KDDI makes move for J-Com, but the hard work is only just beginning

Posted by Tony Brown Sunday, February 7th, 2010

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Japanese operator KDDI’s purchase of a 37.8% stake in Jupiter Telecommunications (J-Com) from US media giant Liberty Global came as no surprise to most watchers of Japan’s market, though the US$4 billion price tag – equating to a 65% premium on J-Com’s share price – certainly caused a few raised eyebrows.
Local investors’ view of the deal quickly because apparent: KDDI’s share value slumped nearly 9% the day after the deal was announced. Many local securities analysts said the deal was too expensive, since J-Com’s growth in subscription count was already flattening out.
Nonetheless, KDDI’s management hopes that the deal will reinvigorate the firm’s fixed-line business, which has been in the red for the last five fiscal years, a factor that KDDI hopes will be reversed in the next two years.
Given that KDDI has found itself effectively locked out of most of the next-generation broadband market by the exorbitant wholesale rates charged by NTT East and NTT West for access to their FTTH lines, the firm’s move to increase last-mile connectivity via the J-Com purchase is logical.
KDDI’s management has already said that there is little point in offering third-party FTTH services on NTT’s networks, since it must pay a staggering 70% of subscription fees to NTT in network-rental charges.
By buying J-Com and its 48 cable networks across 14 prefectures, KDDI has won high-speed access to 12.6 million homes on J-Com’s networks, including more than 180,000 subscribers to the high-speed 160Mbps service, along with 2.6 million cable TV subscribers and 1.58 million cable-modem subscribers.
KDDI already has 1.4 million FTTH subscriptions among the 5.8 million homes its fixed lines cover, largely thanks to its expensive acquisition of independent FTTH operators such as Tokyo Electric Power, but is still a long way behind NTT East and West in terms of FTTH-network deployment.
As of end-September, NTT East and West had already accrued a combined 12.3 million FTTH subscriptions – equating to a market share of over 70% – and rolled out more than 30 million FTTH lines across the country.
As a result, it is fair to say that although the KDDI/J-Com deal does improve KDDI’s position in the fixed-line-broadband market, it leaves it a long way behind NTT.
The deal does at least establish KDDI as the second-largest player in the fixed-line-broadband market, after NTT East and West, and acts as a clarion call to the rest of the market that it has no intention of walking away from its own ambitions in the fixed-line-broadband market.
The decision by third-ranked broadband player Softbank to abandon its plans to roll out its own FTTH networks in favor of simply reselling FTTH services from NTT East and West prompted some speculation that KDDI would also fold its cards and opt to do the same.
The decision to buy into J-Com puts those fears to one side and shows that KDDI sees itself as a long-term player in the next-generation-broadband market. More M&A deals for independent FTTH operators must also be on the firm’s radar, given that it has shown little appetite for rolling out its own FTTH connections.
The next step
For the time being, though, KDDI will have to busy itself with making the acquisition work on a practical level, since J-Com’s networks are DOCSIS 3.0 digital-cable networks rather than FTTH networks, in which KDDI has invested so much capital over the last decade or so.
KDDI will have to work out whether to leave J-Com as a separate source of fixed-line profit or take aggressive steps to integrate its disparate cable networks into KDDI’s wider fixed-line-network infrastructure.
This is where things get tricky for KDDI, because J-Com is already a successful business – the firm made a net profit of ¥61 billion (US$670 million) in 2009 – but leaving J-Com as a stand-alone business in the KDDI empire does not make sense from an operational point of view.
KDDI can benefit from acquiring J-Com only by maximizing the economies of scale that the firm’s 12.6 million network homes bring to the table, so it must work out how to integrate J-Com’s networks with its own.
If KDDI does decide to bring J-Com’s assets into its fixed-line fold, it will then have to decide how to profit from combining its expanded fixed-line-broadband services with its stronger mobile operations, a proposition that is far from straightforward, since even NTT is struggling to figure out how to deploy attractive fixed/mobile-convergence services.
Moreover, KDDI’s ability to shape the future operations of J-Com and make it part of the KDDI family is far from certain, since J-Com’s second-largest shareholder, local conglomerate Sumitomo – which holds a 27.7% stake in the firm – is rumored to be unhappy with KDDI’s purchase.
Sumitomo’s management has previously made it clear that it sees J-Com as a major part of its communications investments, suggesting that it might resist efforts from KDDI to integrate J-Com into its structure.
As a result, KDDI’s management might ultimately be forced to submit a tender offer to acquire full control of J-Com – an expensive move that would probably further displease investors.
The upside
Perhaps the biggest advantage of the J-Com deal – and one that has gone largely unnoticed by the local press – is that it gives KDDI a stake in one of the country’s producers of independent content.
J-Com already produces a wide range of content for its cable networks – some of which is also sold to other cable operators – which KDDI can easily use on its own fledgling IPTV services, which have failed to create much interest among local subscribers in a highly competitive multichannel-TV environment.
The ability to use J-Com’s content on its IPTV services is clearly a benefit for KDDI from a deal that has created almost as many problems as it has solved.
Although the US$4 billion price tag was clearly too high for the tastes of local investors, KDDI had no choice but to pursue this deal if it was to stake a serious claim on the fixed-line-broadband market and prevent itself from falling further and further behind NTT East and West.