Vertical Separation

FTTx & Gigabit Society Project leader
Christoph PENNINGS
M19540MRA
+33 (0)4 67 14 44 40
c.pennings@idate.org
Vertical separation
A code for cord-cutting telcos?
www.idate.org
Christoph PENNINGS, Consultant, Media-Telecom Business Unit
Project leader
Christoph joined IDATE in 2008 as senior consultant. Christoph has extensive expertise in analysing regulatory
matters of fixed and mobile markets. He has been in the lead for client studies for operators in Europe and Northern
Africa and has authored multiclient reports on NGA regulation and network outsourcing. Christoph formerly worked
as telecoms analyst for McKinsey & Company. He holds a Master’s degree in Economics from Maastricht
University, the Netherlands
Contributor: Didier POUILLOT

Didier Pouillot has been with IDATE since April 1986, and worked as the Head of the Industrial Analysis Department, then Head of the Telecom
Markets & Regulation Practice. In this capacity, Didier coordinates IDATE’s research and study assignments on telecom service market trends
(mobile, broadband, …), on the sector’s regulatory, technological and industrial issues (broadband outlook, telecommunications investments and
employment, European industry’s competitiveness…). For more than 10 years, he has also been publishing supervisor of the annual DigiWorld
Yearbook, dedicated to the digital world's challenges. Before joining IDATE, Didier worked as a consultant for Paris firm, B.I.P.E.
Enlighten your digital future! © IDATE DigiWorld 2019 – p. 2

Synopsis
Vertical separation - A code for cord-cutting telcos?
No longer just a regulatory ‘punishment’, there are good business reasons for separation
 This report reviews the concept of vertical separation and its changing role for the telecoms industry.
 ‘Vertical separation’ encompasses different concepts, ranging from rather mild reporting requirements to full ownership separation.
 The report shows that the concept is not unique to telecoms, but has been implemented in a great many industries.
 Within telecoms, vertical separation was long considered a regulatory remedy for those cases where a dominant operator discriminated
unduly against its rivals. The report sheds light on the main drivers of separation, and how they are changing this situation and are
making vertical separation a reasonable business strategy for operators.
 A number of case studies will illustrate the approaches already taken by several operators towards separation and how the current trend
is evolving towards voluntary separation.
 A conclusion wraps up this report.

Contents
1. Executive Summary 6
2. Introduction 8
2.1. What is vertical separation ? 9
2.2. Flavours of separation 10
3. The relevance of vertical separation 11
3.1. Vertical separation is already practised across all network industries... 12
3.2. …and is discussed time and again for big tech 13
4. Separation drivers 14
4.1. Vertical separation: from stick to carrot? 15
4.2. The reason why the Code favours vertical separation 16
4.3. The well-managed quality of service of wholesale products facilitates separation 17
4.4. A promising long-term investment 18
5. Separation cases 19
5.1. Openreach 20
5.2. TDC 22
5.3. TIM: from ‘voluntary’ functional separation to voluntary structural separation? 25
5.4. CETIN/O2 CZ: the first operator to implement truly voluntary separation 29
5.5. Vertical separation is not a ‘fixed-only’ phenomenon 31
6. Wrap-up 32
6.1. Separation sees the convergence or combination of three essential forces 33
6.2. Telcos should explore the separation option 34
About IDATE DigiWorld 35

Tables & Figures
 What is vertical separation 9

 The differing extents of separation 10
 Some European industries – railways are an example – are already well advanced 12
 From regulatory ‘nuclear option’ … to sound business decisions 15
 Europe trailing US investments levels 16
 Open access wholesale model 16
 Ladder of investment 16
 Network slicing in mobile 17
 Trends in the share prices of O2 CZ / CETIN 18
 BT Wholesale / Openreach catering to CSPs 20
 Ofcom assessment of Openreach separation 21
 De-branding of Openreach vans 21
 TDC Nuuday and NetCo 22
 TDC separation approach 23
 Telecom Italia Open Access 25
 TIM divestment considerations for Elliot 26
 TIM Management Plan 2018 27
 TIM / Open Fiber considerations 28
 CETIN separation 29
 Trends in O2 CZ share prices 30
 CETIN EBITDA and EBITDA margin 30
 UK cell site operators 31
 Alignment of major forces for separation 33

Executive
01 Summary

1. Executive Summary
Separation goes mainstream
No longer just a regulatory ‘punishment’, there are good

business reasons for separation
 ‘Vertical separation’ refers to a situation where an integrated From integrated up-/downstream activity... ...to level playing-field downstream
company introduces some degree of impermeability between its
upstream and downstream activities.
 The degree of separation can stretch from rather light measures Upstream
to full ownership divestment. activity/asset
Upstream
 Telecoms is not the only industry concerned by such activity/asset
considerations – other network industries such as energy or rail
have already taken very significant steps towards separation in
certain geographies.
 The separation of platform businesses is being discussed by
Competitive Competitive
politicians both in Europe and stateside. Downstream Downstream
downstream downstream
activity/asset activity/asset
 Lately, voluntary separation has occurred in several situations, activity/asset activity/asset
with investors seeking to maximise value of their assets through
separation.
Source: IDATE DigiWorld, Vertical separation, July 2019
 Regulatory incentives for wholesale-only models; encouraging
business results and the need to finance new infrastructure as
well as new technological opportunities all combine to make
vertical separation a serious option for operators, going forward.

02 Introduction
Vertical separation explained

2.1. What is vertical separation?
An introduction
A remedy for facing vertical foreclosure It ranges from integrated activity up- and downstream … … to a level playing field downstream
 In an industry where several companies are competing in a

market downstream, using inputs from an upstream Upstream
monopoly, there is a potential risk to fair competition.
activity/asset
 A vertically integrated company may have a compelling Upstream
incentive to discriminate against the competitors to its own activity/asset
downstream activity.
 Typically, such discrimination can take various forms: a

refusal to supply, price discrimination or non-price
discrimination through less favourable terms of service Competitive Competitive
Downstream Downstream
provision. downstream downstream
 To introduce elements of separation between the upstream
and downstream assets of the previously integrated
company can level the playing field between all downstream
competitors. Ultimately it can even elevate the overall level
of financial security produced.

2.2. Flavours of separation
Varying degrees of separation
Separation is not a binary option

The differing extents of separation
 Separation is not a simple question of breaking up a
company or not.
 Degrees of separation can be variegated, ranging from
+
Separation
relatively light obligations to the full separation of ownership of
ownership
degree of separation
of the previously integrated assets
Separate
 Accounting separation creates transparency in financial subsidiaries
flows between operating units and makes it possible to
‘Chinese
detect cross-subsidisation within a company.
walls’
 Functional or operational separation requires stricter

Separate
separation of units and staff in order to restrict, for example, accounts
information asymmetry and to ensure equivalence in
handling downstream activities.
accounting functional operational structural
 Structural separation is a very strong intervention in the case
of a private venture and requires the full independence of Source: IDATE DigiWorld, Vertical separation, July 2019
the previously integrated units.

The relevance of
03 vertical separation

3.1. Vertical separation is already practised across all network industries…
Ranging from utilities through railways to telecoms
An established and time-tested option

 The separation of vertically integrated companies has long been an
instrument in the toolkit of regulators – ever since the U.S. Congress passed
the Sherman Antitrust Act in 1890.
Some European industries – railways are an example – are already well advanced
 The 1984 break-up of AT&T into regional companies is another famous
example stateside of regulatory intervention in a monopolistic market
Degree of separation Description EU Member States
structure.
Integrated system Austria, Germany, Hungary,
 On the European scale, the Commission has adopted a number of Directives
Ireland and Northern Ireland,
that favour vertical separation. Organizational separation Latvia, Lithuania, Slovenia
(“holding model”)
 In rail: the Fourth legislative ‘Railway Package’ was finally adopted in 2016. Integrated system with enhanced France, Poland
While less ambitious in terms of separation than initially proposed, its ultimate independency of the IM
version stipulates a legal distinction of infrastructure managers from train Separated IM Belgium, Bulgaria, Croatia,
operators, and prohibits cross-shareholdings. This equates to functional, Czech Republic, Denmark,
rather than structural, separation. Estonia, Great Britain, Greece,
Institutional separation Netherlands, Romania,
 In electricity: Directive 2009/72/EC gave Member States three unbundling Slovakia, Spain
options to choose from:
Separated multimodal IM Finland, Portugal, Sweden
 Full Ownership Unbundling
Source: UNECE, 2018
 Independent Transmission Operator
 Independent System Operator
 In telecoms: the 2009 legislative package gave NRAs an option to mandate
functional separation – the new Code favoured a wholesale-only approach.

3.2. … and is discussed time and again for big tech
Software and platforms are under scrutiny for possible abuse of dominance
Threats in the EU and stateside

Even though no companies have been broken up on either side of the pond
since AT&T, the menace of separation of large tech players has been Source: EURACTIV, 2018
omnipresent.
 When in 2000, a Federal U.S. Court ruled that Microsoft be split up, the judge
compared the company to “drug traffickers” and “gangland killers”. The ruling
was overturned by an Appeals Court in 2001.
 In 2014, the European Parliament adopted a motion in favour of a potential

Source: Reuters
break-up of Google.
 In mid 2018, Competition Commissioner Vestager, having imposed several Source: CNN
multi-billion EUR fines on Google, conceded that breaking up the company
may not be the silver bullet, while keeping the threat option on the table.
 Earlier in 2018, Manfred Weber, Member of the European Parliament, and

recent lead candidate for the Presidency of the European Commission, stated
it was “time to discuss the break-up of Facebook”.
 The Massachusetts Senator and candidate for the Democratic 2020

presidential ticket, Elizabeth Warren, has pledged to break up big tech
companies if elected. She vows to separate platforms or marketplaces with
an annual global revenue above 25 billion USD. The resulting “platform Source: medium.com/@teamwarren
utilities” will not be allowed to own end users or share data with third parties.

04 Separation drivers

4.1. Vertical separation: from stick to carrot?
All in the mind? A regulatory burden or a business opportunity?
Is the sum of the parts greater than the whole?

 Separation has long been considered a regulatory remedy, a From regulatory ‘nuclear option’… … to sound business decisions
sort of ‘punishment’ for a dominant firm allegedly abusing its Then… … and now
market position
 However, in recent times, the long-discussed netco/servco

topic has gathered new momentum with a number of new
entrants setting themselves up as infrastructure players with a
wholesale-only approach. Some established telcos are going
down the same route,
 There are various reasons why vertical separation is in the end

materialising in the market. There are at least three major
powerful forces in the communications sector which are
working in favour of vertical separation.
 Regulation: the new Code rewards open access regimes with

a more favourable regulatory treatment.
 Technology: Greenfield deployments and virtualisation

facilitate the implementation of vertical separation. Source: IDATE DigiWorld, Vertical separation, July 2019
 Finance: Outside investors have developed an appetite for

utility-type investments in telecoms infrastructure with stable
and predictable long-term returns.

4.2. The reason why the Code favours vertical separation
Trying to cut the Gordian knot of investment and competition
The best of both worlds, maybe Europe trailing US investment levels (capex, bn EUR)
 In the recent EU Electronic Communications Code, Articles 76

and 80 offer a light-touch regulatory regime for co-investment
and wholesale-only networks, subject to a number of
conditions.
Open access wholesale model
 This represents a significant change of course to the previously
preferred ‘ladder of investment’ principle which expected new
entrants to climb up its rungs towards fully-fledged
infrastructure competition. CSP CSP CSP
1 2 n
 Investment under the previous regime has remained too low to
achieve the objectives of the ‘Gigabit Society’. Per capita
investment in the EU has been persistently below the levels Ladder of investment
observed in the USA.
Failure of altnets
Own
 The new regime thus acknowledges the economic difficulty of infrastructure
to attain this rung
on a large scale Wholesale operator
physically replicating an access network and recognises that a
single network may be the only viable way to achieve near- Shared/
full
ubiquitous NGA coverage. unbundling
 Since network quality as a differentiating factor is eliminated in Bitstream

this case, competition will play out on the services level.
Quality of service differentiation of wholesale products –if
compatible with net neutrality considerations- will be required Resale
to facilitate competition beyond price and bundle size.

4.3. The well-managed quality of service of wholesale products facilitates separation
Ensuring product differentiation on a single network infrastructure
Competition beyond simple price wars Network slicing in mobile

Network slicing: definition Resources of a single network for different services
 The downside of service competition used to be in the difficulty
 “End-to-end multiple logical networks running on a  Network resources affected for different network services
of achieving differentiation in terms of quality of service, and shared physical infrastructure, capable of providing an operating independently of each other
the tendency for such competition to trigger devastating price agreed service quality” (GSMA definition)  Each slice of the network (4G or 5G) corresponds to a
wars.  Mechanism developed to help serve vertical industries specific performance requirement:
with different network requirements − The different particular constraints are translated into
 The rollout of new network infrastructure involves replacing − Typically in line with the three 5G use cases technical obligations such as speed, latency, reliability
legacy technology and IT systems, creating a unique − Not a new concept since it has already appeared in
opportunity to implement solutions which enable tailor-made LTE architectures
quality of service levels in real time. Network virtualisation and  Currently under standardisation within 3GPP
software-defined networks are important keywords – and Source: IDATE DigiWorld, Vertical separation, July 2019
action – in this context.
5G use cases 5G network slicing example
 Network slicing is a defining feature of LTE and notably 5G
mobile networks. It allows the allocation of different
characteristics of service targeted to the needs of various
applications on the network. In the BEREC net neutrality
guidelines, network slicing is recognised as being a valid
motive for managed services.
 There are means technically available to deliver quality-based

competition on open access networks. They should be
embraced by operators and encouraged by policy makers and
regulators to ensure that European businesses and
Source: ITU-R Source: Euro5G
households can benefit to the greatest possible extent from
fibre and its myriad possibilities.

4.4. A promising long-term investment
The appeal of telecoms utilities finally coming out?
Fibre networks more interesting for financial investors

 Investment in telecoms networks is growing, and not only by Trends in the share prices of O2 CZ / CETIN
industry players planning to provide services over newly-installed
infrastructure in the ground.
 New insights and models are emerging: transactions like the split of
O2 CZ into O2 and CETIN after the Czech incumbent was acquired
by investment fund PPF show that en enforced split into two
focused entities can create value from operating an integrated
company.
 Fibre networks have also attracted the interest of investors from an

infrastructure investment angle. As with other utilities, fibre networks
can generate predictable and stable long-term revenues for
investors. Demand aggregation prior to ground-breaking work can
help to minimise risk levels. Likewise, step-by-step rollout ensures Source: ADL
cash flow from early deployments while later work is underway.

Examples:
 The Danish incumbent TDC was acquired by the Macquarie

infrastructure investment branch and two Danish pension funds
 A similar consortium involving the Canadian asset management firm

Brookfields and two Dutch pension funds is said to have considered
acquiring and subsequently separating KPN in the course of 2019.

05 Separation cases

5.1. Openreach (1/3)
The ‘patient zero’ of functional separation
Equality of access for all players in the market
Operating at arms’s length to ensure non-discrimination

BT Wholesale / Openreach catering to CSPs
 Dissatisfied with market results and regulatory ‘trench warfare’, the
UK regulator Ofcom launched its strategic sector review in 2003. In
a 2004 consultation, it presented three options for further
regulation:
− Deregulation
BT Retail CSP/Altnet CSP/Altnet CSP/Altnet
− Structural separation of BT
− Real equality of access
 In order to avoid more far-reaching structural measures in 2005, BT
presented its undertakings to create real equality of access via a
separate access unit, to become known as Openreach. Its features:
− Having control of the last mile and ensuring equal access to the
services and assets associated with the local loop, BT
Openreach
− Being an independent business unit, owned by BT but with its Wholesale
own brand and staff of 15,000 employees and an Equivalence of
Access Board consisting of five board members, of whom three Source: IDATE DigiWorld, Vertical separation, July 2019
independent, headed by a BT executive and a non-BT executive.
− Incentive plans independent of BT Group
− Separate HQ
− Separate OSS

•
2017 review for more far-reaching independence
Not structural, but full legal separation
Ofcom assessment of Openreach separation
The Openreach brand is no longer associated with the ‘BT Group’ Progress on delivering a more independent Openreach
 This graphic indicates how far aspects of Openreach’s greater independence have been
 Roughly a decade after Openreach became operational, Ofcom opened implemented so far.
 We will report on how effective these measures are in later reports.
another review in 2016 with the aim of improving its functioning and
pushing the limits of Openreach independence further.
 The regulator and the BT Group agreed to implement a series of
measures to implement the full operational and strategic independence
of Openreach including:
 Legal separation: establishment of Openreach Limited as an
independent business within the BT Group and with its own governance
arrangements.
 Transfer of staff: All 32,000 Openreach staff to be transferred to the entity
 Control over strategy and assets: Openreach to define its own strategy
Source: Ofcom (2018)
and operational plans. While the BT Group retains ownership of network
assets, Openreach has full management control over running and
De-branding of Openreach vans
maintaining them. Alternative operators need to be consulted before
Openreach makes major investment decisions. Openreach has to ensure
confidentiality over these inputs.
 Branding: Openreach to make no reference to the BT Group in its
branding, as seen, for example, on the fleet of company vans.

Will infrastructure competition diminish its role?
Competitors overbuild Openreach networks
Will BT eventually offload Openreach? UK fibre projects, examples
 During the first decade of Openreach operation, the company remained

absolutely central to the UK’s fixed telecoms landscape as virtually all
players except Virgin Media relied on the Openreach last-mile asset to
reach their subscribers.
 However, main competitors have launched initiatives to roll out full fibre
networks, allowing them to bypass the incumbent operator’s separate
access network unit:
 Vodafone and wholesale operator CityFibre have struck a deal to co-
invest in fibre. Initially, the partners plan to reach one million homes by
2021 and by 2025, five million. Vodafone will enjoy an initial phase of
exclusivity for residential users.
 TalkTalk is collaborating with a financial investor to build a fibre network
reaching as many as three million homes.
 Virgin Media launched Project Lightning in 2015, covering four million
homes with FTTH
 Together, these projects mean that the financial situation of Openreach
will deteriorate going forward as wholesale revenues fall. At the same
time, pressure to accelerate its own fibre rollout has grown.
 In this situation, BT may wish to consider opening up the capital of
Source: operator’s websites
Openreach to an outside investor.

5.2. TDC (1/2)
Voluntary separation under new ownership
On a path towards structural separation
An ‘open relationship’ between new entities
TDC Nuuday and NetCo
 In 2018 a consortium of the Australian investment bank Macquarie and three
Danish pension funds made a successful bid for the Danish incumbent
operator TDC Group
 In its offer, the consortium announced to establish three separate entities for
the Danish market: a NetCo (bearing that same name), an opco and a
CSP CSP
common holding.
 NetCo will continue the fibre network rollout with a ‘vision’ of achieving full
coverage of Danish households with Gigabit-access by the mid-2020s. It will Nuuday
also drive the deployment of 5G networks. (OpCo)
 The opco, meanwhile branded as ‘Nuuday’, includes customer-facing brands
YouSee, Digital, TDC Business, Telmore, Fullrate and Blockbuster. Nuuday is
in charge of providing access and content services to users.
 NetCo will remain a key supplier to Nuuday. However, both companies are
free to contract with other CSPs and alternative network operators, NetCo
respectively.
 NetCo includes “Wholesale, On-site technicians, Procurement & Logistics, Altnet Altnet
Network, Dansk Kabel TV and IT Operations”. The company pursues an open
access approach, aimed at growing the utilisation of infrastructure.
 The separation transposes previous functional distinctions into a structural
setting of separate management teams for each entity and ultimately separate
governance bodies.
 Following the acquisition, the holding company DKT Holdings ApS was de-
listed.

5.2. TDC (2/2)
Structural separation with certain limits
MVNO business to remain with opco
Exceptions for mobile wholesale and IT systems

 Despite their announced separation, NetCo and Nuuday will TDC separation approach
continue sharing links beyond a purely commercial
supplier/customer relationship.
 In a perhaps counter-intuitive move, DKT Holdings announced

in early 2019 that the mobile wholesale activities will not be
within the responsibilities of NetCo, but will instead be
managed by the Nuuday opco. As an entity with its own retail
activities in mobile, Nuuday may obviously have fewer
incentives to market its capacity to competitors than does a
purely wholesale-oriented NetCo. TDC seems to be
reconsidering to some extent the virtues of “improve[d] retail
competition” promised in the consortium’s original bid.
 Further, TDC has made known that it will continue to use

legacy IT systems and only transition gradually to new IT
infrastructure. It cites as reason issues of complexity and the
risk of outages when replacing legacy systems. Indeed, Source: TDC
previously, TDC has attempted and ultimately refrained from
making this move. However, if there is permeability of
information between the NetCo and Nuuday systems, this may
create a competitive advantage for the latter compared to its
retail competitors, thus infringing on equality among open
access seekers on the NetCo infrastructure.

5.3. TIM (1/4)
From ‘voluntary’ functional separation to voluntary structural separation?
Scope of new regime not clear while dust settles on battle of investors
Functional separation debate at TI actually preceded the Telecom Italia Open Access
Openreach era
 It is not widely known that TI was the first incumbent in Europe to
face some degree of administrative separation. However, already
back in 2000, regulator AGCOM launched a public consultation to
assess the opportunity to take steps to ensure compliance with
the requirement of internal and external equal treatment.
 AGCOM imposed detailed accounting separation on TI and the Source: Fastweb
duty to ensure that by “31 December 2002, […]the organisational
Group Undertakings
units in charge of network management are sufficiently separated
Introduction of: (i) a new delivery process for SMP services; (ii) additional procedures for the management of Co-location
from units responsible for selling final services” 1 Services; (iii) new systems for the management of wholesale users
 Not satisfied by the progress made, the regulator eventually 2 Introduction of a new incentives system and a code of conduct for the staff of Open Access and of the Wholesale function
3 Establishing a performance monitoring system for SMP services
proposed a functional separation of TI in 2007.
4 Guaranteeing transparency of the monitoring system
 In 2008, TI created its Open Access division and committed to 5 Guaranteeing transparency of the Technical Plans for the Quality of the Fixed Access Network
more than 200 undertakings grouped in 14 action areas. 6 Guaranteeing transparency of the Technical Plans for the Development of the Fixed Access Network
7 Establishing a Supervisory Board
 In 2015, amidst ongoing controversies with alternative operators, 8 Integration of Telecom’s regulatory accounting and setting of the transfer charges
TI brought together Open Access and National Wholesale 9 Measures concerning the new generation access networks
Services in a common wholesale unit and at the same time 10 Establishing a body in charge of the resolution of technical/operational disputes relating to network access services
reinforce the equivalence for said alternative operators. The move 11 Ban on selling activities for network forces and training programmes for sale forces
put altnets on an equal footing with TI’s own operations in terms of 12 Obligation to report the activation of unsolicited services to the end users
processes, IT systems and information for service activation. 13 Obligations to notify the termination of CPS services
14 Measures for reducing litigation with the end users
Source: TI

5.3. TIM (2/4)
… competing visions of TIM’s future
How much separation for the TIM access network?
NetCo separation within TIM, spin-off, merger?
 The largest shareholder in TIM, Vivendi, and the US hedge fund TIM divestment considerations for Elliot
Elliot have been engaged in an intense struggle over the future of
TIM.
 In 2018, Elliot presented its plan to divest key assets of TIM.
 In the Elliot plan to reduce debt, create value and facilitate payment
of dividends to investors, TIM should divest substantial assets and
focus in its home market on the activities of a servco providing retail
services.
 A netco, holding all fixed infrastructure assets, would be legally
separated and TIM should be prepared to sell a majority in the entity
to an outside investor.
 The Elliot scheme also foresees the sale of the submarine cable unit
Sparkle and of mobile the towerco INWIT.
 The then Vivendi-backed management of TIM proposed a more
conservative approach to separation. Under them, the netco should
manage the access offer, i.e. central offices, active equipment in the
central offices as well as any downstream infrastructure connecting
clients’ premises. In this constellation, the netco should be a fully-
owned legally separate entity, serving all its customers on the
equality-of-inputs principle. Source: Elliot
 In terms of outside partners, the management’s plan only considered

a potential opening up of its capital for a minority stakeholder in its
fibre activities.

5.3. TIM (3/4)
after wrestling over course of action, TIM in discussions with Open Fiber
State lender Cassa de Depositi et Prestiti (CDP) apparently working to create national broadband network
An intense year for TIM

TIM Management Plan 2018
 At the AGM in May 2018, Elliot staged a coup and saw
10 independent directors appointed to the previously
Vivendi-controlled board.
 This reshuffle led to the ouster of Vivendi-supported CEO
Amos Genish, replaced by Luigi Gubitosi, a leader more
aligned with the Elliot vision for TIM.
 Another event, perhaps even more significant, is the
entry of State lender CDP into TIM’s capital. CDP is also
engaged in the Open Fiber JV with energy company
Enel. Open Fiber has covered some four million Italian
homes with FTTH. Even before the CDP acquisition of a
stake in TIM, Open Fiber was seen as a natural partner
for the netco of TIM which was potentially to be spun off.
 Vivendi announced ahead of the 2019 AGM that it might
support a merger with Open Fiber, provided TIM
remained in control of the network.
 The (new) CEO of TIM expressed similar views in May
2019. He is quoted as saying a merger with Open Fiber
was “a good idea” and that several options existed to
maintain “some kind of control”.
 According to Gubitosi, talks with Open Fiber are well
advanced, although the latter has denied any official Source: TIM (2018)
contacts with TIM on this matter.

5.3. TIM (4/4)
Open Fiber: implications
Despite some hurdles, there are potentially good arguments to proceed rapidly with separation and merger
There are potential gains and risks at TIM and market level
Potential risk
TIM / Open Fiber considerations
 For market:
− Infrastructure monopoly
 For TIM:
− Limited control over key assets
− Increased competition at retail level
− Complication over integration of Flash Fibre, TIM’s JV with Fastweb
Potential upsides
 For market
− No inefficient duplication of infrastructure
− Accelerated rollout of FTTH
− Improved conditions for fixed/mobile convergence at retail level and
potentially for 4G/5G backhaul
For TIM
− Increased stability
− Reduced capex compared to going it alone Source: TIM (2019)
− Reduce risk of overbuild
− Reduced debt
− Improved share price

5.4. CETIN/O2 CZ (1/2)
The first operator to implement truly voluntary separation
Seeking profitability boost, the investor PPF has fully separated the former incumbent
PPF CETIN separation
 Having failed to acquire a mobile license in the Czech market, investor

PPF agreed with Telefónica to take over their operations in the Czech CETIN & O2: structurally separated business models
Republic and Slovakia in January 2014. cooperating for the best possible results
 Their structural separation into a wholesale netco and a retail servco
was announced in August 2014, to be implemented on 1 June 2015.
 A customer-facing servco kept its O2 brand and remained a publicly
listed company on the Prague Stock Exchange. O2 is still majority
owned by PPF, but the latter considers it a financial investment and not
a strategic asset.
 The CETIN netco became a private company, fully owned by PPF. In
all, 1,200 of the previously integrated company’s 4,900 employees were
absorbed by CETIN.
 On the fixed side, CETIN manages a national copper and a VDSL
access networks, with the latter covering more than 6.1 million homes
thus far. CETIN also operates 2G/3G/4G mobile network infrastructure,
which is part of a network-sharing agreement with T-Mobile.
 However, CETIN is not the owner of spectrum licenses, which have
remained with the O2 servco. Likewise, CETIN is not in charge of
dealing with MVNOs. Any MVNO deal by O2 is under the latter’s
responsibility
 Due to its capital-intensive tie-up with O2, CETIN remains subject to full
SMP regulation and does not benefit from the lighter-touch approach
which a standalone wholesale-only operator would. Source: CETIN (2018)

5.4. CETIN/O2 CZ (1/2)
Solid base and performance on domestic market
O2 share price has performed impressively since separation seems to confirm value creation aspects of bid
Long-term contracts provide certainty for CETIN Trends in O2 CZ share prices including CETIN activity prior to 1 June, 2015
 Both companies are performing solidly in the Czech market.

 CETIN has struck long-term supply deals with O2 and T-Mobile to provide fixed and mobile
wholesale services.
 Infrastructure competition for CETIN is limited, coming mainly from cable networks, where they
are present.
 CETIN domestic revenue between 1H 2017 and 1H 2018 remained stable. Its overall 2% decline
in revenue is due to shrinking revenues from international transit activities.
 The netco is sporting a very elevated EBITDA margin of over 60%. Unsurprisingly, given the
CETIN business model, the capex-to-domestic-revenue ratio is relatively high at 30%. Using
EBITDA and capex to approximate free cash flow, the resulting ratio of 30% shows indicates the Source: Prague Stock Exchange
healthy profitability levels of CETIN.
 O2, the servco, also reports healthy figures. The revenue and EBIDTA of the O2 group
(including CZ and SK) both grew in 2018. The O2 fixed business is suffering mainly from the CETIN EBITDA and EBITDA margin
decline of traditional fixed voice traffic. Capex to revenue in its Czech business has risen by
close to 5 percentage points to 10.6% in 2018, driven mainly by investments in content rights.
O2 is building activities in content and in adjacent services such as financial services.
 In terms of growth, the Czech market is relatively mature. It remains to be seen if PPF will
eventually offload O2 in order to be freed of SMP regulation constraints and to win flexibility in its
course of business.
 O2 is diversifying its activities and now enjoys healthy growth beyond the CETIN footprint in
Slovakia. The activities acquired by PPF from Telenor in Hungary, Bulgaria and Montenegro
could potentially be a good match for O2 activities. This is, though, probably contrary to its
position as purely financial investment for PPF and could undermine attempts to obtain Source: CETIN 1H 2018 report
deregulation for CETIN.

5.5. Vertical separation is not a ‘fixed-only’ phenomenon
Mobile towercos are a sizeable – and growing - opportunity
Infrastructure spin-off common in the mobile segment

 The separation of mobile infrastructure into separate towercos or
the sale of antenna sites to standalone towercos is a form of UK cell site operators (42,162 total sites)
voluntary vertical separation that has gained much traction of late.
 Various factors play a role here: cost savings through the
elimination of capex; opex savings from synergies achieved in
scale; the freeing up of substantial amounts of cash from the sale of
mobile sites and assets; these are all fuelling the rise of towercos.
 European operators have been hesitant for some time to separate
themselves from their towers, and have been more cautious than
their peers in, for example, the USA or India. More recently, they
have become more pro-active:
 Altice has sold 75% of its Towers of Portugal activity to a consortium
of financial investors and has also sold 49.9% of SFR TowerCo in
France to KKR
 DT has brought its German and Dutch towers together in a joint Source: TowerXchange
entity, calling it GD Towers, presumably eyeing the unit’s future sale
 TIM has already floated 40% of its INWIT tower business and the
further dilution of its stake or a complete divestment are under
consideration.

06 Wrap-up

6.1. Separation sees the convergence or combination of three essential forces
Is separation already the new normal?
Alignment of major forces for separation
1999 2009 2019 2029
Regulation - Ladder of investment + Functional separation + Co-investment + General competition law

- Unbundling - Ladder of investment + Wholesale-only
- Net neutrality
Technology - ADSL, narrowband + Initial FTTx rollout + All-IP, virtualisation + Legacy switch-off
+ Fibre backhaul + Virtualisation
+ Full fixed/mobile integration
Finance - Booming demand + Saturation of mobile + Growing investment needs + Generalisation of utility model
for BB and mobile +Falling BB ARPU + Financial investors +Telcos have offloaded network

6.2. Telcos should explore the separation option
It has gone way beyond being a hypothetical conversation topic
Separation set to make further inroads
 There are undeniably costs associated with separation: moving staff and assets, separating IT systems, reduced commercial visibility,
rebranding and more.
 However, recent cases of voluntary separation show that serious investors are convinced that the time for separation has indeed come.
 Large-scale, wholesale-only networks can benefit more from economies of scale and scope than multiple, smaller networks, while
investment needs will remain high for many years to come.
 At the same time, technological solutions will facilitate quality-based competition at the retail level.
 Regulatory certainty is growing, while the intensity of regulation is going down, thus giving separated operators greater commercial
freedom and freeing up resources for other purposes.
 Separation allows each unit to focus entirely on delivering excellence to its customers without having to engage in compromises to better
suit other upstream or downstream units.
 Separation may therefore energise the business of operators, many of whom are only now slowly recovering from the different
endogenous and exogenous shocks that have struck the industry since the start of the decade 2000.

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FTTx & Gigabit Society Project leader

Contributor: Didier POUILLOT

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 2

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 What is vertical separation 9

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No longer just a regulatory ‘punishment’, there are good

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 7

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 In an industry where several companies are competing in a

 Typically, such discrimination can take various forms: a

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 9

Separation is not a binary option

 Degrees of separation can be variegated, ranging from

 Functional or operational separation requires stricter

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 10

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 11

An established and time-tested option

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 12

Threats in the EU and stateside

 In 2014, the European Parliament adopted a motion in favour of a potential

 Earlier in 2018, Manfred Weber, Member of the European Parliament, and

 The Massachusetts Senator and candidate for the Democratic 2020

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 13

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 14

Is the sum of the parts greater than the whole?

 However, in recent times, the long-discussed netco/servco

 There are various reasons why vertical separation is in the end

 Regulation: the new Code rewards open access regimes with

 Technology: Greenfield deployments and virtualisation

 Finance: Outside investors have developed an appetite for

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 15

 In the recent EU Electronic Communications Code, Articles 76

 Since network quality as a differentiating factor is eliminated in Bitstream

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 16

Competition beyond simple price wars Network slicing in mobile

 There are means technically available to deliver quality-based

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 17

Fibre networks more interesting for financial investors

 Fibre networks have also attracted the interest of investors from an

cash flow from early deployments while later work is underway.

 The Danish incumbent TDC was acquired by the Macquarie

 A similar consortium involving the Canadian asset management firm

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 18

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 19

Operating at arms’s length to ensure non-discrimination

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 20

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 21

Will BT eventually offload Openreach? UK fibre projects, examples

 During the first decade of Openreach operation, the company remained

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 22

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 23

Exceptions for mobile wholesale and IT systems

 In a perhaps counter-intuitive move, DKT Holdings announced

 Further, TDC has made known that it will continue to use

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 24

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 25

NetCo separation within TIM, spin-off, merger?

 In terms of outside partners, the management’s plan only considered

Enlighten your digital future! © IDATE DigiWorld 2019 – p. 26

An intense year for TIM