TEACHING NOTE:

Strategy and Technology in Telecoms: Digicel Withdraws IPO

Synopsis

Taking advantage of the deregulation in telecommunications sector in the Caribbean, Digicel entered the Jamaican market in 2001. Digicel quickly usurped the dominance of the incumbent, Cable and Wireless, in the mobile segment of the market, using a strategy of affordable phones and a user-friendly approach to mass marketing. This strategy was used to enter other small under-developed markets in the Caribbean and Central America and so, challenge the incumbent by competing aggressively on price. In 2014, Digicel commenced a strategic change, with an evolution from pure mobile to becoming a communications and entertainment provider. Price competition in its most lucrative segment (mobile) saw revenue plummet; competition from non-traditional players and existing competitor C&W strategic acquisition of a leading cable/ internet provider forced the change in strategy.

Digicel’s founder and chairman, Dennis O’Brien, raised equity by issuing an initial public offering (IPO) on the New York Stock Exchange (NYSE). O'Brien surprised observers when he cancelled the IPO days before the shares were to be listed on the NYSE. This created a strategic conundrum for O’Brien which was exacerbated when it was announced that Liberty Global, had agreed to acquire Cable and Wireless Communications plc (CWC), C&W parent company, for US$8.2B1. O'Brien’s expansion strategy was now in jeopardy. The evolving market, the IPO that was required to fund the new strategy was aborted and its main competitor was now awash with cash. Digicel needed to pivot quickly, but how?

Research Methods

This case was developed entirely from public sources, relying heavily on Digicel’s submission to the United States Securities and Exchange Commission. Other sources included newspaper articles, annual reports and company web site information.

Teaching Objectives

The Digicel case provides students with an overview of the growth of a privately held cellular company, owned by Denis O’Brien that had expanded by acquisition, primarily in the Caribbean. The market was undergoing both convergence and disruption simultaneously. Digicel decided to launch an IPO to support its business expansion strategy. The case may be taught to final year undergraduate and graduate students in Telecommunications, Investment and Strategy. Specific learning objectives of the case include:

1. Evaluate Competition in the telecommunications industry2. Understand convergence, innovation and disruption in the telecommunications and cable industry3. Examine the use of dual class shares to fund technology companies4. Understand governance and connected companies5. Study the key industry indicators in evaluating investments in a telecommunications company6. Evaluate strategic options

1 The Gleaner: Liberty Global to Acquire CWC in a US$8.2b deal

Assignment Questions

1. Evaluate the competitive position of Digicel, using Porters Five Forces Model.

2. Convergence and competition from other industries, including (Internet Protocol Television (IPTV) and over-the-top content (OTT) threaten the viability of telecommunications and cable companies like Digicel, how should Denis O'Brien respond to this threat?

3. Digicel IPO proposal offered dual class shares, similar to Google LinkedIn, Groupon and Facebook IPOs. Evaluate how the ownership structure of Digicel would change if the IPO was successful. Discuss the polar views on dual class shares.

4. Key telecom industries indicators may be used to better understand a company's revenue model, and to determine a company's relative valuation. Use the following key indicators to evaluate Digicel:

Key Indicators

Average revenue per user (ARPU) Churn and net additions Subscriber mix: prepaid versus postpaid Smartphone penetration Debt repayment capacity Valuation: price to earnings (PE), price to free cash flow, enterprise value to earnings before

interest, tax, depreciation and amortization (EV/EBITDA) and price to cash flow.

5. As a potential investor interested in technology stocks, and, based on the above evaluation, would you have purchased shares in Digicel?

6. Based on the aborted IPO and the dynamism of the industry what strategy should Denis O'Brien pursue?

Suggested Background Readings

“An investor’s guide to the US telecom industry”: http://marketrealist.com/2015/01/overview-us-telecom-industry/

“Unequal shares”, Surowiecki J. (2012) The New Yorker: http://www.newyorker.com/magazine/2012/05/28/unequal-shares

Suggested Teaching Approach

The teaching plan may vary, depending on the length of the class session, student educational level and exposure to information systems. Instructors should provide students with the teaching case prior to the class. Students may be placed in groups (preferably five per group) and questions distributed across groups.

For question 1, students should be asked to explain each of the factors of Porter’s model and consider the factors in relation to the telecommunication industry, and then discuss those that are relevant to Digicel.

For question 2, students should be asked to discuss the pervasiveness of OTT and IPTV, and debate whether they threaten the viability of telecommunications and cable companies like Digicel. The instructor may ask students to consider not only how these technologies pose a threat, but also how they may be conceived of as an opportunity for the telecom industry. After considering the threat, the technologies pose and the opportunity that they can offer students should be asked to brainstorm the options that Denis O’Brien has.

For question 3, students should be asked to explain the concept of dual class structure, how it works, and the impact it has on voting rights, control, etc. Having understood the concept of dual shares, students should be asked to discuss arguments in support and opposition of dual class shares. In considering the pros and cons, students should discuss how these would affect the manner in which Digicel operates in terms of ownership structure, control, governance, etc.

For question 4 and 5, students should be encouraged to read, prior to the class, “An investor’s guide to the US telecom industry”, and discuss the different indicators. Students should then be asked to evaluate Digicel accordingly, and make an informed decision about whether they, as investors, would purchase shares in Digicel. In making a decision, students should be encouraged to compare the indicators with those of LIME and other telecom operators that the case provides.

For question 6, students can consider using a TOWS matrix as their analytical tool. This would however require a SWOT analysis to be done. A SOWT can be created based on aspects Porters Five Forces and the financial analysis. An alternative or complementary approach is an evaluation sing the Boston Consulting Group (BCG) matrix. Based on the decided strategy a funding strategy should be determined.

*In analyzing the case, students may opt to use alternate approaches of SWOT, PESTEL, Industry and Competitive Analysis.

Teaching Plan/Questions Discussion

1. Using Porters Five Forces Model, evaluate the competitive position of Digicel.

The Porter’s Competitive Model provides a general view of a firm, its competitors and the firm’s environment. Students may apply the Porter’s Five Forces model to analyze Digicel’s competitive environment. In doing so, students must first define the industry. While Digicel traditionally concentrated on the mobile segment, the case shows that Digicel was moving into other services such as cable and broadband services. Students should consider the five forces of competition as applied to the telecommunication industry. Pointers for the analysis are provided below.

Threat of new entrants

For this aspect, students should understand that they need to investigate the industry to assess the ease of access to the industry is It is important to determine if new investors, interested in the telecommunication industry, would encounter barriers or difficulties when trying to open new businesses or acquiring existing ones. The presence of significant barriers to entrance will protect the existing companies from new competitors, and it is generally considered an indicator that the industry is profitable. The instructor

may engage with students to consider the factors relating to entry that play a role in the telecom sector. Some of these factors are discussed below

Factors relating to entry

Capital Requirements: The telecom industry is a capital-intensive industry, therefore one of the biggest barriers is access to finance. Students should consider the high cost associated with licensing, setting up and maintaining infrastructure, network coverage and technology devices. Network operators tend to face significant barriers to entry because of the high capital overlay needed to invest in the necessary infrastructure. Students should note that the investment is not only for the first time the firm breaks into the industry, but there is also the fixed cost associated with maintenance every year. However, students may note from the case that the strategy some companies use is to enter small underdeveloped markets where telecoms networks could be built out relatively cheaply to enable the new entrant to aggressively compete with the former monopoly/incumbent on price. This strategy, as the case highlights, was replicated as Digicel expanded into the Caribbean and Central America.

Students may also discuss how the deregulation of the market, and the Basic Agreement on Trade in Telecommunication Services (BATS) provided a significant reduction in barriers as the new entrants did not need to own their networks. For example, they may pay the infrastructures' owners - which are the governments or the already existing telecom companies, and use the existing infrastructures to offer services. This is a trend among new entrants in the telecoms market. However, new entrants would need to establish business relationships with incumbents, which normally require long-term relationships involving high volumes and money, which a new enterprise, probably of small-medium size, could have problems in guaranteeing.

In addition, students should note that besides cost associated with building up infrastructure, a new entrant has to spend money to acquire new customers, which may include handset subsidies, marketing, advertising, and promotions. An incumbent with an established base of customers has to spend less on acquiring new customers than a new entrant. Also, students may discuss how mergers and acquisition may be seen as a conduit to enter the market, requiring less capital requirements (in terms of infrastructure) and providing access to an already existing customer base. The case provides a prime example of this, where Liberty Global acquired C&WC as a means to enter the market.

Lastly, students may also argue that technological changes could provide impetus to the significant reduction of barriers; for example, internet telephony offers a way for several firms to enter the market and compete with the incumbents without the significant upfront fixed costs.

Declining average revenue per user (ARPU): For telecom operators, ARPU is a useful measure of growth performance. With the market maturing, and in many countries reaching saturation, ARPU for data services has been increasing slowly or, in some cases decreasing Coupled with this is increased churn rate (percentage of subscribers to a service that discontinues subscription to that service in a given time period). As evidenced in the case, both Digicel and C&WC are experiencing patterns of decreasing ARPU and increasing churn rate. Therefore, this can offer a challenge to new entrants as they may have to manage their bottom line with anticipated decrease in ARPU.

Switching Cost/Brand Loyalty: Switching cost is the likelihood of customers moving from one supplier to another. Students should note that new entrants must take into account the switching costs of customer, and some markets have high switching cost and heavy services fees. Furthermore, a characteristic of the mobile Caribbean market is the use of multiple SIM cards, which may suggest that customers may not necessarily ‘switch’ but instead be open to using more than one operator. Also, customers may have established brand loyalty, or may prefer to stick with the incumbent that has been “tried and tested”. Brand identification creates a barrier by forcing entrants to spend heavily to overcome customer loyalty. Therefore, switching cost and brand loyalty may pose a challenge in retaining customers, which may create barriers to entry. Therefore, the high overheads (discussed earlier) coupled with aggressive competition within the market, form high barriers to prospective entrants. Students should also consider the role churn rate plays, as increasing churn rate will make it more difficult for a new entrant to attract new customers and retain existing customers.

Restrictive government policy: Students should note that the trend is that telecom operators are more and more controlled by regulations which impose on them, for example, maximum price rates and minimum quality levels. Despite the fact that the industry no longer has government-controlled monopolies, and telecom operators tend to be private, governments still have a ‘golden share’ in the incumbent companies. The case discusses that the licensing, construction, ownership and operation of telecommunications networks, and the grant, maintenance and renewal of telecommunications licenses, as well as radio frequency allocations and interconnection arrangements, are regulated by different governmental authorities in each of the markets that Digicel serves. Also, the case shows that interconnection rates, and primarily mobile termination rates in the telecommunications industry worldwide, are following a downwards trend, with many regulators moving towards regulating the setting of interconnection rates based on the putative cost of providing such interconnection services. This trend towards lower interconnection rates has largely been adopted or is being adopted in the markets in which Digicel operates. Regulators in the each of the markets where Digicel operates have reduced, or are considering reducing, interconnection rates. This may serve as deterrent to new entrants.

Threat of Substitute Products and Services

In this context, students should note that identifying substitutes involves searching for other products or services that can perform the same function as the telecommunication products or services offered by Digicel. The case highlights that Digicel was considered a pure mobile telecommunications company, but had expanded its product offerings through developing its Business Solutions services and entering Cable TV and Broadband businesses. Also, students should note that although Digicel had not yet entered the fixed-line market, their entry was expected to be through cable, where landline would be offered as part of a package. As such, students should discuss threat of substitutes to the array of products and services offered or planned to be offered.

Students will most likely argue that the direct substitute of traditional wireline telephones would be the wireless cellphone communication, and its strength as a substitute. Discussions may be raised about whether Digicel should enter the landline market. Students may draw on C&WC data in the case which show that fixed line contributed 20 percent of total revenue, with a decline in ARPU from $29.6 in 2014 to $28.4 in 2015. Students may question whether fixed line is a viable substitute product.

Several substitute products and services to fixed-line telephony have emerged as a result of technological breakthroughs, and these substitutes also threaten the mobile product and services. With the emergence of internet, many forms of internet voice communications services have become popular, like VOIPs, Skype, Viber, and Whatsapp. For Digicel’s cable TV, the internet has become a big substitute, as people can stream TV shows, news, and podcasts directly from any device that has internet connection. For this reason, the number of cable subscribers is also declining. Instructors may therefore encourage discussions/debates about whether the Internet could provoke serious damages, as a substitute product, for some of the services within the array of products and services offered by Digicel.

This analysis for threat of new entry is indicative of the dynamism of the telecommunication industry. For traditional players the barriers to entry are high, however for over-the-top services the barriers are less stringent.

Bargaining Power of Suppliers

Digicel, like many other cellular service providers, obtain its supplies from three sources: (i) Original Equipment Manufacturers, (ii) Infrastructure Hardware providers, and (iii) Content providers, aggregators and developers. The case makes explicit mention of handset manufacturers, and, as such, students may focus only on that type of supplier. However, instructors should ask students to also consider and identify Digicel’s other suppliers. In Digicel’s case, the power of the supplier is considered high:

1. Original equipment manufacturers (OEM) of handsets. These are giant corporations with which Digicel would not have much leverage. The case states that both Digicel and LIME use Ericsson as their principal network equipment provider, in addition to Huawei and Alcatel. Supplies of handsets were sourced by both companies primarily from Alcatel, Microsoft, ZTE, Samsung, LG, Sony, Blackberry, Huawei and HTC.

2. The infrastructure component includes base stations, switching equipment, antennas and towers. Activities in the infrastructure sector involve installing and maintaining the extensive network, as well as supporting the design, construction and installation of the infrastructure. The mobile network operators own the infrastructure, but tend to outsource its maintenance. Among the major providers of infrastructure hardware products are Ericsson, Nortel and Nokia.

3. The relatively new sectors of content providers, content aggregators and program developers are growing in importance. Content providers develop and provide information and entertainment on mobile phones and other products/services that require content. Content aggregators typically manage multiple content providers and supply services such as sourcing, reporting, formatting for multiple streams, quality control and cross-referencing. Program developers design new applications that can create further market opportunity for content providers and aggregators, as well as other program developers. Students should also consider the array of products and services that Digicel offers, how content plays a role, and the bargaining power of suppliers for each sector- providers, aggregator, etc. For example, the case discusses Digicel’s move towards cable TV, and highlights that an important subset of cable TV was the competition for content. It also makes mention that neither Digicel nor C&WC produced content, and, therefore was

dependent on their ability to access an attractive selection of television programming from content providers.

All three set of suppliers have considerable influence on the cellular service provider, hence the power of the supplier is considered high.

Bargaining Power of Customers

Switching costs and network effects can bind customers to vendors if competitors’ products are incompatible. Students may contend that consumer switching costs are low, since all phones use SIM cards and consumers are not locked in to long-term contracts. However, the situation is not as simple. Digicel’s market dominance may lock in customers and create switching cost. A characteristic of the Caribbean mobile market is that customers tend to subscribe to multiple networks, making on-net calls with each phone, instead of switching networks. By 2010, Digicel had more than 2.2M Jamaican customers (in a country with a population of 2.8 million), giving it a Jamaican mobile market share of approximately 76%. With an island-wide network of more than 1,000 cellular towers spread across all 14 parishes, Digicel had firmly established itself as the mobile provider with the premier network coverage across the country. Furthermore, with Digicel’s market share at approximately 76%, a size that might convince a customer that they need not continue to buy a separate prepaid SIM card to call friends who are on LIME. Instructors may ask students to consider network effects and how this plays a role in the bargaining power of customers. With network effects, the utility of a service to customers increases rapidly as more customers start using it. With Digicel having a larger market share than its competitors, customers may prefer Digicel, therefore lowering the bargaining power of suppliers as with network effects it increases customers’ willingness to pay for a company’s products and services.

The availability of a many operators allows users to assert their preferences and show their disapproval by switching services. Low switching costs translate into strong bargaining powers. Although the case does not mention mobile number portability, students may discuss how they think that bargaining power of the customer can be strengthened by number portability. However, students may also discuss how network operators can lock their customers in by contractual agreements, under which the latter cannot terminate the former’s services within a stated period of time. The instructor may also encourage discussion about the effectiveness of such ‘lock-in-tactic’ with the rise of prepaid subscription.

Students may also contend that, with the increasing choice of several technologies and means of communication available, the importance of voice services may be diminishing as customers have access to other means like Facebook, instant message, Skype, etc. The bargaining power of the customer is high and continues to grow.

Competitive Rivalry

The case highlights the products and services offered by the two operating telecoms in Jamaica and in the region. Unlike Digicel, C&WC was a full-service telecommunications provider, offering quad play - landline, Internet, entertainment and cellular service. Digicel operated in 21 markets, C&WC in 16 markets, and both competed in 14 of these markets. The nature and level of competition in these markets

varied for each of the product and services offered. However, the strategic approaches by both companies were generally the same, even if the nomenclature was different.

Students should note that competition intensified with Digicel’s acquiring Claro, and would further intensify with Liberty Global acquiring C&WC. Instructors may encourage discussions about how, and if, C&WC would be better positioned in the market, given that Liberty Global was the largest cable television company in the world.

Students may argue that there was high competitive rivalry because of the maturity and undifferentiated nature of the product. Rivalry is intensified when firms are competing for a greater market share in a total market where growth is slow or stagnant. This was the case in the Jamaican market, which could be described as saturated, with cellular penetration at, or above 100%.

When rivalry is intense, competitive actions might take the form of price competition, advertising battles, sales promotion campaigns, introducing new products for the market, and/or improving after sales service, or providing guarantees or warranties. This case provides example of some of these actions. Students should be prompted to offer examples of same.

2. Convergence and competition from other industries, including IPTV and OTT, threaten the viability of telecommunications and cable companies like Digicel, how should Denis O'Brien respond to this threat?

Global trends suggest that telecom and mobile providers should evolve their core businesses to provide new services to attract new customers and retain existing customers. Previously, telecom companies regarded threat from OTT and IPTV as negligible, however, that perception is now changing as OTT and IPTV providers offer more sophisticated and innovative solutions.

Before examining the question, instructors may ask students to define and explain IPTV and OTT. In discussion about IPTV, students should note the difference between IPTV and Internet TV, so as to ensure that they are not using the terms interchangeably. Students may also discuss several OTT and IPTV providers and the products/services they offer. For example, in terms of OTT providers there is Fring, Tru and Mig33, Skype, Google Voice and WhatsApp that offer mobile VoIP and/or web-activated business.

Instructors may also discuss with students whether they believe the IPTV and OTT are real threats to telecom operators.

Based on reports in the telecom arena, it is evident that telecom operators must develop strategies to respond to OTT and IPTV presence. With reference to trends in other markets, students may discuss a number of options that Denis O’Brien could apply in dealing with threats from OTT, and the merit of each option:

1. Prohibit use of mobile OTT: A number of market leaders have banned the use of mobile voice OTT. However, there has been a shift in this strategy, with market leaders that had originally prohibited usage are now exploring new revenue models. For example, T-Mobile and Vodafone

Germany have lifted the ban and, instead, imposed a surcharge. Students should note that the telecom players’ response to OTT tends to depend on the strength of their leadership in the local market. For instance, O2 allowed OTT use with data plans in Germany, but has banned its use in United Kingdom, another market in which they operate. This suggests that the stronger the market leaders’ position, the more prohibitive they may be in their response to OTT. Digicel which operates in multiple markets, would have to assess its strength to determine if prohibiting use of OTT would drive away customers. Students may also discuss the role of regulators in Jamaica in supporting and/or facilitating the ban. In the Middle East, for example, many governments have blocked Skype.

2. Adjust pricing structures: Some telecom operators have implemented structured packages to offer customers larger bundles of texts and minutes

3. Build a bespoke OTT application: Some telecom operators have launched their own OTT services. Proponents of this approach argue that telecom operators can offer a better OTT application than an independent OTT player, on the premise that operators can offer an existing billing relationship, trusted brand, large customer insight and an extensive customer base with which to market. Examples of operator OTT apps include Bobsled (T-mobile) and TuMe (Telefonica). Operators that have launched their own OTT app have used the approach to launch first and monetize later, so as to capture a share of users.

4. Partner with an established OTT player: Some telecom players (for example Sprint, T-Mobile) have seen the shift as an opportunity, and have entered the OTT market by partnering with OTT players as a means of differentiation and also of strengthening their market position. For example, “joyn”, the Rich Communication Suite which includes multimedia call and messaging option, is to be offered by operators such as Vodafone, SK Telecom, Telefonica/Movistar. Other examples of partnership include Skype/Three and Google Voice/Sprint. Students should note that while partnership is attractive, as it requires less capital investment from the operator, it can create conflicts over ownership, especially with the co-branding model.

Telcom players that apply options 2, 3 and 4 are those that see OTT as an opportunity to enhance customers’ experience, broaden the array of services that they provide, better position themselves as an innovator, limit risk and investments in content production, and extend their market reach

For IPTV, the arguments presented by the students may be similar. For example, some telecom operators are embracing IPTV (that is, offering it as part of their suite) as a means to help them transform from traditional telephone service providers to multimedia content suppliers. It can be seen as a way to expand their services without major infrastructural investments. Industry experts argue that this is an opportunity, especially with the demand for traditional voice-call services reaching a bottleneck. Some operators are launching their own TV, delivered either on fiber or by way OTT applications. For example, Cellcom Israel recently launched an OTT TV and Video on demand service that offers customers access to premium movies from major Hollywood studios such as NBC Universal, along with other channels, on a monthly subscription plan. Other operators, such as Telstra in Australia, are expanding their IPTV services with Video on Demand features, and are launching OTT TV services to allow their IPTV channels and content available over the Internet.

Discussions may be raised about whether Digicel’s movement to offer cable TV is strategic, given the rise of IPTV where some households are doing away with their TV in favor of streaming on their smart devices or purchasing streaming devices to bring content on their phones or computers to their TV sets, or do students think that IPTV offers no threat to Digicel. Alternatively, should Digicel also offer IPTV as part of their service pack?

3. Digicel IPO proposal offered dual class shares, similar to Google LinkedIn, Groupon and Facebook IPOs. Evaluate how the ownership structure of Digicel would change if the IPO were successful. Discuss the polar views on dual class shares.

Instructors should ask students to explain dual-class structure and how it works. Dual-class structure allows insiders to hold common stock with multiple votes per share, while the public holds common stock with only one vote per share. Andrew Hill, a columnist from the Financial Times, has been often quoted as he his shared the conundrum facing an analysis of dual class shares:

The advantage of a dual class share structure is that it protects entrepreneurial management from the demand of ordinary shareholders. The disadvantage of a dual class structure is that it protects entrepreneurial management from the demands of shareholders.

There are ongoing debates about the merits and drawback of dual-class structure. Students should discuss both views. Some arguments in support of and opposing dual-class structures are provided below:

Arguments in Support

- Founders or management have a legitimate need to maintain control of the strategic direction of the company. With a dual-class share structure, management has no concern with their control over the company being diluted. By placing voting control in the hand of management, it allows managers to focus on value maximization, for example moving forward with risky projects, without extensive concerns about temporary fluctuation in share value. A Dual class structure reduces the risk to management that shareholders may end their employment, or sell shares to a purchaser of control who may in turn change the company’s business/strategic direction.

- Dual-class structures can help and protect companies against unwanted takeover attempts. The effectiveness of dual class as a takeover defense is widely accepted, as collective action problems inhibit many shareholders from acting in concert, thus dampening their negotiation power. For this reason, internet or technology companies tend to highly value dual class structure because it contributes to innovation that would unlikely generate short-term benefits but, instead, bring about “better future lives”

Arguments in Opposition

- Dual class can lead to management entrenchment, as such structure is argued to eliminate market checks on managerial misconduct. Also there are arguments that dual-class shares structure enables insiders/management to increase their own benefits and may enjoy higher compensation levels because of the strong anti-takeover defenses that the structure allows.

- Dual-class structures increase the risks that insiders may pursue underperforming projects or acquisition owing to lack of shareholder accountability. This, in turn, may weaken insiders’ incentives to better serve their shareholders.

- Dual class structure promotes lack of governance and accountability. Some principles to be considered when thinking about corporate governance issues broadly, according to Scoot Goebel of Fidelity Management & Research Co. are: (1) can we align management and the board’s incentives with the shareholders, 2) can we create accountability both with respect to management to the board and board to shareholders, and 3) are there going to be appropriate disclosures to shareholders of the relevant governance issues? It is argued that with dual-class structure, there is less likely to have alignment and the accountability that exist in a single-class stock structures owing to the disconnect between the economics and voting authority in the dual-class stock structure.

In evaluating how the dual-class structure would change Digicel, students should discuss the current management structure of Digicel. They should note from the case that there was stronger insider control, and implementation of dual-class structure would not fundamentally change who “calls the shots”. Some argue that accountability to shareholders is at least mitigated, if not completely eliminated, in some dual-class structures by the ability for management, through the exercise of super-voting rights, to have a much greater sway over how directors operate. Therefore, this prevents shareholders from exercising any, or only minimal control over Digicel.

The instructor should also raise questions about the governance at Digicel, given the multiple-owner affiliated companies supplying Digicel with goods and services. Would the dual-class structure change this? Could shareholders question this type of operation, with arguments that the company may not be operating in shareholders’ interest, as the owners may be double dipping in the profits? With dual-class structure will Digicel lack the incentive to better serve shareholders and the companies? Students should also consider if Digicel would be allowed more free reign to innovate within a dual-class structure. Nevertheless, based on the nature of dual-class structure, Digicel would likely still maintain control over its operations, with negligible or no change in its ownership structure.

Students should also pay attention to exhibit 5 which highlights the voting rights associated with Class A and B. Class A common shares has 124,137,931 shares with 1 vote per share, while class B has 193, 310, 345 shares with 10 votes per share. Students should be asked to calculate the control that Digicel would have in terms of votes. A count suggests that Digicel could end up retaining control of approximately 94% of the company.

4. Key telecom industries indicators can be used to better understand a company's revenue model and to determine a company's relative valuation. Use the key indicators below to evaluate Digicel. (The financials can be assigned to two students prior to the class for presentation)

Key Indicators

Average revenue per user (ARPU) Churn and net additions

Subscriber mix: prepaid versus postpaid Smartphone penetration Debt repayment capacity Valuation: price to earnings (PE), price to free cash flow, enterprise value to earnings before

interest, tax, depreciation and amortization (EV/EBITDA) and price to cash flow

Average revenue per user (ARPU) - A telecom company’s ARPU indicates the contribution of the different services that the company is selling to its customers. ARPU is an expression of the income generated by a typical subscriber, or device per unit time, in a telecommunications network. The ARPU provides an indication of the effectiveness with which revenue-generating potential is exploited. It is suggested that if ARPUs increase over an extended period, it may also show increased adoption of new higher-priced broadband or bundled triple-play products. The case highlights that ARPU for Digicel- mobile subscriber had shown a declining trend for Digicel: $16.2 in 2013; $16 in 2014; and $15.2 in 2015. In 2015, Cable and Broadband contributed just over one percent of Digicel’s total revenue, and subsequently no ARPU cable information was available. For mobile, the data suggest a decreasing trend for ARPU. Students should comment on what this could mean for Digicel.

Churn Rate and Net Additions - The percentage of subscribers to a service that discontinues subscription to that service in a given time period. When examining churn rate, instructors may raise the points that there are two types of churn rates—post-paid and pre-paid. Owing to the low switching cost associated with pre-paid customers compared with post-paid, pre-paid churn is usually greater than the post-paid churn.

The case highlights that mobile churn percentage or attrition rate for Digicel from 2013 to 2015 was 4.2%, 4.3% and 5%, respectively. A natural question that students may ask is what is a ‘good’ churn rate? Although there seems to be no direct answer for this, students should examine churn rate for other telecoms. For example, marketrealist.com reported that AT&T’s churn rate was as low as 0.86%, which the company achieved in the second quarter of 2014. This churn rate is the best in the U.S. telecom industry, with churn rates for Verizon (VZ) the second best at 0.94%. The churn rates for T-Mobile (TMUS) and Sprint (S) were reported at 1.50% and 2.09%, respectively— for the same period which was much higher compared to AT&T’s. Comparing Digicel’s churn rate with these telecom operators, it may suggest that Digicel’s churn rate is relatively high. Students should consider if, given the high churn rate, Digicel would have to spend a lot of money acquiring new customers. Students may refer to and comment on the direct operating and subscriber acquisition costs in Digicel’s Consolidate Financial and Operational Information (Exhibit 4). Also, students may be asked to comment on how the subscriber mix affects the churn rate.

The difference between new customers and lost customers—over a period—is called net additions. It’s a good sign if a telecom company’s net additions increase periodically. The case provides no details on the net additions for Digicel.

Subscriber mix: prepaid versus postpaid – Instructors may ask students to think about their own country and discuss their thoughts on where the majority of subscribers lay on the - prepaid versus postpaid spectrum. Also, students may be asked to indicate where they are on the spectrum. Trends in the telecom market have suggested an increase in customers on prepaid, and a downward trend in postpaid customers. Globally, macroeconomic factors coupled with recent financial challenges have severely impacted the declining pool of prime-credit customers, forcing these potential subscribers to consider prepaid alternatives, as opposed to traditional postpaid rate plans. This is similar in the Caribbean market, and as reported in the case, Digicel has a prepaid subscription rate of approximately 94%. Therefore,

Digicel is not considered an anomaly. The case highlights that low-income users were more likely to subscribe to pre-paid mobile service than to post-paid mobile or fixed line service.

Students should be encouraged to discuss how the subscriber mix can provide insights on Digicel. Students may examine this in terms of switch cost, churn rate, etc. For example, prepaid customers tend to have a more distant operator relationship, higher churn and higher unit service prices with a lower overall spend, while postpaid customers tend to have predictably higher spend and. owing to the contract-lock, they have a lower churn rate. Switching cost is thus higher for post-paid customers. Also, ARPU levels remain significantly lower for prepaid than postpaid customers.

Smartphone penetration- Market trends suggest that smartphone penetration has increased because of technological advancements which, in turn, have made these devices affordable and accessible to the market. The case highlights that smartphone usage in the Caribbean has increased from 14.4% in 2013 to 33% in 2015. There was a belief that with the availability of entry-level smartphones’ prices falling to less than US$50, this would drive internet usage, consequently driving demand for data services. In terms of performance indicators, students may talk about revenues associated with smartphones. Revenue per smartphone is higher than regular mobile phones’ revenue. Therefore, increased smartphone adoption translated into higher revenues for wireless telecom companies. A larger share of smartphone users in the customer mix translates into increased data service usage. This, in turn, also means higher average revenue per user, or ARPU, for telecom companies.

Debt repayment capacity

Students may be reminded that telecom is a highly capital-intensive industry, as highlighted in question 1 above. Telecom companies finance these investments through debt. It is recommended that a key metric to gauge companies’ repaying capacity is net debt-to-EBITDA (earnings before interest, tax, depreciation, and amortization). The debt figure in the metrics is calculated net of cash. The metric tells us how many years it will take the company to repay the debt. It will use the cash it generates from its core operations.

Instructors may encourage students to draw on data/information from the case to make assertions about Digicel’s debt repayment capacity. Digicel’s debt repayment capacity is calculated (see Exhibit 4):

Net debt:- Total Debt $6,498.7 minus net cash provided by operating activities - $433.4 EBIITDA: Operating profit $707.8 and add depreciation, amortization and impairment of

property, plant and equipment and intangible assets - $405.3

The result is 5.44 years. This may be compared with its main competitor C&WC which is 8.8 years. An additional comparison may be made with operators in the USA: AT&T 1.8 years, Verizon 2.4 years and Sprint 4.8 years.

Valuation: price to earnings (PE), price to free cash flow, enterprise value to earnings before interest, tax, depreciation and amortization (EV/EBITDA) and price to cash flow-

It is argued that investors often use different metrics to determine telecom companies’ relative valuation, which includes PE (price-to-earnings), price-to-free cash flow, EV/EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization), and price to-cash flow. The case does not provide sufficient information to answer this question. The valuation metrics indicated here assumes post IPO.

5. As a potential investor interested in technology stocks and, based on the above evaluation, would you have purchased shares in Digicel?

Based on insights in question 4, instructors may ask students to think as investors, and give some views on how these insights would affect their decision to invest.

Investors should expect relatively stable revenues in telecom companies that have a larger share of post-paid users in their subscriber mix. Post-paid users are normally considered ‘sticky’ subscribers. They have higher switching costs than pre-paid users. However, note should be taken that Digicel has innovative actions to address this gap. For example, as noted in the case, the company led the market in innovative ways of adding credit to a mobile account, such as phone–to-phone transfers and credit purchases via automated banking machines. Persons living abroad could purchase credit on behalf of their friends and relatives in Jamaica. Nevertheless, trends in the industry were resulting in the margins on prepaid products decreasing over time. Investors should understand how wireless telecom companies managed their post-paid churns.

Smartphone adoption is said to translate into higher revenues for wireless telecom companies, thus higher ARPU. However, these advancements and the resulting pace of device penetration have spawned new business models (for example, OTT) that have disrupted the communications industry. Investors may wonder how Digicel would be handling this; will OTT lead to loss of revenues to Telecom operators?

In terms of churn rate, telecom companies with high churn rates have to incur high customer acquisition costs. Lower churn rates help companies save cost that they would otherwise incur acquiring new customers.

Owing to the fact that telecom operators finance these investments through debt, it is important for investors to also examine a telecom company’s capacity to repay its debt. Students should compare Digicel’s debt with that of C&WC and Sprint, as provided in the case, noting that Digicel’s is lower and, thus, may not be considered troublesome. Students should consider if and how Digicel could control their debt. Also, students may be asked to ponder Digicel’s possibility of growth (as a means to reduce debt) considering that mobile penetration was high and broadband penetration was low, and the decreasing demand for fixed line. Also, given declining revenue because of cable services, student should consider alternatives that consumers have (threat of substitute discussed earlier). Also, students should pay attention to exhibit 3, including the GDP and population, in making arguments for the potential of growth.

6. Based on the aborted IPO, and the dynamism of the industry what strategy should Denis O'Brien pursue?

One approach to evaluating strategic options is to employ a TOWS matrix. The TOWS matrix is a positioning approach to strategy which builds upon a SWOT analysis and categories strategic options under the following headings: SO: strategies employ strengths to seize opportunities

ST: strategies employ strengths to avoid threats WO: strategies address weaknesses so as to exploit opportunities WT: strategies are defensive, aiming to avoid threats and the impact on weaknesses

Figure 1: TOWS Matrix

External factors (opportunities: threats)

SO: Use strengths to maximize opportunities (maxi-maxi strategy)

ST: Use strengths to minimize threats (maxi-mini strategy

WO: Minimize weaknesses by taking advantage of opportunities (mini-maxi strategy)

WT: minimize weaknesses and avoid threats (mini-mini strategy)

Instructors may allow students to create a SWOT based on previous sections. After students have created a SWOT Instructors can use the table as framework to discuss and determine Digicel’s strategic options.

Despite the convergence taking place within the telecommunication sector another approach that instructors can take in this analysis is the use of the Boston Consulting Group (BCG) matrix. This would require examining each of the segments or strategic business units (SBU) in terms of potential cash generation and cash expenditure requirements. SBU are categorized in terms of market growth rate and relative market share.

Assessing rate of market growth as high or low depends on the conditions of the market. No single percentage rate can be set since new markets may grow explosively while mature ones grow hardly at all.

Relative market share is assessed as a ratio: it is market share compared with the market share of the largest competitor.

Figure 2: Boston Consulting Group (BCG) Matrix

Relative Market Share

High LowHigh Stars Question marksLow Cash cows Dogs

Stars require capital expenditure in excess of the cash they generate in order to maintain their position in their competitive growth market, but promise high returns in the future. Strategy: build.

In due course starts will become cash cows Cash cows need very little capital expenditure, since mature markets are likely to be quite stable and they generate high levels of cash income. Cash cows can be used to finance the stars. Strategy: hold or harvest if weak.

Question marks must be assessed as to whether they justify considerable capital expenditure in the hope of increasing their market share or should they be allowed to die quietly as they are squeezed out of the expanding market by rival products? Strategy: build or harvest

Dogs: may be ex-cash cows that have fallen on hard times. Although they will show only a modest net cash outflow, or even a modest net cash inflow, they are cash traps which tie up funds and provide a poor return on investment. However they may have useful role, either to complete a product range or to keep competitors out. There are also many smaller niche businesses to market that are difficult to consolidate that would count as dogs but which are quite successful. Strategy: divest or hold.

Analysis

Internal factors (strengths:weaknesses)

Market Growth

Students assessment of the segments will differ however one scenario is outlined below

Mobile: Digicel is a mobile company with 87% of its revenue coming from this segment. However there are some distributing trends, average revenue per user (ARPU) for mobile shows a declining trend and churn is increasing. In addition price competition has driven the cost per minute per call to US$0.01. Digicel had established switching with high interconnection rates; however with the regulator intervention in reducing interconnection rates in several markets (e.g. the regulator reduced interconnection rates by 70%) has virtually switching cost. The only switching cost that remains in some markets was the inability of customers to port numbers. Another issue that students may highlight is the use of other platforms to make calls like Skype, Facebook or Google Hangouts. There are also substitute products like WhatsApp. Mobile could therefore be classified as a dog or question mark. With the company's main product being classified a dog or a question is indicative of Digiel's dilemma.

Business Solutions:

Digiecl's business solutions focuses on cloud computing. According to Forbes in 2016, spending on public cloud Infrastructure as a Service hardware and software is forecast to reach $38B, growing to $173B in 2026. SaaS and PaaS portion of cloud hardware and infrastructure software spending are projected to reach $12B in 2016, growing to $55B in 2026.  The following graphic provides an overview of spending on public cloud infrastructure worldwide from 2015 to 2026. Digicel therefore can offer a range of services including co-location, cloud disaster recovery, cloud networking, content delivery, storage, security and enterprise mobility management. Based on the market growth projections this would be considered a star for Digicel. http://www.forbes.com/sites/louiscolumbus/2016/03/13/roundup-of-cloud-computing-forecasts-and-market-estimates-2016/#3dcb8a0f74b0

Cable TV Broadband: While many persons are 'cutting the cord' and opting for streaming services over traditional cable TV, quality high-speed broadband connections are essential to cloud computing because broadband provides the link between the purveyors of cloud computing services and their clients. Broadband is also the conduit for streaming and other internet services, hence it is a prerequisite for the services that Dicicel is likely to offer. Digicel can also consider developing and or acquiring unique content. Instructors may decide to discuss the importance that content is expected to play in this new paradigm. While cable TV in its current form maybe considered a question mark, the need for broadband as a service to facilitate streaming, cloud services and the Internet of things (IOT) is indeed a growth segment and can be therefore considered a star.

Fixed Line: Ask the class for the show of hands of the persons who owns a fixed line. We have found that only older persons have a fixed line. Internationally there is precipitous decline in fixed line use and is primarily offered as part of a quad package included in a data package. Fixed line will not offer a competitive advantage in the market. While it can be argued that Fixed Line is a dog, Digicel should continue to offer this service as part of a quad package. The company should continue to access the offering of this service as the market evolves.

Subsequent a decision on strategic option a decision will be required on funding option congruent to strategy. Discussions may be had around options such as a loan, private equity, and merger/acquisition partner. Students may also consider if Digicel should reconsider and return to the market for an IPO.

Obtaining a loan is an option, and students may discuss the pros and cons of each. Students should note the huge capital that telecom companies need to sustain their operation, and debate whether Digicel, having been already burdened with debt, would want to further increase such. Private equity refers to a

type of investment which aims at gaining significant or complete control of a company with the intention of earning a high return. While private equity provides a large amount of funding, private equity firms tend to have a large stake in companies, and companies can run the risk of losing control. Thus, students should consider how private equity would affect Digicel, given the dilution/loss of ownership stake and loss of management control that it encompasses. Based on arguments in the case, this seems like an option that Digicel would least, or not, consider. With a merger and/or acquisition partner, students may be asked to consider if Digicel should use a similar approach to C&WC, which was acquired by Liberty Global. Should Digicel merge with another telecom company that can provide the funding needed, or should it allow itself to be acquired by another company that will further its growth agenda? Another option, as mentioned earlier, is returning to IPO. Based on arguments raised in question 5, students should look at the feasibility of this option. Considering the arguments in support and opposition of each option (keeping in mind Digicel’s situation), student should justifiably provide a solution to Denis O’Brien.