Wayne Rooney’s salary

 

By Simon Woodhead

I’m not a football fan, but I know others are. It doesn’t really matter either way though because if you consume telecommunications in the UK, you’re paying for it!

When Ofcom applies charge controls to an operator, because they have concluded they have ‘Significant Market Power’, they often do so using the LRIC economic model. 

LRIC stands for Long Run Incremental Cost. It is not the average cost per minute of, say, a phone call, it is the incremental cost of adding just one more minute to your network assuming current technology and improving efficiencies over the life of the charge control, often using a hypothetical network as a reference. It takes no account of many real world costs and amounts to basically nothing unless written in Scientific Notation.

Where we depart from that principle is often charge controls featuring the former monopolist who have some products set with reference to strange parameters – for example, assuming that all copper and duct is replaced over x years when they sweat them for y or longer. We won’t go as far as saying Italian accounting scandals are included, but expensive sports rights, we feel confident throwing in the mix. 

What!? Sports rights?

At a headline level, BT Sport launched in 2013, not long after the controversial award of £1bn of funding for broadband network upgrades. It could be coincidence…

BT Sport is a strategic ambition of BT’s and they’re entitled to them. They’re no longer tax-payer owned, which I support, and competing in a free market, albeit with a lot of help through their Crown Guarantee on pension liabilities amongst other things. In my view they can do with their money, what they like, to deliver long-term value for their shareholders. If that includes BT Sport, fair enough.

And they’ve been busy. According to Wikipedia

“BT Sport holds exclusive live UK and Republic of Ireland TV rights to 52 Premier League matches per season, all Australia’s home cricket matches, the UEFA Champions League, UEFA Europa League, UFC, National League, Ligue 1, the Bundesliga, the FA Community Shield, the FA Trophy and the European Rugby Challenge Cup, the Premiership Rugby Cup, MotoGP, the FIH Hockey World League and WWE. They are also the official broadcast partner of the European Rugby Champions Cup and Premiership Rugby. BT Sport also holds shared rights to the FA Cup with the BBC until 2020–21, the Scottish Professional Football League with Sky Sports and BBC Alba.”

Wow, they must have cost a lot of money. I cannot find a comprehensive list but they paid £1.2bn in 2019 for the Champions’ League and in 2020, facing tough competition from Amazon, shared a £4.5bn bill with Sky for the Premier League. Whilst these are the flagship rights, the others are not free as most sports now depend on TV rights to exist. What therefore would be a reasoned estimate of BT’s spend on sports rights? Is £1bn a year too conservative? Hopefully Ofcom knows. In 2020 they made £1.7bn of net income, so it is a huge percentage (£1bn=58%) wherever it ultimately sits.

Why do I care? I’m not berating Sky or even Amazon here (but let’s face it neither are above criticism!). And I don’t even like football.

Well, remember those price control calculations? They include the Weighted Average Cost of Capital (WACC), which whilst more encompassing than the rate of debt interest could simply be viewed that way – it is the return all providers of capital, be it debt or equity, require to offset their risk. In 2013/14 BT commissioned research to argue against Ofcom, and that research made the case that BT’s WACC was 10.3-10.8%. Market statistics suggests it is closer to 7% today, but I’m pretty confident they’d still argue it was higher.

So in short, the higher the WACC BT convinces Ofcom of, the higher the controlled prices they can impose. In theory, a utility company or a monopolist should have a low WACC – they should be a safe bet for investors and lenders offering a low risk steady return. If you were to do a comparison of WACCs, you would see this play out – luxury brands have high ones due to their intrinsic risk associated with the fickleness of consumer confidence and overall market strength – historically the lowest I’ve ever heard of was British American Tobacco – because everyone still smoked (back then) 20 a day regardless. 

Without going into a lecture on economic theory, BT (especially with Openreach) should have a low WACC – close to that of a utility monopolist. It also has that multi-billion pound Crown Guarantee underwriting its pension fund to boot, giving investors even more confidence. 

In theory. 

Unfortunately, in reality, BT’s credit rating is near-junk, it is highly leveraged with debt at 211% of of its equity …. So does it present a higher or a lower risk to investors when it spends possibly 58% of its annual profits on sports rights? That very same risk which flows through to the WACC calculation?

The answer to that depends of course on what they do with those rights – they could conceivably reduce risk if very profitable – but considering their return on investment for the whole business in the last 12 months amounts to just 3.61% we can take a reasoned guess. I’d therefore suggest that their sports rights endeavours result in higher WACC than had they instead made efforts to reduce debt or invest in other needy areas of the business. 

We also have to ask why they’d choose sports rights. Well, strategically investing in TV gives them competitive advantage over other operators and enables them to bundle sport with their retail propositions, make their offerings stickier to end users and grow their margin on voice and internet bundles. That makes sense, especially if your competitors pay for it! Why instead would they invest to make service better for competitors, or reduce their debt mountain, or surrender the Crown Guarantee?

So, pulling all that together, we have a market that has a disproportionately high view of risk associated with a former monopolist than it should – perhaps the market has a less than rosy view due to BT’s diversification into TV? It wouldn’t be a problem, but a regulator that takes that same risk, and incorporates that into what it allows BT to charge its competitors for certain products would be funny if it weren’t true. 

In other words – BT’s competitors, including Sky, are contributing to BT’s acquisition of TV rights. 

However, the Irish are a lot more canny – when Eir’s WACC started to diverge from what should be expected from a utility monopolist, ComReg, the Irish regulator, moved to use the hypothetical WACC of such an operator. Thus, Ireland’s regulation became divorced from the (potentially unrelated) strategic decisions of the former incumbent. 

I hope you really like football!