UK broadband and calls supplier TalkTalk Telecom (TALK) continues to pull off a neat little trick. By concentrating on the cheap end of the broadband and calls market, and adding an easy-to-access YouView TV service, it has been able to maintain its push for new subscribers.
Average revenue per user (ARPU) rose 2.8% to £26.08 in its second quarter, with overall revenues in the latest half year 1.8% higher at £843 million. The group has also upped its revenue guidance for the full year, from 2% growth to 3%, not exactly racy but respectable for a mature business in a saturated market, and enough to drive the shares 9% higher to 272.3p.
Yet there are tell tale signs that this tactic might be running out of juice. Throwing an extra £86 million at marketing is largely a response to aggressive salesmanship by both BT (BT.A) and British Sky Broadcasting (BSY), particularly in the run-up to the current Premier League football season (read 'BT not mad to pay up for football').
Virgin Media is also cranking up the marketing machine. That pressure could ease but there's no escaping the fact that rising subscriber acquisition costs (SAC) are knocking TalkTalk's profits. SAC increased 78% to £174 million, slashing net profit from £68 million a year ago to £7 million.
TalkTalk argues this investment has paid-off. In the three months to September, 167,000 new TV subscribers joined and the company expects its YouView-based TV user base to rise to nearly 1 million from 557,000 by the end of the financial year. There were a net 5,000 additions in broadband, while mobile added 43,00 customers and fibre 47,000.
But here's the thing. While TalkTalk sees SAC peaking, I cannot see why it should. Yes, it's clearly gained some momentum thanks to the launch of its Essentials TV package for £7.50 a month (minus landline rental of £15.40 a month), and has brushed up a Simply Broadband internet offer for £2.50 a month (again, less the line rental). But where does it go from here? That's the problem with pitching to lower price brackets of calls and internet, there's little room for upselling, a vital ingredient for ARPU bolstering.
Rising subscriber churn is also back, from 1.4% to 1.7%, and YouView is not exclusive. Any consumer can get it from any numbers of suppliers, or consumers can even buy their own subscription-free YouView box for about £190, and those prices will only fall.
Speculation in the City is once TalkTalk nears its 25% earnings before interest, tax, depreciation and amortisation (EBITDA) margin target, cashflows could be funnelled into a one-off special dividend. But there's little hint in these figures that investors will see any sort of windfall. If anything, TalkTalk seems to be talking its target out to the right, it's not likely until 2017 the group reckons, and is careful to spell out that it might not make it even then.
The immediate EBITDA margin aim, for the second half this year, is just 15%. Bottom fishing customers is great for volumes but it'll do little for profits, and if it does end up having to plough increasing amounts of cash into SAC, investors could be left fretting over an ordinary dividend covered just 1.3 times by estimated earnings for 2015, let alone enjoying one-off windfalls.