The UK residential communications sector continues to be in rude health, with revenue growth in Q4 accelerating by 1ppt to 5.7%, the strongest it has been for years, with all of the operators enjoying an improvement. Volumes were strong, and ARPU even stronger, with the latter driving most of the revenue growth progress, driven by firm pricing and high speed broadband adoption

Growing revenues and profits in an industry tends to encourage both investment and competition, and this is certainly the case in the fixed telecoms market, as BT announced plans for higher speed services using G.fast and Virgin Media announced a 4 million premises network expansion. The timings suggest that Virgin Media will keep its edge; given historic trends and its network capabilities we expect it to be offering superior speeds to G.fast by the time G.fast hits the mass market

In competitive terms the biggest short term threat is EE, which is growing its broadband base at 15%, and may accelerate further in 2015. Its success appear to stem not so much from the raw appeal of ‘quad play’ bundling as improved performance in the mechanics of cross-selling from physical shops. EE itself may be less of a threat if its planned merger with BT is completed, but Vodafone is launching broadband services in the spring, and H3G/O2 may yet be encouraged into the market

Consumer expenditure on recorded music continued its decline in 2014 by about 6% to $18 billion, as purchasing of download-to-own (DTO) albums and singles passed its peak in 2013, adding to the ongoing decline in total sales of CDs that started a decade ago Streaming is now the only growth story left for the industry, and it has a global footprint, being embraced by developed and emerging markets alike, unlike purchasing The US phenomenon of rapidly rising revenues from ad-supported audio streaming services such as Pandora and music video streaming on YouTube is quite unique as other markets currently lack the potential for online advertising

Sky plc, the coming together of BSkyB, Sky Deutschland and Sky Italia, has enjoyed an excellent start, as adjusted H1 2015 figures delivered a 5% increase in revenues versus a 3% increase in costs, resulting in EBITDA growth of 7% and with free cash flow up by 25%

The strong financial results were accompanied by strong subscriber growth figures, especially in the operations covering Austria, Germany, Ireland and the UK, while all markets showed large reductions in churn, reinforcing confidence in the strategic approach of Sky plc

It is too early to assess Sky’s delivery of its target group synergies. Individually, the former BSkyB and Sky Deutschland markets may be showing much stronger subscriber and product growth, but they also look to be more exposed to risk over football rights, while Sky Italia has more going for it than may appear at first sight

Speculation has arisen about a possible acquisition by Sky of Mediaset Premium, the DTT competitor to Sky Italia. The unprofitable platform faces a 50% cost increase this summer due to the start of new football broadcast contracts

Getting rid of competition would allow Sky to raise prices, but also burden it with the new contracts. At best, if it kept the Premium subscribers on DTT to limit churn, Sky would have a small revenue upside

But the regulatory risk looks substantial, including mandated third-party access to the platform and wholesale of content. On balance, we believe that it would be better for Sky to let the situation play out

Customer movement between operators shows susceptibility to dynamism in branding; O2 are picking up the majority of EE churners as customers move to the new “cool brand” while EE pull in Vodafone churners tempted by the new “best network”. O2 have the lowest churn though the lion’s share move to Vodafone and H3G churners are more evenly picked up by the other three

Customer perceptions of own operator network quality are high among the big 3 with no less than 75% of customers reporting theirs is the best network. O2 is the best regarded while H3G is the least best regarded highlighting a stark contrast between the (prospective) merging parties

Consumers report little interest in quad play and indeed operators in the both fixed and mobile markets have publicly confirmed the same from other market research. However the arrival of converged players in the form of a merged BT/EE or Vodafone re-entering the fixed space will see operators seeking to change this

The posited deal merging H3G and O2 would create a new largest UK mobile operator with 40% market share, with massive synergy benefits available from cutting overlapping network and operations costs

Regulatory hurdles would be very significant, and the remedies required may well counteract the benefits of reduced network operator competition, as they will be designed to do

For Vodafone and EE, the impact will be mixed; a potentially aggressive competitor is removed, but their preferred positioning as being the best mobile networks is under threat

The European mobile market had a rare quarter of solid improvement in Q3, with reported service revenue growth improving by over 2ppts to -4.7%, helped by a 1ppt improvement in regulated MTR cuts (which have now dropped to near zero) and a 1ppt improvement in underlying growth

The improvement appears largely driven by improved pricing trends, with the improvement in Italy particularly strong. However we feel that pricing is still in general in a fragile equilibrium, with the potential longer term structural improvements - consolidation and network focus - yet to be made

Consolidation has certainly progressed, but more in-market mobile deals need to be made, and while current levels of investment are encouraging, with accelerating data volume growth also encouraging, they will take some time to have an effect at the consumer level

A merger between BT and EE would create a converged operator directly serving around half of the UK adult population with fixed broadband, mobile or both services

We remain sceptical of the direct benefits of quad play and cross-selling, but we can see the benefits of merging the largest fixed and mobile operators under a single brand, and the long term strategic sense of owning both networks in case converged service offerings do become more important

The implications for other market participants are mixed, with benefits in the short term from the distraction of a large merger, and perhaps some regulatory concessions, but a longer term threat from the enlarged brand, and BT having a much enlarged customer base over which to spread content costs

Sky Italia’s latest strategy presentation to investors focuses on a number of positive revenue-generating and cost-cutting initiatives it is taking in the Italian pay-TV market

Sky Italia is taking a disciplined approach to subscriber recruitment and upsell of optional products as it anchors its brand at the upper end of the Italian entertainment market, supported by proactive development of original content, advertising sales and IPTV distribution

Growing product penetration has helped to reduce churn and support ARPU growth, but Sky Italia’s ability to arrest subscriber erosion and return to growth in fiscal 2015 and beyond also depends on the degree to which the economic climate becomes milder, as expected by forecasters

UK mobile service revenue growth stayed positive in Q3 2014, albeit at a slightly lower level than last quarter, an achievement given performance in recent years, but a slight disappointment given the previous improving trend. Pricing trends were a little worrying, but data volumes continue to accelerate markedly

With Phones 4U ceasing to trade towards the end of the quarter, Q4’s subscriber shares will be largely determined by where its prior customers end up. With these representing 13% of market gross adds which implies 65% of net adds, the impact is significant

Merger talks underway with the parents of O2/EE and BT, with H3G reportedly getting involved, will have an impact whether they lead to a deal or not; if either EE or O2 (or both) remain independent within the UK, they will likely need reinvigorating and re-motivating as to their raison d’etre or risk drifting without a clear direction