The Road Ahead for UK Digital Connectivity

A wave of M&A and consolidation is unfolding across the UK’s Telecoms sector. The sector is experiencing significant disruption. Expect M&A, new entrants, and technological advancements to shape its future.

The UK broadband market is booming. In the past seven years alone, more than 50 percent of the UK has been connected to full fibre fixed broadband.^[1]Recent estimates from Ofcom suggest that total full fibre connections jumped from 1.1 million in 2020 to 4.6 million in 2023.^[2]And money keeps pouring in. In 2022, UK operator investment into full fibre fixed access jumped to £3.9 billion, a nearly 100 percent increase over 2020.^[3]

In part, this speaks to the success of the incumbents in rolling out their fibre to the premises (FTTP) networks across major urban areas. But it is also driven by more than 100 so-called ‘AltNet’ providers who have sprung up to provide their own fibre infrastructure and services, primarily serving smaller centres^.[4] Estimates suggest the UK’s AltNets serve around 7 percent of the overall broadband retail market, but most have ambitious plans for expansion.^[5]

While the prospects may have initially seemed rosy for AltNets, the reality has become somewhat more challenging. Higher interest rates are putting pressure on capital expenditure plans. Inflation is squeezing already tight margins. Competition is heating up as AltNets push down prices to capture market share. Average revenue per user and penetration rates are sagging.

At the same time, BT’s Openreach – by far the largest FTTP operator – continues to accelerate their infrastructure buildout. Some analysts believe that AltNets will struggle to secure more than 20 percent market share – likely not enough to remain viable.

So consolidation seems inevitable. It would be easy to see Virgin Media O2 playing a key orchestrating role in shaping the AltNet sector. Their ‘anchor tenant’ model with nexfibre provides them with some significant advantages that could allow them to play a leading role in the consolidation of AltNets. The acquisition of Upp (an AltNet with some 175,000 connections in the East of England) by nexfibre may be a sign of things to come.

We believe that some Altnets-Altnets M&A is also likely. Of the 100-odd AltNets currently operating, the majority are minnows with lots of assets, but fewer than 150,000 connections. Whilst Altnets-Altnets M&A may help the merging Altnets in terms of broad reach, it will not solve the issue of driving higher penetration. That being said, we have already seen some AltNets merge over the past year and more should be expected as players vie for dominance in more contested markets.

At KPMG, we expect to see an uptick in M&A activity across the AltNet market over the coming years – ultimately leading to just a handful of specialty and regional AltNets existing alongside Openreach and nexfibre to deliver secure and reliable full fibre fixed broadband to UK homes. We expect the AltNets to take market share from Openreach and the recent announcement of Sky signing a wholesale deal with CityFibre maybe a sign of things to come.

In addition to AltNet-related developments, a number of other trends are likely to impact the shape of the broadband and mobile sector in the UK:

• The separation of the vertically-integrated telco. Many traditional vertically-integrated telcos are finding they can achieve greater valuations by decoupling into InfraCos, ServCos and NetCos. That is creating opportunities for partnerships and transactions, particularly at the network level.
• The role of private wireless networks. We are going to need more private wireless networks if we are going to see the well touted benefits of 5G. Whether the eventual winner here will be mobile network operators (MNOs) or smaller players is yet unknown. But expect to see significant growth in this segment.
  
• The role of neutral host operators. These are infrastructure providers who traditionally rolled out physical infrastructure but are now offering wholesale radio capacity to other mobile operators. This could change the capital investment dynamics in some markets.
  
• Demand and the importance of indoor coverage. We spend about 90 percent of our time indoors, where we consume about 80 percent of our data. Expect the topic of indoor access and demand to become more central to policy and, potentially, investment plans.
  
• Big Tech in the supply chain. We see the potential for Big Tech and hyperscalers to provide core and telco cloud services into the supply chain. That would not only have an impact on supply chain diversification, but may also help spur innovation in key segments.
  
• The role of satellites. There has been huge investment in this space and observers expect global capacity to jump from a current 2 terabits per second to around 34 Tbps in the not-too-distant future^[6]. That could change the dynamics, particularly for rural service, significantly.
  
• The promised 5G use cases. We expect to see significant uptick in activity in the VR/MR/XR space due to substantial investments by companies such as Meta and Apple. This could have an important impact in the telco sector. These developments may well result in the “killer apps” that network operators hoped would move the dial for them when they invested in 5G networks, although there is still significant uncertainty due to the relatively low take up of headsets and availability of content.
  
• Quantum computing. This is going to be incredibly important from a network security perspective and – while still on the cusp of wider commercialisation – we are already seeing increased investment flow into the sector.
  
• Network APIs and Mobile Edge Computing. This was the talk of the most recent Mobile World Congress with some observers suggesting network APIs may have an impact in the hundreds of billions of dollars for telcos globally.
  
• Spectrum: We expect to see massive innovation in the spectrum space, not only in how we use the spectrum we have, but also in its function and importance.
  
• 6G: While we’re still not at full 5G in most parts of the country, engineers are already thinking about 6G and the innovation and use cases it might bring. The industry is probably not as excited about this as it was in case of 5G, given 4G is likely to stay in the mix for years to come and operators are yet to see the returns on their 5G investments. In any case, research on 6G has started, and it will be important to see what happens in that space as well.
  
• Vodafone and Three UK: A successful completion of the proposed merger between Vodafone and Three UK, currently being investigated by Competition and Markets Authority (CMA), is likely to have a significant impact on the shape and dynamics of the UK telco sector. Proponents of the merger suggest an increase in network quality, significant network investments in 5G and lowering of quality adjusted prices if the merger is approved. However, CMA has expressed concerns in its Phase 1 decision around lessening of competition at both the retail and wholesale level, in addition to merged entities gaining access to commercially sensitive information through its participation in both MNO network sharing arrangements. Somewhat surprisingly, the concentration of spectrum holdings was not mentioned in the CMA phase 1 decision but it is likely to play a significant role in the Phase 2 analysis. Therefore, it appears that the merger, which is most likely being very closely watched by other competition authorities, appears to face significant regulatory hurdles.

I believe the next few years will bring a heightened level of M&A activity to the UK telecoms sector. And while I expect that to lead to some consolidation in key segments (particularly those rapidly becoming commoditised), I also anticipate that new competitors with different value propositions will emerge into the market, driving future growth and opportunity.

At KPMG, our TMT professionals have deep experience helping telecoms companies develop, plan and execute their organic and inorganic growth ambitions. Contact us today to see how we can help your organisation thrive.